CFA Institute Research Challenge
CFA Institute Research Challenge Hosted in
Utah Utah Valley University
Stock Rating
SELL
Highlights_____________________________________________________________ We initiate coverage on Nu Skin Enterprises (NUS) with a SELL recommendation
Industry View
NEUTRAL based on a one year price target of $29.00, yielding 9.5% (including dividend yield)
Price Target
USD 30.50 is primarily driven by the following factors:
Price (01-Feb-2016) Potential Upside/Downside Ticker
USD 33.60 -5% NUS
Market Cap (USD mn) Shares Outstanding (mn) Free Float (%) 52 Wk Avg Daily Volume (m Dividend Yield (%) Return on Equity TTM (%) Current BVPS (USD)
1830 57.23 55.1 96.27 4.47 15.97 14.97
downside from its closing price on February 4, 2016 of $33.60. Our recommendation
Price Performance 52 Week range
Decreased distribution – Nu Skin’s revenues follow their distributor trends. As Actives and Sales Leaders have dropped following litigation issues in Greater China and Taiwan, Nu Skin's revenues have followed suit. Nu Skin plans to re-enter their primary market in Mainland China by once again holding sales meetings and offering new products in 2016; however, growing their salesforce in a sustainable manner is unlikely as tight regulation and lingering litigation remain. Nu Skin is unlikely to see significant revenue growth in the wake of stalled distributor expansion.
•
Model saturation in mature markets leaves little upside in terms of distributor growth - The beauty industry in the Americas, Europe, EMEA and North Asia continues to grow in terms of revenue growth; however, these markets have stalled in terms of distributor growth since 2012. This signals model saturation in these mature markets, and we believe Nu Skin’s directselling model has plateaued in these areas. This places a high amount of pressure on Greater China and South Asia/Pacific to drive distributor and revenue growth.
•
High operating leverage - Nu Skin spends a high amount of money on SG&A expenses (the highest amongst competitors), which eats away at their net income (and EPS) during periods of growth and draws value away from shareholders. This high operating leverage also intensifies the impact of missing revenue guidance by magnifying errors in cash flow projections. These drawbacks/risks justify Nu Skin trading at a discount compared to their competitors.
•
Macroeconomic uncertainty in key markets – China, Nu Skin’s largest market, is experiencing an economic slowdown, leaving Chinese consumers with less discretionary income to spend on personal health and beauty products. Japan’s population is forecasted to decline through the next four years, hurting growth prospects in North Asia. In South Korea, domestic brands have begun dominating the market as they have the ability to distribute their products through fast and powerful retail channels.
Exchange-NYSE USD 29.52-62.87
Valuation
Proforma Multiples
Rev/Active
Estimated Price
$28.93
$28.93
Weights
50%
50%
Price Target
•
$29.00
Business Description: Nu Skin (NUS) Enterprises was founded in 1984 and is currently headquartered in Provo, Utah. Nu Skin operated as a private company for 12 years before its IPO on November 27, 1996. Together, with its principal subsidiaries, Nu Skin develops and distributes anti-aging personal care products and nutritional supplements under the Nu Skin and Pharmanex brands. Nu Skin is a global direct-selling company that markets personal care and nutritional products in 53 markets worldwide. The company operates in the direct selling channel, primarily utilizing person-to person marketing to promote and sell its products. Strategy The company’s main strategy is to expand and capture market share in the beauty and personal care products markets. Nu Skin’s operations are designed to generate growth and increase value through: •
High-end products that warrant higher pricing - Nu Skin has established research and development operations in the United States and China. The company develops and patents all products sold internally. Collectively, there are 75 product development employees that work on developing high-quality products comparable to Estee Lauder and Clinique. High-end products lead to high margins and increased profitability.
•
Successful product launches that lead to growth in sales force - Nu Skin’s announced product launch strategy for 2016 revolves around the new ageLOC Me product. Nu Skin seeks to create a business opportunity that empowers individuals to establish, grow and expand their business. Through the direct selling method, Nu Skin looks to achieve revenue growth through an expanded sales force. The product launches work in a feedback cycle with sales force expansion, where they both serve to generate growth for the other. For products to be successful, Nu Skin must grow its net number of sales force by 10-12% per year.
•
Strategic cash management policy to attract investors - Nu Skin utilizes cash for 3 main purposes: (1) To invest back into the business. This involves developing new products as well as providing incentives for sales leaders. (2) To pay an attractive dividend. Nu Skin has been able to increase its dividend consistently since 2008 with a current yield of 4.42%. (3) To repurchase shares. Nu Skin does not attempt to look for buyouts or external projects, but rather focuses on an aggressive share buyback program to increase earnings potential for shareholders.
Industry Overview & Competitive Positioning: Demand Drivers Nu Skin’s demand drivers are as follows: 1) available discretionary income, 2) cultural/social practice and 3) financial opportunity. Available Discretionary Income As many global economies have experienced consistent economic growth from 2008 thru 2015, incomes have been steadily increasing. As consumers have received larger discretionary income, they are more willing to spend a proportionately higher amount for high-end products. Cultural/Social Practice The beauty and personal care products sector has seen an increasing amount of markets become more aware and concerned with personal grooming. Many new markets show increasing demand for these products, but they vary on how much they are willing to spend. Financial Opportunity For the MLM business model, there is an effort to portray a business opportunity for consumers to become sales leaders and business owners. If Nu Skin can produce products that are desirable to the consumer, then this will likely translate into a new sales leader which will lead to revenue growth. This concept is a key driver of how the MLM business structure can simultaneously lead to demand and revenue growth. Industry Supply In the beauty and personal care products sector, there are a variety of suppliers. Amongst suppliers, there are many business models that range from direct sales to mass retail. As the sector has seen overall growth since the recovery from the global recession of 2008, many new competitors have entered the market and existing competitors have developed broad product mixes. This has resulted in more intense competition amongst suppliers to gain market share. Large multinational companies (ex. Estee Lauder) with mass retailing strategies have gained a competitive advantage by increasing market share and brand awareness as seen in Figure 1. Figure 1: Competitive Positioning Competitive Positioning
NUS
AVP
HLF
USANA
Market Capitalization
$1.83B
$1.32B
$4.29B
$1.58B
Sales Leaders
62,009
6,000,000
366,489
349,000
Gross Margin
81.40%%
60.50%
80.20%
82.20%
Revenue per Sales Leaders
$41,438
$892
$10,848
$2,263
$2,569.5M
$5,352.1M
$3,975.7M
$790M
Revenue As of December 31, 2014
Investment Summary: We issue a SELL recommendation on Nu Skin (NUS) with a target price of $29.00 using a Relative Multiples Valuation, a Dividend Discount Model, and a Discounted Cash Flow Analysis. This valuation is supported by the following merits: 1) revenue headwinds in terms of decreased distribution channels, 2) minimal growth in Sales Leaders in 2016, 3) high operating leverage, and 4) macroeconomic uncertainty in key markets. •
Nu Skin faces revenue headwinds in terms of decreased distribution channels resulting from litigation and regulation in their expanding markets. Nu Skin’s revenues follow their distributor (number of Actives and Sales Leaders) trends. Due to the business model of Nu Skin, the declining number of distributors means there are fewer channels to generate sales. In 2013, the number of Actives and Sales Leaders increased by 126.9% and 232.2% from the previous year, increasing total revenue by 48.9%. From 2013-2014, however, the number of Actives and Sales Leaders decreased by 9.5% and 39.3%, driving revenue down by 19.1%. This demonstrates the effect that Actives and Sales Leaders have on revenue growth. Following China’s investigation of Nu Skin in January of 2014, Nu Skin was prompted to pull out of the Chinese market. Nu Skin was unable to hold sales meetings, forcing a large amount of the sales leaders in Greater China out of the business. Moving forward, Nu Skin plans to re-enter Greater China, but following the government investigation, China has implemented tight governmental regulation surrounding how sales meetings can be conducted. Nu Skin also plans to introduce new products (ageLOC Me and ageLOC Youth) to the market via LTOs (Limited Time Offers). A slow rebound in China up to this point adds a high degree of uncertainty to Nu Skin’s ability to generate sustainable growth following these sales efforts. For that reason, we have issued very conservative guidance in regards to top line growth. Figure 2: Change in Revenue (1Q:13 – 3Q:15)
•
Model saturation in mature markets leaves little upside in terms of distributor growth - The beauty industry in the Americas, Europe, EMEA and North Asia continues to grow in terms of revenue growth; however, these markets have stalled in terms of distributor growth since 2013. Active distributors decreased by 9.5% from 2013-2014, and we project an 11.6% decrease for YE2015. Revenue per active also decreased by 12.5% from 20132014, and similarly we forecast a decline for 2015. This signals model saturation in these mature markets, and we believe Nu Skin’s direct-selling model has plateaued in these areas. This places a high amount of pressure on Greater China and South Asia/Pacific to drive distributor and revenue growth.
High degree of operating leverage which will hinder management’s ability to increase the bottom line •
Nu Skin spends a high amount of money on SG&A expenses (the highest amongst competitors), which eats away at their net income (and EPS) during periods of growth and draws value away from shareholders. Revenues increased 49% from 2012-2013 while gross income only increased 1%. Conversely, revenues decreased by 19% form 2013-2014 which caused a 3% decrease in gross product and net income. This high operating leverage also intensifies the impact of missing revenue guidance by magnifying errors in cash flow projections. We estimate that 2015 revenues will end 12% below 2014, driving margins down another 1%. These drawbacks/risks justify Nu Skin trading at a discount compared to their competitors. Figure 3: Operating Leverage
SG&A/REV AVP HLF USANA NUS
2012 55.76% 63.80% 67.01% 67.45%
2013 57.39% 64.80% 66.00% 66.63%
2014 55.95% 69.82% 67.50% 67.67%
AVG 56.37% 66.14% 66.84% 67.25%
Macroeconomic uncertainty in key markets. •
The personal products industry has been experiencing consistent growth over the past several years; however, a portion of this is attributed to the global financial collapse of 2008, which provides a very low base for growth metrics. Due to the recovery in the global economy, consumers are returning to spend discretionary income on higher quality beauty and personal care products. Despite this fact, there are recent developments in major markets, namely China, that signal the global recovery has reached a temporary peak.
Figure 4: Global Wealth Growth by Region
N. America Latin America Europe Africa Middle East Asia - Pacific
2010 8.60% 6.20% 6.30% 11.10% 10.40% 9.70%
2011 -1.10% 5.40% 1.10% 3.90% 2.70% 1.60%
2012 11.50% 4.40% 7.50% 9.90% 8.10% 9.40%
2013 15.90% 3.50% 12.50% 3.70% 16% 17.30%
2014 8.30% -2.10% 4% 5.20% 7.70% 8.50%
•
China, which accounted for 37% of Nu Skin’s 2014 total revenue, has weakening momentum in economic growth. The Chinese beauty and personal care market has experienced this same slowdown in sales growth. Due to rising awareness of personal grooming, along with increasing personal hygiene standards, strong revenue growth was recognized in men’s grooming, color cosmetics, and skin care. Korean brands, specifically AmorePacific, have been well perceived by Chinese consumers and are taking market share from other multinational brands in the country. Despite the economic slowdown, there is still a healthy forecast in sales growth due to an increasing pursuit of personal well-being and growing household incomes. Despite this growth, there are valid concerns for Nu Skin to grow/maintain market share in China, as evident in the dramatic decline in ‘actives’ as well as ‘sales leaders.’
•
Beauty and personal care in Japan is projected to remain flat in terms of growth based on forecasts from 2014-2018. A volume sales decline is likely as the population is predicted to decline over the same forecast period. This market prediction - along with a recent trend in declining actives, sales leaders, and revenue - will likely provide further challenges for Nu Skin to generate growth.
•
In South Korea, beauty and personal care continued to show moderate growth through 2014, but the growth rate has slowed down compared to previous years. In the South Korean market, domestic brands dominate beauty and personal care with insight in reading consumers’ demands as well as being able to distribute through fast and powerful retail channels. Despite this fact, there still remains a healthy forecast of growth which may provide some benefit to Nu Skin. This growth is somewhat uncertain as the regional figures for actives, sales leaders, and revenue have all seen recent declines in 2014.
Other Factors Posing Additional Downside Risk Potential Lawsuits and Lack of Control over Distributor Statements Nu Skin is currently being investigated by Taipei City for the illegal distribution of 10,000 units of their ageLOC Spa devices. Nu Skin Taiwan claims that these devices were never sold in Taiwan. The maximum fine payable is (US$3,000), and individuals involved could face similar fines and jail sentences up to three years. In our opinion, the lack of oversight over Nu Skin distributors enhances Nu Skin's risk to litigation and diminishing market penetration. The information breakdown from company to distributor whether true or fales is what places Nu Skin in a tight place. Since 2007 five of the largest global direct selling institutions have been investigated by governments stating that they were operating a pyramid scheme, Usana (`07), Amway (`10), Mary Kay (`12), Nu Skin (`14), Herbalife (`15). In all cases these investigations have a significant impact on competitors not improving market share but enhancing scrutiny.
Figure 5: Formal Investigation Effects on Competing Companies
Forex Risk
Source: Company Data
Source: Company Data
Although fluctuations in exchange rates can impact revenue data, regression analysis showed no statistically significant relationship between Nu Skin’s quarterly revenue changes and quarterly average currency exchange rates. These fluctuations are more likely explained by changes in levels of distributors per quarter as well as product saturation levels by region. The dollar is expected to remain strong, and even strengthen relative to many currencies in 2016. There is a consensus forecast that China will continue to manage economic turbulence through currency policy. The 0.5% devaluation of the Chinese Yuan in early January 2016 has been interpreted as a sign of things to come in terms of further devaluation in 2016. Exchange rate risk cannot be ignored as it is factored in under other comprehensive income. We have forecasted exchange rates for the end of 2016 for Nu Skin’s three largest foreign markets - China, South Korea, and Japan. As compared to today’s exchange rates, China will experience a 1.2971% loss in revenue value, while South Korea will see a 0.4608% loss in revenue value. Japan’s currency is forecasted to strengthen against the dollar, so Nu Skin will gain 0.9619% in revenue from currency exchange. Valuation We rate Nu Skin a SELL. The stock is currently trading at ~12x our next 12 months’ EPS estimate of $2.63. Our December 2016 price target is $29.00 and is based on an 11 P/E multiple on our 2016E EPS. We think the stock deserves to trade at a discount to its recent historical averages given declining revenue and distributor trends, consolidated class action complaints, macroeconomic uncertainty in its key markets, and a high degree of operating leverage that will hinder management’s ability to increase the bottom line. In the absence of near-term improvement of generating sales growth, we expect these recent trends to limit growth moving forward and rate Nu Skin as SELL.
Source: Bloomberg
Discounted Cash Flow One valuation method we considered was using DCF. We forecasted FCF for Q4 2015 by taking the average change between Q3 and Q4 since 2008 (8.89%) and multiplying Q3 2015 by that number. Then we averaged the quarterly FCF for 2015 to get our projected Q1 2016 FCF. We then grew the cash flows at an annualized 1% over the next 2 years. However, starting in 2018 we projected a slow and steady decline of 3.2% annually for the foreseeable future. We believe it is at that point that the mlm
model of Nu Skin will have reached its saturation point globally and will subsequently begin to lose traction. Using the constant growth model for a horizon value and the company’s average WACC over the last 10 years of ~11 as a discount rate, an NPV function determined a market value of $2.158B, or $37.72 per share. However, we believe that Nu Skin’s extreme growth patterns and financial statement volatility make this DCF model an inappropriate valuation model. We will be using a variety of multiples to determine our target price. Market Approach For our first price target, we forecasted 2016 revenue using expected revenue/active distributor numbers and as well as projected active distributor numbers. We expect the final 2015 revenue/active number to experience a 2% decrease from 2014. However, due to possible recapturing of the Chinese market, we expect an aggregate 1% increase in revenue/active in 2016. To estimate the number of actives, we first forecasted Q4 2015 by taking the average increase between Q3 and Q4 active distributors for the past 4 years (6.38%) and multiplying that by the number of active distributors in Q3 2015. Given a likely increase in the China market, distributor saturation in other major markets will lead to a net 0% growth in active distributors for 2016. This leads to a projected revenue of $2.246B and an EPS of $2.63 for 2016. Using a P/E multiple of ~11, our target price is $29.00. Figure 6: Revenue per Active Ratio (2009 - 2016E)
For our second price target, we determined the geometric mean of revenue growth rates from Q1:2014 thru Q3:2015. We then projected Q4:2015 using this geometric growth rate. Factoring in our projected net revenue growth of ~1% and using a historic NI margin (6.7%), we determined a year end 2016 EPS of $2.63. This estimate multiplied by the current P/E ~11x approximates to a price of $29.00. Figure 7: Annual Dividend History (2008 – 2015)
We used a weighted average of the annual dividend growth rate from 2013 - 2015 to estimate a growth rate of 5.5%. We then used a required return of 12% in the DDM to determine a price target of $22.72. However, we feel this valuation method is difficult to justify due to Nu Skin’s small-capitalization and inconsistent growth rate. Total Shareholder Return With a price target of $29.00, we anticipate a capital loss of (-13.7%). However, with an annual dividend yield of (+4.2%), total shareholder return is expected to net ~(9.5%). We believe that an investor can expect a higher return by investing in the broad market index, and reaffirm our SELL rating.
Financial Analysis
Risks to Rating and Price Target Upside risks to our SELL rating include (1) potential market penetration in new regions (2) rebound in distributors within the Chinese market and (3) greater than expected success with new product launches. 1.
Potential market penetration
Although this is difficult to precisely measure, there is a possibility that Nu Skin will be able to generate sales growth in new regions. During the company presentation, CFO Ritch Wood stated that “Latin America and Southeast Asia look promising.” If this statement materializes during 2016, then this may work against the valuation model. 2.
Rebound in distributors within the Chinese market
It is possible that Nu Skin may be able to once again establish a new direct sales model in China in 2106. If Nu Skin can determine a method of circumnavigating the Chinese legislation preventing direct sales, then this would likely result in a strong increase in revenue. Both of these issues are complex and political in nature, and therefore difficult to forecast. Nu Skin has not yet released any statements verifying any definitive plans that they are making headway regarding these key points. 3.
Greater than expected success with new product launches
If Nu Skin is able to generate enough buzz around their new products set to be released in 2016, specifically ageLOC Me, we believe Nu Skin may be able to raise guidance and/or beat earnings estimates. This is important consideration relative to Nu Skin not launching any new products in 2015. Depending on the magnitude of this increase, Nu Skin could once again gain favor with investors and surge to a price level of $40-50/share. However, this prospect seems highly unlikely as the distribution channels have contracted significantly. We took this new product launch factor into account and only forecast a slight increase of ~1% in revenues 2015 - 2016.
Appendix A: Glossary of Terms Actives --- number of persons who purchased products directly from the company during the previous 3 months.
Sales Leaders --- number of persons who have completed and who maintain specified sales benchmarks at the end of a period.
Appendix B: NuSkin 2016 Product Launch Schedule
Source: Company Data
Appendix C: Insider Holdings Name
Position
Market Value (2/3/16)
% of shares
Hunt M. Truman
325,559
$
10,385,332
0.57%
Joseph Y. Chang
112,841
$
3,599,628
0.20%
Andrew D. Lipman
59,198
$
1,888,416
0.10%
Daniel W. Campbell
53,031
$
1,691,689
0.09%
Matthew D. Dorny
52,789
$
1,683,969
0.09%
603,418
$
19,249,034
1.05%
Total Source: Yahoo Finance
Appendix D: China Macroeconomic Factor
Source: World Bank
Appendix E: Japan Macroeconomic Factor
Appendix F: Discounted Cash Flow Analysis
Appendix G: Revenue Growth Model Equally Weighted Average of the following components to determine 1% forecast revenue growth 2016: Geometric average of revenue growth 2011 – 2014 - This component used the annual growth rates from 2011 2014. We excluded prior years because of inflated growth rates due to lower base year figures. Average growth 2013 – 2014 - Factored in to serve as a worst-case factor to smooth out the model. 2 consensus analyst estimates - Analyst estimate of 2.7% for NuSkin revenue growth. Analyst estimate of 6.9% for sector growth. Sustainable growth rate - Calculated by retention ratio multiplied by ROE. Decrease in actives growth rate – Determined based on decline from 2014 - 2015E.
Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society of Utah, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.
CFA Institute Research Challenge
Utah Utah Valley University
Stock Rating
SELL
Highlights_____________________________________________________________ We initiate coverage on Nu Skin Enterprises (NUS) with a SELL recommendation
Industry View
NEUTRAL based on a one year price target of $29.00, yielding 9.5% (including dividend yield)
Price Target
USD 30.50 is primarily driven by the following factors:
Price (01-Feb-2016) Potential Upside/Downside Ticker
USD 33.60 -5% NUS
Market Cap (USD mn) Shares Outstanding (mn) Free Float (%) 52 Wk Avg Daily Volume (m Dividend Yield (%) Return on Equity TTM (%) Current BVPS (USD)
1830 57.23 55.1 96.27 4.47 15.97 14.97
downside from its closing price on February 4, 2016 of $33.60. Our recommendation
Price Performance 52 Week range
Decreased distribution – Nu Skin’s revenues follow their distributor trends. As Actives and Sales Leaders have dropped following litigation issues in Greater China and Taiwan, Nu Skin's revenues have followed suit. Nu Skin plans to re-enter their primary market in Mainland China by once again holding sales meetings and offering new products in 2016; however, growing their salesforce in a sustainable manner is unlikely as tight regulation and lingering litigation remain. Nu Skin is unlikely to see significant revenue growth in the wake of stalled distributor expansion.
•
Model saturation in mature markets leaves little upside in terms of distributor growth - The beauty industry in the Americas, Europe, EMEA and North Asia continues to grow in terms of revenue growth; however, these markets have stalled in terms of distributor growth since 2012. This signals model saturation in these mature markets, and we believe Nu Skin’s directselling model has plateaued in these areas. This places a high amount of pressure on Greater China and South Asia/Pacific to drive distributor and revenue growth.
•
High operating leverage - Nu Skin spends a high amount of money on SG&A expenses (the highest amongst competitors), which eats away at their net income (and EPS) during periods of growth and draws value away from shareholders. This high operating leverage also intensifies the impact of missing revenue guidance by magnifying errors in cash flow projections. These drawbacks/risks justify Nu Skin trading at a discount compared to their competitors.
•
Macroeconomic uncertainty in key markets – China, Nu Skin’s largest market, is experiencing an economic slowdown, leaving Chinese consumers with less discretionary income to spend on personal health and beauty products. Japan’s population is forecasted to decline through the next four years, hurting growth prospects in North Asia. In South Korea, domestic brands have begun dominating the market as they have the ability to distribute their products through fast and powerful retail channels.
Exchange-NYSE USD 29.52-62.87
Valuation
Proforma Multiples
Rev/Active
Estimated Price
$28.93
$28.93
Weights
50%
50%
Price Target
•
$29.00
Business Description: Nu Skin (NUS) Enterprises was founded in 1984 and is currently headquartered in Provo, Utah. Nu Skin operated as a private company for 12 years before its IPO on November 27, 1996. Together, with its principal subsidiaries, Nu Skin develops and distributes anti-aging personal care products and nutritional supplements under the Nu Skin and Pharmanex brands. Nu Skin is a global direct-selling company that markets personal care and nutritional products in 53 markets worldwide. The company operates in the direct selling channel, primarily utilizing person-to person marketing to promote and sell its products. Strategy The company’s main strategy is to expand and capture market share in the beauty and personal care products markets. Nu Skin’s operations are designed to generate growth and increase value through: •
High-end products that warrant higher pricing - Nu Skin has established research and development operations in the United States and China. The company develops and patents all products sold internally. Collectively, there are 75 product development employees that work on developing high-quality products comparable to Estee Lauder and Clinique. High-end products lead to high margins and increased profitability.
•
Successful product launches that lead to growth in sales force - Nu Skin’s announced product launch strategy for 2016 revolves around the new ageLOC Me product. Nu Skin seeks to create a business opportunity that empowers individuals to establish, grow and expand their business. Through the direct selling method, Nu Skin looks to achieve revenue growth through an expanded sales force. The product launches work in a feedback cycle with sales force expansion, where they both serve to generate growth for the other. For products to be successful, Nu Skin must grow its net number of sales force by 10-12% per year.
•
Strategic cash management policy to attract investors - Nu Skin utilizes cash for 3 main purposes: (1) To invest back into the business. This involves developing new products as well as providing incentives for sales leaders. (2) To pay an attractive dividend. Nu Skin has been able to increase its dividend consistently since 2008 with a current yield of 4.42%. (3) To repurchase shares. Nu Skin does not attempt to look for buyouts or external projects, but rather focuses on an aggressive share buyback program to increase earnings potential for shareholders.
Industry Overview & Competitive Positioning: Demand Drivers Nu Skin’s demand drivers are as follows: 1) available discretionary income, 2) cultural/social practice and 3) financial opportunity. Available Discretionary Income As many global economies have experienced consistent economic growth from 2008 thru 2015, incomes have been steadily increasing. As consumers have received larger discretionary income, they are more willing to spend a proportionately higher amount for high-end products. Cultural/Social Practice The beauty and personal care products sector has seen an increasing amount of markets become more aware and concerned with personal grooming. Many new markets show increasing demand for these products, but they vary on how much they are willing to spend. Financial Opportunity For the MLM business model, there is an effort to portray a business opportunity for consumers to become sales leaders and business owners. If Nu Skin can produce products that are desirable to the consumer, then this will likely translate into a new sales leader which will lead to revenue growth. This concept is a key driver of how the MLM business structure can simultaneously lead to demand and revenue growth. Industry Supply In the beauty and personal care products sector, there are a variety of suppliers. Amongst suppliers, there are many business models that range from direct sales to mass retail. As the sector has seen overall growth since the recovery from the global recession of 2008, many new competitors have entered the market and existing competitors have developed broad product mixes. This has resulted in more intense competition amongst suppliers to gain market share. Large multinational companies (ex. Estee Lauder) with mass retailing strategies have gained a competitive advantage by increasing market share and brand awareness as seen in Figure 1. Figure 1: Competitive Positioning Competitive Positioning
NUS
AVP
HLF
USANA
Market Capitalization
$1.83B
$1.32B
$4.29B
$1.58B
Sales Leaders
62,009
6,000,000
366,489
349,000
Gross Margin
81.40%%
60.50%
80.20%
82.20%
Revenue per Sales Leaders
$41,438
$892
$10,848
$2,263
$2,569.5M
$5,352.1M
$3,975.7M
$790M
Revenue As of December 31, 2014
Investment Summary: We issue a SELL recommendation on Nu Skin (NUS) with a target price of $29.00 using a Relative Multiples Valuation, a Dividend Discount Model, and a Discounted Cash Flow Analysis. This valuation is supported by the following merits: 1) revenue headwinds in terms of decreased distribution channels, 2) minimal growth in Sales Leaders in 2016, 3) high operating leverage, and 4) macroeconomic uncertainty in key markets. •
Nu Skin faces revenue headwinds in terms of decreased distribution channels resulting from litigation and regulation in their expanding markets. Nu Skin’s revenues follow their distributor (number of Actives and Sales Leaders) trends. Due to the business model of Nu Skin, the declining number of distributors means there are fewer channels to generate sales. In 2013, the number of Actives and Sales Leaders increased by 126.9% and 232.2% from the previous year, increasing total revenue by 48.9%. From 2013-2014, however, the number of Actives and Sales Leaders decreased by 9.5% and 39.3%, driving revenue down by 19.1%. This demonstrates the effect that Actives and Sales Leaders have on revenue growth. Following China’s investigation of Nu Skin in January of 2014, Nu Skin was prompted to pull out of the Chinese market. Nu Skin was unable to hold sales meetings, forcing a large amount of the sales leaders in Greater China out of the business. Moving forward, Nu Skin plans to re-enter Greater China, but following the government investigation, China has implemented tight governmental regulation surrounding how sales meetings can be conducted. Nu Skin also plans to introduce new products (ageLOC Me and ageLOC Youth) to the market via LTOs (Limited Time Offers). A slow rebound in China up to this point adds a high degree of uncertainty to Nu Skin’s ability to generate sustainable growth following these sales efforts. For that reason, we have issued very conservative guidance in regards to top line growth. Figure 2: Change in Revenue (1Q:13 – 3Q:15)
•
Model saturation in mature markets leaves little upside in terms of distributor growth - The beauty industry in the Americas, Europe, EMEA and North Asia continues to grow in terms of revenue growth; however, these markets have stalled in terms of distributor growth since 2013. Active distributors decreased by 9.5% from 2013-2014, and we project an 11.6% decrease for YE2015. Revenue per active also decreased by 12.5% from 20132014, and similarly we forecast a decline for 2015. This signals model saturation in these mature markets, and we believe Nu Skin’s direct-selling model has plateaued in these areas. This places a high amount of pressure on Greater China and South Asia/Pacific to drive distributor and revenue growth.
High degree of operating leverage which will hinder management’s ability to increase the bottom line •
Nu Skin spends a high amount of money on SG&A expenses (the highest amongst competitors), which eats away at their net income (and EPS) during periods of growth and draws value away from shareholders. Revenues increased 49% from 2012-2013 while gross income only increased 1%. Conversely, revenues decreased by 19% form 2013-2014 which caused a 3% decrease in gross product and net income. This high operating leverage also intensifies the impact of missing revenue guidance by magnifying errors in cash flow projections. We estimate that 2015 revenues will end 12% below 2014, driving margins down another 1%. These drawbacks/risks justify Nu Skin trading at a discount compared to their competitors. Figure 3: Operating Leverage
SG&A/REV AVP HLF USANA NUS
2012 55.76% 63.80% 67.01% 67.45%
2013 57.39% 64.80% 66.00% 66.63%
2014 55.95% 69.82% 67.50% 67.67%
AVG 56.37% 66.14% 66.84% 67.25%
Macroeconomic uncertainty in key markets. •
The personal products industry has been experiencing consistent growth over the past several years; however, a portion of this is attributed to the global financial collapse of 2008, which provides a very low base for growth metrics. Due to the recovery in the global economy, consumers are returning to spend discretionary income on higher quality beauty and personal care products. Despite this fact, there are recent developments in major markets, namely China, that signal the global recovery has reached a temporary peak.
Figure 4: Global Wealth Growth by Region
N. America Latin America Europe Africa Middle East Asia - Pacific
2010 8.60% 6.20% 6.30% 11.10% 10.40% 9.70%
2011 -1.10% 5.40% 1.10% 3.90% 2.70% 1.60%
2012 11.50% 4.40% 7.50% 9.90% 8.10% 9.40%
2013 15.90% 3.50% 12.50% 3.70% 16% 17.30%
2014 8.30% -2.10% 4% 5.20% 7.70% 8.50%
•
China, which accounted for 37% of Nu Skin’s 2014 total revenue, has weakening momentum in economic growth. The Chinese beauty and personal care market has experienced this same slowdown in sales growth. Due to rising awareness of personal grooming, along with increasing personal hygiene standards, strong revenue growth was recognized in men’s grooming, color cosmetics, and skin care. Korean brands, specifically AmorePacific, have been well perceived by Chinese consumers and are taking market share from other multinational brands in the country. Despite the economic slowdown, there is still a healthy forecast in sales growth due to an increasing pursuit of personal well-being and growing household incomes. Despite this growth, there are valid concerns for Nu Skin to grow/maintain market share in China, as evident in the dramatic decline in ‘actives’ as well as ‘sales leaders.’
•
Beauty and personal care in Japan is projected to remain flat in terms of growth based on forecasts from 2014-2018. A volume sales decline is likely as the population is predicted to decline over the same forecast period. This market prediction - along with a recent trend in declining actives, sales leaders, and revenue - will likely provide further challenges for Nu Skin to generate growth.
•
In South Korea, beauty and personal care continued to show moderate growth through 2014, but the growth rate has slowed down compared to previous years. In the South Korean market, domestic brands dominate beauty and personal care with insight in reading consumers’ demands as well as being able to distribute through fast and powerful retail channels. Despite this fact, there still remains a healthy forecast of growth which may provide some benefit to Nu Skin. This growth is somewhat uncertain as the regional figures for actives, sales leaders, and revenue have all seen recent declines in 2014.
Other Factors Posing Additional Downside Risk Potential Lawsuits and Lack of Control over Distributor Statements Nu Skin is currently being investigated by Taipei City for the illegal distribution of 10,000 units of their ageLOC Spa devices. Nu Skin Taiwan claims that these devices were never sold in Taiwan. The maximum fine payable is (US$3,000), and individuals involved could face similar fines and jail sentences up to three years. In our opinion, the lack of oversight over Nu Skin distributors enhances Nu Skin's risk to litigation and diminishing market penetration. The information breakdown from company to distributor whether true or fales is what places Nu Skin in a tight place. Since 2007 five of the largest global direct selling institutions have been investigated by governments stating that they were operating a pyramid scheme, Usana (`07), Amway (`10), Mary Kay (`12), Nu Skin (`14), Herbalife (`15). In all cases these investigations have a significant impact on competitors not improving market share but enhancing scrutiny.
Figure 5: Formal Investigation Effects on Competing Companies
Forex Risk
Source: Company Data
Source: Company Data
Although fluctuations in exchange rates can impact revenue data, regression analysis showed no statistically significant relationship between Nu Skin’s quarterly revenue changes and quarterly average currency exchange rates. These fluctuations are more likely explained by changes in levels of distributors per quarter as well as product saturation levels by region. The dollar is expected to remain strong, and even strengthen relative to many currencies in 2016. There is a consensus forecast that China will continue to manage economic turbulence through currency policy. The 0.5% devaluation of the Chinese Yuan in early January 2016 has been interpreted as a sign of things to come in terms of further devaluation in 2016. Exchange rate risk cannot be ignored as it is factored in under other comprehensive income. We have forecasted exchange rates for the end of 2016 for Nu Skin’s three largest foreign markets - China, South Korea, and Japan. As compared to today’s exchange rates, China will experience a 1.2971% loss in revenue value, while South Korea will see a 0.4608% loss in revenue value. Japan’s currency is forecasted to strengthen against the dollar, so Nu Skin will gain 0.9619% in revenue from currency exchange. Valuation We rate Nu Skin a SELL. The stock is currently trading at ~12x our next 12 months’ EPS estimate of $2.63. Our December 2016 price target is $29.00 and is based on an 11 P/E multiple on our 2016E EPS. We think the stock deserves to trade at a discount to its recent historical averages given declining revenue and distributor trends, consolidated class action complaints, macroeconomic uncertainty in its key markets, and a high degree of operating leverage that will hinder management’s ability to increase the bottom line. In the absence of near-term improvement of generating sales growth, we expect these recent trends to limit growth moving forward and rate Nu Skin as SELL.
Source: Bloomberg
Discounted Cash Flow One valuation method we considered was using DCF. We forecasted FCF for Q4 2015 by taking the average change between Q3 and Q4 since 2008 (8.89%) and multiplying Q3 2015 by that number. Then we averaged the quarterly FCF for 2015 to get our projected Q1 2016 FCF. We then grew the cash flows at an annualized 1% over the next 2 years. However, starting in 2018 we projected a slow and steady decline of 3.2% annually for the foreseeable future. We believe it is at that point that the mlm
model of Nu Skin will have reached its saturation point globally and will subsequently begin to lose traction. Using the constant growth model for a horizon value and the company’s average WACC over the last 10 years of ~11 as a discount rate, an NPV function determined a market value of $2.158B, or $37.72 per share. However, we believe that Nu Skin’s extreme growth patterns and financial statement volatility make this DCF model an inappropriate valuation model. We will be using a variety of multiples to determine our target price. Market Approach For our first price target, we forecasted 2016 revenue using expected revenue/active distributor numbers and as well as projected active distributor numbers. We expect the final 2015 revenue/active number to experience a 2% decrease from 2014. However, due to possible recapturing of the Chinese market, we expect an aggregate 1% increase in revenue/active in 2016. To estimate the number of actives, we first forecasted Q4 2015 by taking the average increase between Q3 and Q4 active distributors for the past 4 years (6.38%) and multiplying that by the number of active distributors in Q3 2015. Given a likely increase in the China market, distributor saturation in other major markets will lead to a net 0% growth in active distributors for 2016. This leads to a projected revenue of $2.246B and an EPS of $2.63 for 2016. Using a P/E multiple of ~11, our target price is $29.00. Figure 6: Revenue per Active Ratio (2009 - 2016E)
For our second price target, we determined the geometric mean of revenue growth rates from Q1:2014 thru Q3:2015. We then projected Q4:2015 using this geometric growth rate. Factoring in our projected net revenue growth of ~1% and using a historic NI margin (6.7%), we determined a year end 2016 EPS of $2.63. This estimate multiplied by the current P/E ~11x approximates to a price of $29.00. Figure 7: Annual Dividend History (2008 – 2015)
We used a weighted average of the annual dividend growth rate from 2013 - 2015 to estimate a growth rate of 5.5%. We then used a required return of 12% in the DDM to determine a price target of $22.72. However, we feel this valuation method is difficult to justify due to Nu Skin’s small-capitalization and inconsistent growth rate. Total Shareholder Return With a price target of $29.00, we anticipate a capital loss of (-13.7%). However, with an annual dividend yield of (+4.2%), total shareholder return is expected to net ~(9.5%). We believe that an investor can expect a higher return by investing in the broad market index, and reaffirm our SELL rating.
Financial Analysis
Risks to Rating and Price Target Upside risks to our SELL rating include (1) potential market penetration in new regions (2) rebound in distributors within the Chinese market and (3) greater than expected success with new product launches. 1.
Potential market penetration
Although this is difficult to precisely measure, there is a possibility that Nu Skin will be able to generate sales growth in new regions. During the company presentation, CFO Ritch Wood stated that “Latin America and Southeast Asia look promising.” If this statement materializes during 2016, then this may work against the valuation model. 2.
Rebound in distributors within the Chinese market
It is possible that Nu Skin may be able to once again establish a new direct sales model in China in 2106. If Nu Skin can determine a method of circumnavigating the Chinese legislation preventing direct sales, then this would likely result in a strong increase in revenue. Both of these issues are complex and political in nature, and therefore difficult to forecast. Nu Skin has not yet released any statements verifying any definitive plans that they are making headway regarding these key points. 3.
Greater than expected success with new product launches
If Nu Skin is able to generate enough buzz around their new products set to be released in 2016, specifically ageLOC Me, we believe Nu Skin may be able to raise guidance and/or beat earnings estimates. This is important consideration relative to Nu Skin not launching any new products in 2015. Depending on the magnitude of this increase, Nu Skin could once again gain favor with investors and surge to a price level of $40-50/share. However, this prospect seems highly unlikely as the distribution channels have contracted significantly. We took this new product launch factor into account and only forecast a slight increase of ~1% in revenues 2015 - 2016.
Appendix A: Glossary of Terms Actives --- number of persons who purchased products directly from the company during the previous 3 months.
Sales Leaders --- number of persons who have completed and who maintain specified sales benchmarks at the end of a period.
Appendix B: NuSkin 2016 Product Launch Schedule
Source: Company Data
Appendix C: Insider Holdings Name
Position
Market Value (2/3/16)
% of shares
Hunt M. Truman
325,559
$
10,385,332
0.57%
Joseph Y. Chang
112,841
$
3,599,628
0.20%
Andrew D. Lipman
59,198
$
1,888,416
0.10%
Daniel W. Campbell
53,031
$
1,691,689
0.09%
Matthew D. Dorny
52,789
$
1,683,969
0.09%
603,418
$
19,249,034
1.05%
Total Source: Yahoo Finance
Appendix D: China Macroeconomic Factor
Source: World Bank
Appendix E: Japan Macroeconomic Factor
Appendix F: Discounted Cash Flow Analysis
Appendix G: Revenue Growth Model Equally Weighted Average of the following components to determine 1% forecast revenue growth 2016: Geometric average of revenue growth 2011 – 2014 - This component used the annual growth rates from 2011 2014. We excluded prior years because of inflated growth rates due to lower base year figures. Average growth 2013 – 2014 - Factored in to serve as a worst-case factor to smooth out the model. 2 consensus analyst estimates - Analyst estimate of 2.7% for NuSkin revenue growth. Analyst estimate of 6.9% for sector growth. Sustainable growth rate - Calculated by retention ratio multiplied by ROE. Decrease in actives growth rate – Determined based on decline from 2014 - 2015E.
Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society of Utah, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.
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