Herbalife Ltd. (HLF): “Pyramid” Scheme Is Outperforming

Herbalife Ltd. (NYSE:HLF)The company accused of being one large fraud continues to outperform and reward shareholders in the long run. Embattled Herbalife Ltd. (NYSE:HLF) has been fighting with Bill Ackman over whether or not it is a pyramid scheme. Considering that Herbalife as been operating in the U.S. since 1980, let’s assume that they are at least somewhat legal (at the very least) and that it is worth looking at the company’s fundamentals and latest earnings.

Beat and a raise

Herbalife Ltd. (NYSE:HLF) beat earnings expectations and hit the high end of the revenue growth. Herbalife posted 9.9% income growth and 17% sales growth, and raised its forecast for the year to $4.60-$4.80 from $4.45-$4.60.

When you adjust for legal expenses resulting from Bill Ackman and Venezuela’s currency devaluation, Herbalife would have made $1.27 per share. When a company continuously beats earnings and raises its forecast, you’d figure that investors would reward it. But, due to the regulatory investigation, Herbalife Ltd. (NYSE:HLF) has fallen 45% over the past year, while the S&P 500 has gone up 13.5%.

Herbalife competitors

USANA Health Sciences, Inc. (NYSE:USNA) is a multilevel marketing company, like Herbalife, and it also recently posted earnings. It, too, beat earnings estimates and raised its full year guidance from $5.10-$5.25 per share to $5.25-$5.40 per share.

One thing to watch out for with USANA Health Sciences, Inc. (NYSE:USNA) is that its revenue missed and its revenue expectations are just at the midpoint of what analysts were expecting. What propelled its earnings to grow by 42%, and not something lower, was a 10% decrease in the number of shares outstanding due to an aggressive stock buyback program and lower incentive payouts. While the company is still becoming more profitable, its sales aren’t keeping up with its fast growth (9.7%) and should be watched.

With these two companies beating, one could guess that Nu Skin Enterprises, Inc. (NYSE:NUS), another multilevel marketing company that sells nutritional products, has a good chance of beating expectations. Nu Skin Enterprises, Inc. (NYSE:NUS) saw its Q1 profit rise to $0.90 per share (beating estimates for $0.79) and its revenue rise to $550.1 million, $45 million above estimates. It also raised its full-year forecast and now sees revenue of $2.51 billion to $2.54 billion, $190 million above the previous estimate. On the income side, the company also raised its forecast, now seeing $4.18-$4.30 per share, versus $3.72-$3.92 a share it was expecting in February. It is always a good sign when both you and your competition are beating expectations and raising outlooks, and it means that there is a bigger pie for everyone.

All three of these companies trade at low PE ratios and should see PE expansion if they raise guidance and have regulatory concerns disappear. All three of these companies are expected to grow their EPS between 12%-18%, so at those PE ratios, clearly they are undervalued and are trading at a discount over uncertainty. When the investigation ends and it is ruled that Herbalife Ltd. (NYSE:HLF) isn’t a pyramid scheme, all these MLMs should see PE ratios around the 15-20 level, the same level similar companies get for 15% growth rates.

Even just a PE ratio of 15 would boost Herbalife’s stock price by 50%, and USANA’s by 30%. Nu Skin already trades at a PE of 15 (with a low forward PE of 12), but is growing at a faster rate and should see a PE ratio of 18, which would push its stock up by 20%.

Bill Ackman

Bill Ackman seems very sure that Herbalife Ltd. (NYSE:HLF), which has been around for over 30 years, is a pyramid scheme and has placed a $1 billion bet against Herbalife. Carl Icahn, on the other hand, is bullish on Herbalife, has gotten into numerous arguments with Ackman, and has a large bet on Herbalife being legit.

Bill Ackman is the single largest obstacle for Herbalife Ltd. (NYSE:HLF) and should be closely watched, as he pushes for the SEC and FTC to file a lawsuit against the company, or engage in some sort of disciplinary action.

Bill Ackman is also currently engaged with J.C. Penney Company, Inc. (NYSE:JCP), and was responsible for instituting Ron Johnson, a former Apple executive and the ex-CEO of J.C. Penney, who largely failed.

J.C. Penney stock is down over 50% in the past year. Johnson tried to end the department store sales and have J.C. Penney Company, Inc. (NYSE:JCP) offer continuously low prices. This caused consumers to flock away and led to double-digit drops in both same store sales and online sales, which is why he was replaced by the old CEO.

While George Soros has bought up a 7.91% stake in J.C. Penney Company, Inc. (NYSE:JCP), and Goldman Sachs has given the company a $1.75 billion loan to keep it going (it only has $930 million left and is hemorrhaging cash), it still knew to undo all, or at least most, of the overhauls that Ron Johnson put in.

This has two possible implications. One, Ackman might have to devote less time to bashing Herbalife, as he tries to turn around J.C. Penney for the second time. Ackman has lost several hundred million in J.C. Penney and will have to cover those losses somehow. The other possibility is that, since Ackman bought a stake in J.C. Penney, its stock has done very poorly, so why trust him on Herbalife?

If the regulators decide not to pursue any action, then Ackman will have to exit his short position in Herbalife, and this will cause an enormous short squeeze, propelling Herbalife upwards. The question is, how long can Ackman sit on his short position before he decides to pull the trigger, take his profit, and walk away? His investors aren’t going to be happy if Herbalife Ltd. (NYSE:HLF) slowly trends upward and its profits erode away as J.C. Penney continues to lose cash.

Final Thoughts

I think that all MLM companies, like these three that operate and sell similar things, are undervalued and are trading at a discount due to regulatory worries. With Bill Ackman having two major battles ahead of him, it will be hard for him to keep pushing these stocks down, while also turning around a failing retailer and keeping Pershing Square investors happy.

Herbalife continues to outperform on a fundamental level, even as all these pressures continue to weigh heavily on the stock, and is worth a look by any investor who likes dirty value stocks.

The article The “Pyramid” Scheme Continues To Outperform originally appeared on Fool.com and is written by Callum Turcan.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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