It would seem like Weight Watchers (NASDAQ:WTW) stock is cheap. After all, Weight Watchers stock has fallen by 80% just since July. Yet WTW stock (soon to be WW stock, as the company is changing its ticker) has deserved that steep decline.
WW’s earnings are expected to plunge in 2019, based on the company’s own guidance. Add in WW’s heavily leveraged balance sheet, and the declines of WTW stock make some sense.
In fact, at this point, Weight Watchers stock actually is pricing in a turnaround. The company’s volatile history suggests that might be too optimistic.
The Weight Watchers Stock Rollercoaster
Trading in Weight Watchers stock over the past few years has been something close to incredible. WTW stock was at $80 in early 2012. It steadily collapsed over the next few years; by 2015, it had bottomed out below $4.
Then Oprah Winfrey rode to the rescue, taking a stake in the company and becoming its spokesperson. Weight Watchers stock would bounce -and keep bouncing. At its 2018 peaks, Weight Watchers stock had gained over 2,600% from those 2015 lows .
Starting last summer, WW then reversed yet again. Weight Watchers stock has now fallen some 81% in nine months. Clearly, WW is not for the faint of heart.
The question looking back might be: Why is WTW stock so ridiculously volatile? And there are actually two answers to that question.
Why WW Is So Volatile
First, Weight Watchers has – and long has had – quite a bit of debt. It closed 2018 with about $1.5 billion of borrowings, net of its cash.
That magnifies the effect of valuation changes on the price of Weight Watchers stock. At those July peaks, including net debt, WW was valued at about $8.5 billion. At the moment, the enterprise value of Weight Watchers stock is closer to $3 billion. That’s a roughly 65% decline, but it’s not as big as the share price decline would suggest.
The other, larger issue is incremental margins. Each additional subscriber is hugely profitable for Weight Watchers. But the company also loses at great deal of profits when it loses subscribers, so its margins move wildly. Between 2013 and 2015, its adjusted operating margin fell from 26.5% to 16.3%. Revenue over those two years tumbled by $560 million, and its adjusted operating profit dropped by nearly half that.
Essentially, Weight Watchers stock is doubly leveraged: first on the balance sheet, and then in the operating model. When the company adds subscribers, its operating profit rises sharply. Thanks to the debt, those increases lead to even larger increases in net profit. Those profits are amplified further by the increasing size of the equity value in comparison with the company’s total valuation.
In that context, the huge movements of WW stock make more sense. This is a stock that can soar when its subscriber growth looks positive and plunge when customers start fleeing. Both have happened over the past few years.
Be Careful With Weight Watchers Stock
The history of WW, and the nature of the model, highlight why it’s risky to call a bottom of WTW stock. Subscribers are heading in the wrong direction, which is the key reason why Weight Watchers stock plunged after WW reported disappointing Q4 earnings in February. And the company’s second-quarter subscriber numbers contributed to the first leg down last summer.
On the Q4 conference call, CEO Mindy Grossman attributed the weakness in part to the increasing popularity of “keto” diets. But there may be more going here. Rival Nutrisystem, now owned by Tivity Health (NASDAQ:TVTY), has struggled in recent quarters. And Weight Watchers is embarking on a cost-cutting effort, which suggests management itself doesn’t see a reversal on the way in the near-term.
Fundamentally, too, WTW looks problematic. Its 2019 EPS guidance was close to stunning: the company projected EPS of just $1.25-$1.50 for the year. The consensus EPS outlook heading into the report, at $3.53, was more than twice even the high end of the guidance range. And the guidance suggests that WW’s earnings will drop by more than half in 2019.
Yet Weight Watchers stock still trades at 14 times the midpoint of its guidance. That’s a figure that suggests the company will grow going forward. To justify that valuation, Weight Watchers must start improving in 2020, and the company itself doesn’t expect that to happen until the second half of this year at the earliest.
The company’s declining profits could also negatively impact its debt. WTW predicts that it will end 2019 with debt of roughly four times its EBITDAS (earnings before interest, taxes, depreciation, amortization, and stock-based compensation). As a JPMorgan Chase analyst pointed out, that could violate its debt covenants, forcing it to make a huge prepayment this year.
On the Sidelines on Weight Watchers Stock
Where WTW traded in 2018 really has little bearing on what it should, or will, trade at in 2019. Looking at the company right now, I think it does not have a shortage of risks. Its earnings are declining, its subscribers are falling, and its debt is worrisome. And Weight Watchers stock is a classic “falling knife.” Yet WTW stock still is pricing in growth going forward.
All isn’t lost for WW. As history shows, WTW stock can quickly bounce back. But even the new, lower share price is baking in improvement. Given the risks posed by Weight Watchers stock, anyone who’s bullish on the shares must believe that WW will improve soon.
As of this writing, Vince Martin has no positions in any securities mentioned.