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Medifast: Doubts About Long-Term Potential

Seeking Alpha
Medifast: Doubts About Long-Term Potential

Medifast: Doubts About Long-Term Potential


Medifast, Inc. (MED)
The Prospector
 

Summary

Medifast got slammed on subdued growth guidance in its Q3-19 report.

The company has been growing revenue at a torrid rate in recent quarters.

The revised guidance will result in FY 2019 revenue growth of 40% vs. previous company expectations of at least 46% revenue growth.

The company looks like a value play on paper and is nearly 50% off its 52-week highs.

But the company is a multi-level marketing company like Herbalife. Given the business model and its me-too health products, it's hard for me to have long-term faith in Medifast.

Thesis

Medifast (MED) stock price got crushed after reduced full-year revenue guidance following its Q3-19 earnings report. As of this writing, the stock is nearly 50% off its 52-week highs.

While the company has posted a stellar year from a revenue growth perspective, the company scaled down its own full-year revenue guidance issued in Q2, advising the Street that revenue would likely come in at a minimum of $700 million for the year vs. the previous company estimate of $730 million.

Despite the curtailed growth estimate, the company has had a strong year, which comes on the heels of a strong 2018. That said, it remains to be seen how long this growth run can last. Medifast is a multi-level marketing (MLM) company whose growth depends on the recruitment of Health Coaches who sell the company's products to individual consumers who wish to improve their diet and lose weight. Medifast products are not available in retail. It remains to be seen what the long-term viability of the Medifast is. More than 90% of company revenue is derived from its Optavia brand of products, which were branded in 2017. Prior to this, revenue had gone sideways for five years.

On paper, Medifast looks like a value play. The nature of the MLM industry and my uncertainty about the viability of Medifast's Optavia business long term keeps me on the sidelines.

Source

Q3: More Health Coaches = More Growth

Medifast sells a variety of meal replacement and dietary products under multiple brand labels. The most popular brand is the OPTAVIA label. Medifast products are not available in stores. Instead, the company recruits "Health Coaches" who sell diet products to consumers in person and online.

As of Q3, the company employed 32,200 coaches, which was a 42% increase yoy. The company initially hoped to have 30,000 total coaches by year-end 2019 but hit that goal in Q2. Ultimately, the company hopes to have 50,000 coaches by 2021. Revenue per coach has been relatively stable. The company believes the ultimate path to growth is not in increasing revenue per coach but in increasing the total number of coaches.

Source

That said, becoming a coach for Medifast doesn't sound like the most lucrative gig in the world. If we just break down the Q3 numbers, the average sales total per coach was $5,904 for the quarter vs. $5,781 a year ago. Multiply that by four and you've got the average health coach selling less than $25,000 in product per year. Coaches earn a commission on product sold.

Revenue grew 36.5% in the quarter and gross margins remained strong at 75.2%, which pretty much tracks where the company was in the first two quarters of the year. However, net margins were down both yoy and sequentially.

Additionally, the company revised its own full-year guidance downward. Last quarter, the company expected FY revenue growth to be at least $730 million. That estimate is now at least $700 million. The share price has gotten crushed as a result. That said, the company is working off a revenue base of $501 million in 2018, so the company is still tracking for 40% full-year revenue growth yoy.

Source

Valuation and Risks

The Q3 selloff builds upon a selloff that began earlier in the year. The stock is nearly 50% off its 52-week highs and by nearly every valuation metric, the company looks like a clear value play. The revenue growth rate and EPS growth rates have been stellar. The company has a strong balance sheet and it appears the company's revenue growth trajectory will continue absent an issue with product or an economic downturn.

That said, Medifast is an MLM company. And as others have noted on Seeking Alpha, the MLM industry has a less than stellar reputation. MLMs, in general, could face regulatory risk and the business model could be impacted as a result. Additionally, it's unclear to me how long Medifast's current Optavia sugar high can last. This is a newer brand to the company, the original brand being the Medifast brand, and it appears part of the appeal to diet and weight loss fad products is their newness. If we go back several years, Medifast wasn't always a high-flying revenue grower. In fact, revenue growth went sideways between 2011 and 2016, which suggests to me that the company had to reinvent its marketing wheel to find growth again. The Optavia brand itself wasn't invented until 2017, and Optavia now is the clear revenue generator of the company, having comprised 92% of company revenue in 2018.

Conclusion

On the surface, Medifast looks like a compelling investment given its revenue growth and discounted valuation. But it's unclear how long the company's recent Optavia success can last. I have doubts about the long-term growth potential of Optavia and Medifast, in general.

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