GNC: Pullback Presents An Opportunity

Executive summary:

• The sell-off in GNC Holdings shares appears overdone.


• $500 million share buyback program designed to return value to shareholders could provide support for shares.


• International expansion offers new avenue for growth.


• Multi-faceted operating model, including company-owned stores, franchised outlets, manufacturing/wholesale products to third-parties and online sales diversifies revenue base.

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Shares of GNC Holdings (GNC) are 26% cheaper today than they were just two months ago. Meanwhile, both top line revenue (+8.6% consolidated, +5% same-store sales) and bottom line EPS (+26%, excluding certain non-recurring items) growth continue to be robust.

Today, GNC shares are offering an interesting entry point given management's 2014 guidance, which includes EPS growth in the low teens, and is expected to come in at about $3.20 per share, or about 14 times next year's earnings, which is well below its historical range. That said, the shares appear to be suffering from reduced investor temerity regarding GNC's revenue growth potential.

GNC PE Ratio (Annual) data by YCharts

While management did indicate a tough retail environment in January/February (mostly as a result of weather patterns), I think investors are overly discounting GNC's growth potential in international markets and its multi-pronged operating model - company-owned stores, franchise agreements and manufacturing/wholesale - which is set up to deliver earnings growth at a faster pace than revenue growth as a result of operating leverage in the business model.

GNC EPS Diluted (Annual) data by YCharts

In terms of international expansion, GNC announced its entry into the Russian market through a master franchise agreement with Rusvit. I understand Rusvit's CEO Alex Kovaler has been instrumental in bringing to market other Western brands such as Wendy's (WEN), Nathan's and RC Cola. Given the size of the Russian market, this could provide a substantial lift to sales and earnings over the next several years. By partnering with a local incumbent who understands the Russian market (and through the franchise agreement), GNC benefits from muted capex requirements relative to the scale that can be achieved in Russia via a "capital light" arrangement.

Channel Conflicts

There are some issues with respect to GNC's sales channels. We know generally that more sales are transitioning online, where GNC generates a decidedly small portion, 9 or 10%, of its overall sales through its gnc.com and luckyvitamin.com eCommerce properties. GNC is actively attempting to fill this gap in its revenue base, both from organic means and through acquisitions. GNC acquired another eCommerce property in the UK, A1 Sports Limited, in October 2013.

While the sports nutrition and supplement market is expected to grow at 7% annually for the next several years, more of these sales are moving online, where GNC is posed by more competition, including Vitacost.com (VITC) and VitaminShoppe (VSI). According to industry studies, the online sales channel is expected to grow at a faster pace than brick-and-mortar. Therefore, a solid eCommerce sales channel is essential to capturing customers without a local shop nearby, or those discouraged from shopping as a result of some exogenous factor such as the weather.

Because much of the sales stagnation in the first 6 weeks of the year was attributed to the tough weather conditions and heightened promotional activity in various markets around the country, a robust online sales channel helps mitigate the risk of decremented sales on account of the weather (although it doesn't really help with promotions). In addition, the online sales channel is less capital-intensive once the infrastructure is in place to handle that sales volume. To that end, I understand GNC management is guiding to $70 million in capex in 2014 to build out a new distribution facility to help complement its online sales activity. Of course, a less capex-intensive eCommerce operating model compensates for price competition by generating returns on smaller levels of invested capital.

Given the dynamics of the market, I expect GNC to more aggressively build out its eCommerce platform to compete with Vitacost and VitaminShoppe.

Conclusion

The sell-off in GNC shares appears to be overdone.

While GNC does have issues that need to be resolved - namely, transitioning its sales to online channels - the shares do seem to offer value at these levels. The nutrition and health products industry is positioned to benefit from continued growth as consumers turn to health products to enhance well-being.

GNC has a strong brand name and recognition, and its global scale should allow it to benefit from the secular tailwinds to which it is levered. In my view, this is a good business offering a temporary markdown on shares and, therefore, a fair price and good buying opportunity. I expect potential investors will be buying alongside management, who still has another ~$440 million left in its buyback program (or about 10% of the float).

If the market re-rates the EPS multiple back to historical levels (say 17.5x), there could be 25% upside in these shares.

Source: GNC: Pullback Presents An Opportunity

Disclosure: I am long VITC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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