I’m very excited about Herbalife Ltd. (NYSE:HLF), but not for the reason you might think. Herbalife stock has become the toast of Wall Street, skyrocketing 52.4% year-to-date. It’s putting the broader indices to shame, as well as several top performers. To me, this is a perfect time to go negative on Herbalife.
I understand that such a view is not only unoriginal, but highly unprofitable. A few years back, notorious short seller Bill Ackman placed a $1 billion bet that Herbalife stock would eventually go to zero. Documentaries detailing this gamble were produced. Ackman even got embroiled in a heated debate with fellow Wall Street mercenary Carl Icahn.
The bet, of course, didn’t pan out the way Ackman imagined, quite the opposite. Yes, we saw zeroes in the HLF stock price. The problem was that it was preceded by a big, fat one. The usually cocksure Ackman conceded defeat, pulling out of the short position.
Inevitably, HLF soared on the news, but that wasn’t the only catalyst. As our own Tim Biggam wrote:
“The most recent leg up was predicated on the announcement of a name change, stock split and Dutch auction — basically the kitchen sink approach to squeeze the HLF stock shorts into submission.”
I love that everyone is piling into Herbalife stock. It’s patently clear that speculation is driving HLF, and not much else. Biggam believes that it’s a “perfect time from a contrarian standpoint to revisit the short thesis.”
I couldn’t agree more. My colleague focuses on the technical reasons why HLF is due for a pullback. Here are three more points to consider:
Herbalife Stock Has Declining Fundamentals
I’m intrigued in a trade when seemingly everyone jumps on one side of the argument. I’m really glued to my screen, though, when the target company’s bullishness is fundamentally unjustified.
For instance, why is HLF stock mooning when it’s clear as daylight that the business has matured? Over the past four years, Herbalife’s top-line sales have consistently declined. Not only that, operating expenses have jumped substantially in the past three years.
But what really intrigued me was the days inventory count. Since 2014, days inventory has increased 13%, while the turnover rate has declined nearly 12%. If I didn’t know any better, I’d assume that the company’s products aren’t as popular as they once were. It also explains why I’m not seeing revenue growth.
That’s not all: I don’t like the company’s balance sheet, either. Management has consistently racked on more debt, and its total equity currently runs negative. That’s not something I want to see in a growth-challenged organization.
Herbalife Stock Is Overvalued
It’s a common charge whenever a flavor-of-the-week investment skyrockets. Still, don’t mistake this for a merely emotional reaction: Herbalife stock is overvalued.
In 2014, the average HLF share price was $55.71 against an earnings per share of $5.93. In 2017, the average share price jumped 17% to $65.42 on a deflated EPS figure of $4.86. Somehow, investors were willing to pay more for a company that earns less. It gives you an insight into the Herbalife mentality.Against last year’s EPS, that’d put the price-earnings ratio at 18-times earnings. Moreover, analysts forecast that this year’s EPS will be $5.31. At the current share price, the P/E ratio would be 19-times earnings.
Either way you look at it, the valuation is far richer than the average 11-times earnings seen between 2014 and 2017.
Plus, HLF may not hit the consensus EPS target for this year. Sales have matured, expenses are up, inventory turnover is down. These trends are not great confidence boosters.
Along with the points Biggam forwarded, I see more downside risk to Herbalife stock than upside reward.
It’s an MLM, for Crying Out Loud!
I don’t care how you phrase it: Herbalife is a multi-level marketing (MLM) company, which is a fancy way of saying “legal pyramid scheme.”
MLMs are like herpes – almost everyone at one point in their lives has been infected by its charm. And at the end of the day, unless you’re the guy or gal at the top of the pyramid, you’re going to get hurt.
But HLF stock is a special kind of MLM, the vitamin-drink kind. There’s a reason why this business model has been parodied at every opportunity: it’s ridiculous and a time is coming soon when this business model will be obsolete.
You just need to look at the competition. Avon Products, Inc. (NYSE:AVP) is mired in a downward spiral. Nu Skin Enterprises, Inc. (NYSE:NUS) is rising, but is well behind its all-time highs. In the internet world, we don’t have a need for door-to-door salespeople.
Bottom line: Herbalife stock is overvalued on poor financials and a declining industry. If there’s a better short candidate, I don’t know what that would be.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.