In my view, Nu Skin has been underperforming the market due to a confluence of negative factors. However, this might change in 2020.
I gather that the company's business fundamentals are likely near the bottom of their current cycle, and should pick up in 2020.
Moreover, new product launches and sales leaders should improve by next year, and I consider that both of these variables are linked to the company's revenues.
Furthermore, I used conservative inputs for my valuation model of the shares and it still suggests that there's upside at these levels. In my opinion, this reinforces the bull case for the stock.
Hence, I conclude that investors who are willing to take on NUS' regulatory risks could be very well compensated over the long term.
Nu Skin (NUS) has severely underperformed the broader market. This is mostly due to the recent China crackdown on healthcare product claims and direct selling, which has limited NUS' ability to do business. In my view, this perfectly illustrates NUS' fat tail risks stemming from regulation. Nevertheless, if investors are willing to take on such risks, I believe they might find NUS compelling. NUS' business tends to have some cyclicality to it, and currently, management seems to think we're close to its nadir. Thus, if all goes according to management's plan, 2020 could be a turnaround year for the company, which should justify a higher share price. Moreover, my valuation model on the shares suggests that the stock does have some upside at these levels. Hence, NUS could be an exciting play for investors looking for exposure to the direct selling business model.
Source: Nu Skin's website.
It's undeniable that the current China crackdown has fundamentally shifted NUS' story from growth to a managed short-term contraction. This has caused NUS to disappoint its guidance. Moreover, the PRC now adds a new additional layer of risk on NUS' most prominent market, while also raising questions about NUS' business model and products. So, it's been a double whammy for shareholders, as they've seen revenues take a hit and the shares' premium disappear.
Source: Yahoo Finance.
Nevertheless, I consider it essential to note the difference between multi-level marketing and direct selling. After all, the recent China crackdown is mostly due to unfounded health claims made by a sales leader, rather than the company's business model itself. This is an important distinction because it means that NUS should still be able to maneuver in China, as long as it focuses on remaining compliant with China's new strict regulations.
Still, I would point out that NUS' fat tail risk is now significantly higher after 2019's events. Up until this year, the MLM and direct selling industry seemed untouchable across all jurisdictions. However, now investors have realized that, indeed, regulation can come out of nowhere and derail an otherwise compelling growth story. Naturally, NUS' is technically a direct seller in China, not an MLM. But still, the point remains. Regulatory risks were mostly being overlooked before, but now investors are starting to price them in.
Was it just bad luck or a new normal?
Furthermore, it's reasonable to attribute most of NUS' recent underperformance to a slowdown in sales leader growth in China. The company thinks that this occurred mainly due to China's limitations on meetings, which restricted the company's ability to do business. In fact, NUS believes that China accounts for over 75% of the total YoY revenue contraction. So, without a doubt, NUS' main issue has been China.
Source: NUS' Q3 earnings call.
The rest of NUS' underperformance can be attributed to other smaller markets also disappointing. You see, even worldwide, several of NUS' markets came in softer than expected. There were multiple factors to blame, depending on each region. Smaller markets like Latin America and Hong Kong came in weak due to regional trends.
Source: NUS' Q3 earnings presentation.
For instance, Latin America was adversely affected due to inflation (i.e., Argentina). On the other hand, Hong Kong's recent political instability has also been bad for business. Only Japan and manufacturing were positive. Thus, overall, across the world, NUS' has been hit by exogenous factors that contracted revenues. However, I believe this all of this is mostly a confluence of negatives and not a new normal.
A cyclical business
You see, NUS reminded investors that its business tends to be inherently cyclical. In other words, customer and sales leader growth tend to follow each other. Prospective customers typically convert into potential new sales leaders over time. Moreover, at the end of the quarter, NUS saw a considerable disparity between customers and sales leaders, which coincided with its lackluster revenues.
Source: NUS' Q3 earnings presentation.
This is important because management noted that October and November saw an uptick in sales leaders. This means we already see some signs of stabilization, which is very promising for future quarters. These new sales leaders will likely bring additional customers in their typical virtuous cycle. This is why new sales leaders tend to correlate with NUS' revenues.
I think regarding leading and lagging indicators, we do see typically that that our pipeline generally flows from customers to prospective sales leaders of sales leaders and so we're encouraged by the increase in customers (...).
- Ryan Napierski, NUS' President.
Furthermore, NUS' management feels optimistic about the company's future in 2020. So, it could very well be that 2019 was a one-off bad year. If this is the case, new investors might benefit from buying at these levels as growth could pick up once again into 2020. After all, the market currently seems to be pricing in a prolonged business decline, rather than short-term underperformance.
New product launches are another positive catalyst
Additionally, NUS believes that one of its main sales drivers is new product launches. As management explained in their last earnings call (see link above), 2019 didn't have any meaningful product launches. Instead, 2019 mainly focused on extending the life cycle of previous products. However, going into 2020, the company plans to have multiple product launches. Thus, this also coincides with the start of a new growth cycle to kick off the new decade.
Source: Yumpu. Nu Skin's new "ageLOC" is one of the company's main products.
In particular, the new product launches that management is focusing on are going to come into effect in the second half of 2020. In my view, these new products shouldn't cannibalize the existing product lines. In fact, management believes they should be additive from a value proposition perspective as they'll be complementary to its current product portfolio. Moreover, they're now catering to Gen Z and millennials, which I deem vital for the company's long-term growth.
Outlook and valuation
I think the company's valuation is compelling at these levels. Many positives can quickly continue to grow the company's top line and improve its margins. For example, NUS has been heavily investing in the required digital infrastructure to facilitate sales leaders with their jobs. This should leverage the flexibility and power of the cloud into its direct selling business. In my opinion, this is a perfect fit, which should help boost sales and margins going forward. Also, Brazil and India should eventually become huge markets for the company. Thus, these will provide additional growth verticals that could justify a meaningfully higher share price for the stock as well.
Nevertheless, for my valuation model, I'm going to assume the worst-case scenario for NUS. Thus, I'll simply value the company's declining FCF according to the CAPM, and expect no turnaround in 2020.
As you can see, despite my conservative inputs, the model still suggests that NUS has some upside in it. To me, this is very supportive of a meaningfully higher share price if the company's performance starts picking up in its new growth cycle.
Lastly, I'd also add that the current downside risk should be limited at these levels. During the company's last earnings call, management explained the lack of share purchases for the recent quarter through high CAPEX, debt repayment, and financing its dividend. Thus, adding it all up, this particular quarter left little cash available for share buybacks. However, going forward, NUS should be in an excellent position to resume repurchases. This is important because NUS has a massive share repurchase program authorized and can still buy back up to $470.2 million, which represents over 20% of its current market cap! In my opinion, this explanation makes sense, and if valid, it should lend support to NUS' share price at these levels.
Several factors are lining up nicely and support a 2020 recovery for NUS. From an investment perspective, this suggests that today should be an excellent time to buy before such improvement begins to show in the company's top and bottom lines. Hence, I think that purchasing NUS here should make sense over the long-term.
Naturally, new investors need to keep in mind that they're mainly taking on regulatory risks at this point. Yet, assuming the regulatory status quo remains, NUS' business fundamentals are likely to pick up from here. Ultimately, the investment thesis hinges on NUS recovering from a particularly rough 2019 and posting YoY growth in 2020. The market appears to be pricing in further declines, so there should be ample room for upside surprises. Moreover, NUS' CEO, Ritch Wood, seems to believe that we're probably near the bottom of the current cycle. Hence, 2020's revenues should be higher compared to 2019. In my view, this would signal that today is an excellent buying opportunity to ride the next leg up in the cycle.
Thank you for reading, and good luck.