Recommendation: Buy GNC Holdings (NYSE:GNC)
Options Alternative: Buy to open the GNC June 2013 $35 Calls
GNC Holdings, the largest supplement and vitamin retailer in the U.S., has taken a hammering with the recent market sell-off. Despite reporting earnings above consensus, its shares are down over 15%. Is there a deeper concern with the company’s strategy or is this a sympathetic sell-off that has created an opportunity to buy growth inexpensively?
Reasons for the Decline
- Macro trends: 5% decline in the broader market
- Changes to discount program: Changes to GNC’s Gold Card discount may cut into gross margins. While GNC does expect an initial hit to margins, they anticipate that this program will positively impact margins after three to four months. Nevertheless, bearish market sentiment has GNC investors selling and waiting to see if the new strategy will pay off.
- Private equity investors sold off their shares in GNC: With the sale of this lingering 11% stake, the free float was inundated with additional shares and may have contributed to the recent decline. But now that private equity is no longer shedding shares as the stock advances, a significant overhang to future uptrends is removed.
So Why Buy?
The recent divergence between GNC’s stock price and its upward earnings revision could be an ideal time to buy significant 2013 growth.
- Divergence between stock price and upward earnings revision: Trading at only 12.1x forward (2013) EPS with 18-20% EPS growth, shares could be poised to rebound as the market digests the upward revisions to earnings and revenue growth.
- Upbeat guidance: Compared to average multiple of 17x forward EPS over the last year, the current 12.1x multiple is compelling, especially given the recent upbeat guidance from management and the fact that the company is expected to earn 35% more in 2013 than analysts had anticipated at the beginning of this year (current consensus of $2.70 vs. $2.00 in February 2012).
Drivers Behind Upbeat Guidance
According to CEO Joe Fortunato, GNC’s success is the result of groundwork that the company has been building since 2004 by investing heavily in product development, brand recognition and multiple channels for selling GNC products. GNC has also focused on understanding their customer base of young, athletic customers and why they are loyal to the GNC brand. At a recent investor conference, Fortunato highlighted some of the key reasons for GNC’s success and why he believes 2013 will see increased growth.
- Revamped Franchise System: 60% of franchise operations are performing better than company stores in same-store sales, even though company stores show double-digit growth.
- New Mass Market Strategy: GNC recently started a significant mass market initiative, most notably by selling product through Sam’s Club.
- Marketing Campaigns: GNC’s Live Well ad campaign was very effective in establishing the company as a lifestyle brand. In January 2013, the company plans to launch another television, print, and direct marketing campaign to cement their brand with the health and fitness movement.
- Gold Card: The results from the new program (permanent discounts rather than just the first week of the month) in test markets have shown a dramatic increase in sales despite the initial hit to gross margins.
- New stores: GNC will open 150 stores in 2012 and expects to open 150-200 new stores every year for at least the next three to four years. They also plan to continue to open hundreds of stores internationally.
- Delivering Shareholder Return: Fortunato’s forecast for the company in 2013 is 6-7% same-store comps, 9-10% revenue growth, and 18-20% earnings growth. The company intends to deliver shareholder return through earnings dividends or share repurchases. With fundamentals heading higher and the stock heading lower, the price for the earnings growth alone going into 2013 is compelling. An increased dividend or share buyback would only add to the case.
Recommendation: Use current decline to buy excellent 2013 growth at discounted valuation. Buy below $35 reflect a multiple under 13x forward earnings; look for stock to rebound to near $40+ range to reflect raised estimates.
Options Alternative: Buy to open the GNC June 2013 $35 Calls for $5.00 or less.
Investors looking for more leverage on the trade may be interested in the June 2013, 35 calls at $5.00 or less. However, traders should be cautious that if GNC continues to channel below $42 per share, those options should be sold early. Time value can erode quickly heading into the second quarter of 2013 and if GNC is moving slowly, an early exit near the top of the channel is advisable.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.