NutriSystem – Sell or Hold?

by Quan Hoang

One of my best friends listened to my advice and bought NutriSystem (NTRI). NTRI shares recently dropped more than 30% and he asked me about my thoughts. I feel like I should stop writing completely. But I’ll try an honest evaluation of my idea.

Let’s start with the reasons I like the stock:

  • Business model
  • Marketing
  • Products

Profitable Business Model

I like NTRI’s business model. NTRI doesn’t manufacture food. They develop recipes and outsource manufacturing. The business requires little additional capital to grow. To sell more, they need more inventories. But more inventories can be offset by more accounts payable.

I prefer businesses that spend on advertising instead of on PPE. If you spend on PPE, you have to replace the used-up PPE every year. If you spend on advertising, the value can stay. That’s brand value. And it’s not reported on the balance sheet.

I think NTRI’s marketing is good. It’s appropriate to run 2 minute TV ads. It’s the right amount of time to convince people to look at the product.

Not So Good Product Economics

 I think NTRI has interesting products. They provide a variety of low-carb foods. The taste seems not good but they can improve. It’s the most convenient and the quickest way to reduce weight. Although their main customers are women 40-50 years old, I imagine that the products are great for single men.

The product economics are not very good. It takes much marketing effort to get a customer but he/she stays on the program for only 2 to 3 months. NTRI always has to find new customers.

Some customers will gain weight and return to NTRI in the future. But this isn’t a great way to make profit. I prefer a business that makes money by making customers happy.

It’s true that a lot of customers are happy when they’re successful with NTRI. But I’m not sure that’s true when customers gain weight after they stop using NTRI several times. I didn’t learn enough about customer behavior.

Hard-to-sell Products

NTRI diet is convenient but can be difficult to follow. McDonald’s (MCD) sells unhealthy food but customers enjoy it when they eat it. On the contrary, it takes a lot of discipline to use NTRI diet. A lot of people were successful with NTRI but perhaps I looked at a skewed sample.

I recently read the “Power of Habits” and “Mindless Eating”. I felt the difficulty faced by those who failed with the NTRI diet. It’s really difficult to change a habit. You see some cue, mindlessly repeat a response, and you get rewards. It’s like every day at 3PM, you get up from your desk, and go to the cafeteria to get some cookies. But you’re not hungry at all. You just feel stressed and want to go out. Or you’re working on your laptop with a box of chocolate beside you. You just keep eating. But you can eat a lot healthier if you simply replace the box of chocolate with fruits.

I think Weight Watcher (WTW) can help with that. WTW has a better model. WTW’s meetings are more effective for changing a habit. There’s peer pressure and sharing of experience in dealing with problems in reducing weight. And hopefully, people can get into the habit of going to the meetings. I know people who continue going to the meetings after they achieved their target weight.

I think each product fits a different lifestyle. Some people find NTRI program difficult to follow. Others find it easy. The reason I’m interested in NTRI is that the market is huge. Nutrisystem just needs a small share to succeed. I look at the earnings in 2007 as proof. I think NTRI will return to growth when the macroeconomics condition gets better.

Facts Disproved My Original Thesis

But now, I’m questioning my thesis. Is it possible that NTRI’s past success was due to a fad? Maybe. A difficult to sell product can enjoy huge success as a fad and then lose people’s interests.

I raise this question because of NTRI’s protracted underperformance. The economic condition got better this year, but Nutrisystem’s sales just got worse. What’s wrong with NTRI?

I can’t answer. I tend to think Nutrisystem’s past success was due to a fad. That could be unfair. A lot of customers were satisfied. But the result seems to disprove my original thesis. I find it safer to sell the stock right away.

Turnaround Situation

The management says they are modifying the marketing. NTRI is now a turnaround situation. The success is based on marketing effectiveness instead of pure product appeal.

I’m still interested in NTRI. But I remember Peter Lynch only bought companies that were getting better. Even with cyclicals, he only bought when there were signs of turning around. I have no indicator other than sales growth. So, I’ll sell the stock right away.

I’ll still watch NTRI. I’ll see if NTRI will improve or if they’ll keep declining. It’s a good learning experience.

Talk to Quan about NutriSystem (NTRI)