Description

Executive Summary

NUTR, headquartered in Park City, Utah, is a manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products that are sold through domestic heath food and natural food stores.  NUTR was formed by Bain Capital in 1993 to roll-up smaller firms within its fragmented industry.  NUTR currently sells over 3,000 SKUs domestically and over 650 SKUs internationally.  NUTR employs a sales and marketing force that sells its products to the Health Foods Channel which it defines as roughly 15,000 retailers comprising: (1) independent health and natural food stores, (2) health and natural food stores affiliated with local, regional, and national health and natural food chains (including Wild Oats, Whole Foods, Vitamin Shoppe and Vitamin World) and (3) GNC stores.  Currently, NUTR products are carried at 8,500 retail locations.  Management believes that within the Health Foods Channel it has a 6% to 7% market share.

 

Key statistics of NUTR are as follows:

 

Annual revenues (TTM)            $151.5 million

EBITDA (TTM)                       $28.1 million

Net income (TTM)                   $14.3 million

Current share price (8/10)         $14.00

Enterprise value                        $162.0 million

TEV to EBITDA                      5.7x

P/E Ratio                                  11.2

Price to tangible book               2.4x

Expected growth rate                1% - 3% (absent acquisitions)

Dividend yield                           N/A

Share repurchases (last 2yrs)    $9.2 million

 

As you will read below, NUTR is competing in a highly fragmented industry with fairly intense competition.  Given the fragmented nature of the business, NUTR has become a mid-tier player and should be able to continue acquiring firms until a larger player eventually buys out NUTR.  NUTR has both recognized brands and solid distribution.  The recent down trend in earnings and demand for products across the industry represent an opportunity to enter this industry at an attractive point.  NUTR has done a good job paying down debt and should be able to finance an acquisition of some size once one is located.  Acquisition opportunities should be plentiful as some smaller players appear to be suffering given the overall slowdown.

 

While this business is attractive, the entry point is critical.  One of the analysts who has followed this stock for a long time, David Block of Seidler (David Block left Seidler to start a hedge fund), recommended buying only when the PE ratio is in low double digits as it is currently.  We believe that a stock price of over $18 is achievable within the next 12 months as operating results improve and sales grow.  NUTR is the most attractively valued public firm in its industry.

 

Business

NUTR, headquartered in Park City, Utah, is a manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products that are sold through domestic heath food and natural food stores.  Currently, NUTR products are carried at 8,500 retail locations.  NUTR was formed by Bain Capital in 1993 to roll-up smaller firms within its fragmented industry.  NUTR currently sells over 3,000 SKUs domestically and over 650 SKUs internationally.  The products come in a variety of forms such as capsules, tablets, softgels, chewables, liquids, creams, sprays, powders and whole herbs.  Unlike many of the myriad of firms competing in the industry, NUTR does not seek to develop home-run products, but rather has a diverse line-up of solid sellers.  The most popular product is a Red Yeast Rice product which accounts for 2.5% of sales.  The sales clerk at Wild Oats said the Red Yeast Rice products are flying off the shelves.

 

NUTR does not sell its products to mass merchandisers.  The largest chains sold by NUTR are Whole Foods and Wild Oats.  The top three customers of NUTR are Whole Foods, Wild Oats and Vitamin Shoppe and none of these three customers is over 5% of sales.  Instead of focusing on the mass channel, NUTR employs a sales force to target the Health Foods Channel which it defines as roughly 15,000 retailers comprising: (1) independent health and natural food stores, (2) health and natural food stores affiliated with local, regional, and national health and natural food chains (including Wild Oats, Whole Foods, Vitamin Shoppe and Vitamin World) and (3) GNC stores.  Management believes that within the Health Foods Channel it has a 6% to 7% market share.  NUTR employs its own internal sales and marketing force of 70 dedicated employees who are regionally deployed to sell and service these accounts.

 

NUTR has the following broad portfolio of brands given its history of acquiring business:

 

            Solaray – Top brand comprising over 60% of sales

            KAL

            Nature’s Life

            Natural Balance

            NaturalMax

VegLife

Premier One

Pioneer

Sunny Green

Natural Sport

FunFresh Foods

ActiPet

Action Labs

Thompson

Montana Big Sky

Body Gold

Healthway

Monarh Nutritional Laboratories

Woodland Publishing

 

Retail Stores operate under the names: The Real Food Company, Thom’s Natural Foods, Cornucopia Community Market, Arizona Health Foods, Pilgrim’s Natureway and Granola’s.

 

The manufacturing of over 80% of the products sold in the most recent fiscal year was performed in-house.  Other than the retail locations operated in Northern California and Arizona, all of the operations of NUTR are conducted in Utah - primarily Ogden and Park City.  NUTR has 633 full-time employees and 123 part-time employees.

 

NUTR believes that its 25 owned retail store locations provide good feedback to management and R&D personnel on changing consumer preferences and providing shopping cart data on which products are typically purchased together.  Currently, the retail locations are operating at break-even and represent roughly $18 million of sales.  Management is working to improve the profitability and believe that margins of 5% to 10% should be achievable in the next 12 to 24 months.

 

As noted above, NUTR grows through acquisition.  The CFO indicated that he always has at least 10 deals that are in various stages of being evaluated.  Late in fiscal 2005, he said that there were two deals that he hoped to close that would have nearly added $70 million in sales.  Both those deals fell apart for separate reasons.  Generally, NUTR tries to buy firms at a 4x to 6x EBITDA multiple which, in NUTR’s hands, becomes a 3x to 4x EBITDA multiple as synergies are realized.

 

During my due diligence, I visited several retailers including Whole Foods, Wild Oats and also some smaller outlets.  At both Whole Foods and Wild Oats NUTR is one of the dominant suppliers in the vitamin department and probably supplies 25% to 30% of the SKUs at Whole Foods and 15% to 20% of the SKUs at Wild Oats..  NUTR has a goal of supplying all retailers with 25% to 30% of their SKUs.

 

Industry issues

Growth rates for the vitamins, minerals, and herbal supplements industry (VMS) have substantially slowed in the last several years.  In the mid 1990’s, following the passage of the Dietary Supplement Health & Education Act of 1994, the industry was growing at double digit growth rates with peak growth of roughly 14% per year in the 1995-1997 timeframe.  Sales since that point have slowed dramatically: 11% in 1998, 6.5% in 1999, 5% in 2000, 4.5% in 2001 and just barely 4% in 2002.  Since 2002, sales rates have somewhat rebounded to a 6% increase in 2003, and estimates of longer range growth are between 4% to 5% over the next 10 years.  VMS industry sales were estimated at $20.3 billion.  While the industry may grow at 4% to 5% much of this growth is from weight loss products and sports related products both segments which have a smaller impact on NUTR.

 

In 2004, the industry got some disturbing news related to several studies of Vitamin E which seemed to link high doses of Vitamin E to an increase in one’s chance of dying.  This was a big reversal from earlier studies which indicated that there was no risk of taking Vitamin E and that there were actually benefits toward preventing cardiovascular disease.  Several issues with that study have been highlighted including the fact that the most recent survey was really a data-mining search of 17 prior studies some of which dated back more than a decade.  Further, many of the individuals studied were older and had chronic illnesses to begin with.  Regardless of the validity of the study, the damage over the last year has been done as sales have fallen for most industry participants.

 

Looking forward, several factors should help to drive industry growth.  These are as follows:

 

• Aging population – There is going to be a substantial increase of persons over age 65 in the US during the next ten years.  THIS WILL BE A HUGE DRIVER.
• Rising healthcare costs – Costs are increasing at such a rapid rate that consumers are seeking lower cost and longer term preventative treatments to combat the rising costs of healthcare.
• Increasing focus on fitness – Fitness club and gym membership is growing at very rapid rates in the U.S. as more and more people become focused on a healthy lifestyle.  From 1990 to 2003, health club memberships increased from 20.7 million members to 39.4 million members.  Most interesting, for the period between 1987 and 2003, the 55-and-older health club member segment grew 353%.
• Increasing obesity – Currently it is estimated that over 65% of people in U.S. are either overweight or obese.  Further, estimates show that 50% of the U.S. population are currently dieting.

 

The combination of these factors should keep up growth rates for the VMS industry.

 

Competitors

There are a wide range of both public and private firms that compete with NUTR.  The only firm that is truly a direct comparable with NUTR is NBTY, Inc. (NBTY).  Other firms compete, but they either manufacture store branded merchandise, offer distribution through multi-level marketing or are non-diversified firms with a few hit products that drive results.  The scariest firms of all are the non-diversified firms with a hit product.  They look great for a few quarters, or years, and then the fad falls apart and so do the financial statements.  Both NBTY and NUTR are on the other side of the spectrum from the fad players because they both offer extremely broad product lines that are not fad related and are sold through a diverse network of retail stores.  Both NUTR and NBTY have owned stores.  Further, GNC which is currently owned by Apollo is expected to come public on 8/11/06.

 

NBTY, Inc. – (AMEX: NTY) – is a large manufacturer, marketer and retailer of nutritional supplements in the U.S. and abroad.  NBTY does about $1.7 billion in sales and sells its products through mass merchandisers, drug stores, supermarkets, pharmacies, health food stores, direct response and its own store chain comprising 1,255 stores evenly split between the U.S. and abroad.  Sales by major division are as follows: Wholesale 43%, North American retail 13%, European retail 33% and Direct response, 11%.  NBTY carries a broad product array of over 22,000 products.  Key brands carried are: Nature’s Bounty, Solgar, SISU, Sundown and Puritan Pride.  NBTY also owns the specialty brands Osteo-Bi-Flex, Met-Rx, Flex-A-Min and Knox.  From filings, NBTY has noted its intention to exit some of its retail stores in fiscal 2006, possibly up to 50 of its Vitamin World stores that are weak performers.  NBTY is planning on exiting stores where it cannot renegotiate the leases at more favorable terms on renewal.  Further, NBTY is struggling to integrate its acquisition of Solgar which it completed on August 1, 2005.  Solgar was doing roughly $105 million in annual sales and NBTY paid Wyeth $118.4 million for Solgar.  The Solgar deal gives NBTY a deeper penetration into the natural food and health food stores.  Solgar was carried in 5,000 locations. 

 

Interestingly, NUTR really wanted the Solgar acquisition, but only NBTY was contacted for a bid as there were some relationships that kept all other bidders out.  After learning of the sale process, NUTR submitted a bid $15 million in excess of the NBTY bid, but it was rejected by Wyeth.

 

NBTY uses a two tier approach to sell to the wholesale market by offering certain brands to the mass channel and other brands to the natural food and health foods stores.  NBTY employs 11,200 employees and manufactures over 90% of its own products.  During the most recent fiscal year, NBTY had one undisclosed customer that represented roughly $100 million in sales, or 6% of total sales.  NBTY ceased selling all ephedra products in March 2003.  NBTY has seen its profit margins fall over the last three years from 53.5% in fiscal 2003 to 48.4% in fiscal 2005 mainly due to product pricing incentives offered to stimulate demand.

 

Nature’s Sunshine Products, Inc. – (AMEX: NATR) – is a manufacturer and multi-level marketing company which sells a line of over 700 products including herbal products, vitamins, mineral supplements, personal care, nutritional drinks and miscellaneous other products.  NATR sold $331 million of products in the year ended 12/31/04.  NATR sells products both in the U.S. (69% of sales) and abroad (31% of sales) through a multi-level marketing structure comprised of 665,000 active distributors of which approximately 223,000 are in the United States.  The largest distributors selling the highest volume earn the “Manager” and there were roughly 21,600 (9/30/05) of these individuals of which 6,000 were located in the U.S.  The managers resell product purchased directly from NATR to the distributors.  Turnover of the sales force seems pretty high as roughly 20% of the distributors and 60% of the managers renew their status annually.  The products offered by NATR are not unique.

 

Given the multi-level marketing structure, NATR generally collects payment for its products prior to shipping on either a credit card or by cash.  As with most multi-level marketing firms, the product gross margins are huge.  NATR has gross margins in the 80% range and selling costs to compensate the multi-level structure are roughly 40% of sales.  NATR ran a dutch tender in August 2005 to repurchase 500,000 shares of its stock at a price of $21.75.

 

Perrigo Company – (NasdaqNM: PRGO) – manufactures and markets a broad line of over-the-counter and nutritional products for the store brand market.  PRGO generates annual sales of just over $1 billion.  PRGO sells products that are identical to the product formulations of the national brands, but at prices that allow the retailer to under-cut the national brands.  Such store brand products also generate a higher gross margin percentage for the retailer.  Key retail customers are: Wal-Mart, CVS, Walgreens, Albertson’s, Kroger, Safeway and Dollar General.  Overall, PRGO has 300 customers and sells 1,300 different products.  I don’t get the sense from reading their filing that their vitamin, mineral and supplements business is the main driver of sales. Actually, Perrigo could be a good short opportunity because of some changes with pseudoephedrine products.  Pseudoephedrine can be used to make the addictive drug crystal meth.  Accordingly, two large mass merchandisers are in the process of either completely eliminating the product or moving a reformulated version of it behind the counter in the pharmacy.  Sales of products containing pseudoephedrine represented almost 20% of PRGO sales. 

 

 

Natrol, Inc. – (NasdaqNM: NTOL) is engaged in the manufacturing and marketing of a full line of dietary supplements, herbal teas, nutraceutical ingredients and sports nutritional products under three brands: Natrol, Laci Le Beau (teas), and Prolab (sports nutritional).  The nutraceutical ingredients sold to other manufacturers are sold under the Essentially Pure Ingredient brand and accounted for 2.3% of sales in 2004.  Natrol’s top 10 customers represented 48% of total sales in 2004.  Natrol sells its products both to health food stores and health food chains as well as to the mass channel.  For the health food store market, Natrol primarily uses distributors such as United Natural Foods, Nature’s Best and Tree of Life.  Natrol sells products to health food chains such as Wild Oats, Whole Foods, GNC, Fred Meyer Nutrition Centers and The Vitamin Shoppes.  Natrol also sells its products through mass retail including: Walgreens, Albertson’s, Brooks/Eckerd, BJ’s Wholesale Club, HEB, Costco, Rite Aid, Sam’s, Hannaford, Von’s, CVS Long’s Drug, Wal-Mart, Dominick’s and Kroger. No customer is greater than 10% of sales.  Product returns have been a big problem historically for Natrol with returns due to product expiration, damage or simply not selling.  Returns have been declining and were down to 3.5% of sales in 2004 and have been as high as 14.5% in past years.  In 2003, Prolab abandoned its unprofitable multi-level and direct marketing units. 

 

In 2004, both the Ester-C line and Carb Intercept line represented more than 10% of sales, however, in 2005, the sales of Carb Intercept have dramtically slowed as consumers have abandoned the carbohydrate avoidance fad of the last few years and, accordingly, overall sales for the first nine months of 2005 were off 15% from the prior year.  The loss of these sales have led to overall net losses in 2005 and NTOL’s stock has suffered and the stock is off almost 50% in the last year.  At some point, NTOL might represent an attractive acquisition opportunity for someone as the firm has trailing 12 month sales of $70 million and an enterprise value of $25 million.  A strategic buyer could likely rationalize the cost structure and make a more reasonable return on sales.

 

Herbalife, Ltd. – Public (NYSE: HLF) – offers weight management, nutritional supplement, and personal care products in the United States.  Its weight management product portfolio includes meal replacements, weight-loss accelerators, and various healthy snacks.  The company’s collection of nutrition products consists of dietary and nutritional supplements, each containing herbs, vitamins, minerals, and natural ingredients are sold by a multi-level sales operation.  Herbalife also offers personal care products, including skin cleansers, moisturizers, lotions, shampoos, and conditioners.  As of December 31, 2004, the company operated in 59 countries located in the Americas, Europe, other parts of Asia/Pacific Rim, and Japan.  The company was founded in 1980 by Mark Hughes.  It was formerly known as WH Holdings (Cayman Islands), Ltd. and changed its name to Herbalife, Ltd. in December 2004. Herbalife is based in George Town, Cayman Islands for tax purposes, but the executives reside in Los Angeles.

 

General Nutrition Centers, Inc. – Private (Owned by Apollo) – is the largest specialty retailer of nutritional supplements including sports nutritional products, diet products, vitamins, minerals and supplements and other specialty supplements.  GNC offers its products through a network of over 5,700 stores of which nearly 5,000 are in the U.S. and over 700 stores operating internationally.  During fiscal 2004, GNC generated $1.3 billion in sales.  Of the GNC store network, 2,642 are stand-alone GNC stores that are company owned, 1,027 are store-within-a-store locations inside of Rite Aid stores and the remainder are franchised locations.  The majority of stores are 1,000 to 2,000 sq. ft. in size.  At its stores, GNC offers both its own proprietary products and branded products sourced from third parties.  Roughly 50% of the revenue generated at company owned stores is from sales of GNC branded products.  GNC generates about $1 billion of sales from its retail stores, $227 million of sales from franchised stores and $116 million from manufacturing goods for third parties.

 

Country Life – Private (Family Owned) – provides nutritional products. Its product line includes amino acids, digestive enzymes, herbal products, herbal extracts, sports and fitness products, sports nutrition products, performance nutrition products, multiple vitamin-mineral formulations, and various nutritional supplements. The company supplies its products through health food stores in the United States and distributes worldwide. Country Life Vitamins is based in Hauppauge, New York.

 

Enzymatic Therapy – Private (Owned by several partners) – engages in the manufacture and distribution of therapeutic dosage natural medicines and nutritional supplements. It offers various products for anxiety/sleep/wellbeing, blood sugar, bone health, digestion, energy, eye and heart health, immune system, joint health, kidney and bladder, liver and gall bladder, neurological support, respiratory health, skin and vein health, weight management, and sexual health. The company also provides educational materials and protocols for consumers and medical practitioners. Enzymatic Therapy, Inc. offers its products to health food stores, natural product retailers, and pharmacies. The company was founded by Terry Lemerond in 1981. Enzymatic Therapy, Inc. is headquartered in Green Bay, Wisconsin.

 

Garden of Life – Private – engages in the formulation, manufacture, and distribution of whole food nutritional products. Its products include Acid Defense that provides naturally occurring potassium, calcium, and other alkalinizing substances; Super Seed, a food blend of seeds, sprouted grains, and legumes; and Extra Virgin Coconut Oil, an unprocessed culinary oil with natural coconut flavor and aroma. The company also provides Goatein, a goat’s milk protein powder; Olde World, Icelandic cod liver oil; Perfect Food that includes green grasses, micro-algae, sea vegetables, whole vegetables, and their juices, as well as sprouted grains, seeds, legumes, and acerola cherries. Garden of Life, Inc. was founded by Jordan S. Rubin in 2000. The company is based in West Palm Beach, Florida.

 

Nature’s Plus – Private – engages in the manufacture and marketing of vitamins and nutritional supplements. The company offers various products for natural energy production, brain function, natural defenses, blood, antioxidant systems, weight management, capillaries, bones, electrolyte balance, immune system, digestion, urinary tract, prostate, and heart. Natural Organics, Inc. was founded in 1972 and is based in Melville, New York. (Sales estimated at $64 million).

 

Nature’s Way – Private - manufactures natural healthcare supplements. Its products include single herbs and herbal formulas, herbal extracts, phytomedicines, vitamins, minerals, probiotics, homeopathy, specialty formulas, and over-the-counter medicines. In addition, the company supports worldwide environmental programs; use recycled packaging materials; and sponsor alternative healthcare education. Natures Way is based in Springville, Utah.  (Revenues estimated at $25 million)

 

Now Foods – Private – manufactures vitamins, minerals, dietary supplements, natural foods, and health-related products. It also provides herbs, herbal teas, whole and functional foods, essential oils, cosmetics, and skin care products. The company was founded in 1968 and is based in Bloomingdale, Illinois.  (Revenues estimated at $51 million)

 

Twinlab – Private – offers a full line of nutritional supplements, including a complete line of vitamins, minerals, nutraceuticals, herbs and sports nutrition products.  The products are marketed at both mass merchandisers and natural food and health food stores, including Whole Foods and Wild Oats.

 

The list of competing firms could go on and on and on.  There are no shortage of firms competing in this Industry.  Some compete on one small product or a small family of products and many of the larger players noted above compete on a diverse line-up products.

 

Relative valuations are as follows:

Ticker Symbol	Current Price	52 Wk Low	52 Wk High	TEV	Price to Tang. Book	EBITDA Mult.	TEV to Sales	P/E
HLF	$29.33	$25.25	$41.21	$2,165.9	NM	7.6x	1.3x	16.3
NTOL	$1.70	$0.88	$2.94	$25.4	0.7x	NM	0.4x	NM
NATR	$9.00	$7.83	$23.89	$105.4	1.4x	3.8x	0.3x	8.2
NTY	$28.80	$15.54	$30.72	$2,093.1	4.6x	9.8x	1.1x	23.3
PRGO	$15.32	$12.76	$17.11	$2,026.2	4.2x	12.2x	1.5x	27.6
GNC	$17.00	N/A	N/A	$1,485.2	NM	9.9x	1.1x	Note 1
NUTR	$14.07	$11.51	$17.08	$159.7	2.4x	5.7x	1.1x	11.0

 

NATR appears cheap, but the company is currently subject to a number of shareholder lawsuits stemming from claims that management cooked the books.  Further there are issues with past financial statements and the company has made no SEC filings of its financial statements since the 3^rd quarter 10-Q of 2005.  Subsequently, Nasdaq has delisted the securities.  Accordingly, while the numbers appear cheap for NATR they may be wholly unreliable and accordingly we do not believe they are comparable.

 

Financial and Valuation

The following is a work-up of the current valuation and related multiples:

 

	Current
Current share price	$14.00
Fully diluted shares out.	11,478
Equity market cap.	160,692
(-) Cash	(2,150)
(+) Average Net Debt	3,500
TEV	162,042
		TTM
Measures (excluding inv. income):	TTM	Margins
Sales	151,520
Pre-tax profit	24,192	16.0%
Net income	14,326	9.5%
EBITDA	28,131	18.6%
Book value	91,096
Tangible book	65,980
Levered FCF	10,130
Unlevered FCF	11,898
Multiples:
Sales to TEV	1.07x
Pre-tax profit to TEV	6.70x
P/E	11.22x
EBITDA to TEV	5.76x
Share price to book	1.76x
Share price to tangible book	2.44x
Levered FCF Yield	6.30%
Unlevered FCF Yield	7.34%
Fair value EBITDA Multiple	7.50x
Implied enterprise valuation	210,983
Implied equity value (net of avg. net debt)	209,633
Current discount	48,941
Implied share price	$18.26
Discount to current price	30%

 

Capex was $6.8 million in fiscal 2005 and is projected to be $7 to $8 million in the current fiscal year.  The CFO indicated that a normal level of maintenance capex for this business is $3.5 to $4 million or slightly lower than depreciation.

 

Management of NUTR has no plans to institute a dividend, but there is a common stock repurchase plan in place and $3.4 million shares of stock were repurchased in the trailing twelve month period.  During the last two quarters share repurchases have shrunk the outstanding by nearly 1% per quarter.  I think it is highly likely that NUTR will do a large acquisition in the next 12 months that adds debt to the balance sheet, but the CFO indicated that they are being very methodical in this process and want to find things that will be accretive right out of the gates.

 

Typically sales are highest in the quarter that ends in March.  Management believes this is due to increased vitamin, mineral and supplement usage following New Year’s resolutions and the cold and flu season.

 

Key risks

 

The key risks to an investment in NUTR are as follows:

 

1. Regulatory risk that something changes in the regulatory framework related to the products that NUTR sells.  A prime example of this is would be the regulations enacted that effectively have ended the sale of ephedra.
2. Risk that a study or finding is released which causes consumers to lower their intake of herbs and vitamins.
3. A deficiency in the manufacturing of NUTR products results in damage to a consumer and/or a product recall.  NUTR manufactures over 80% of its own products.  Anything that damages NUTR’s reputation for producing safe quality products could be quite damaging.
4. Risk that the overall market for vitamins, minerals and supplements begins to contract.  Growth has already slowed substantially in the last five years.
5. Inability to source key ingredients required for products.  While NUTR does manufacture a larger percentage of its products, it requires substantial raw material inputs from third parties.

 

Ownership

 

Institutional owners hold over 75% of the outstanding shares.  Insiders own 17% of the outstanding shares.

 

DISCLAIMER:  this does not constitute a recommendation to buy or sell this stock.  We own shares of the NUTR and may buy shares and sell shares at any time.

Catalyst

1. Improving profitability
2. Major stock repurchases of 1% of outstanding per quarter
3. Clean balance sheet supports acquisitions or leveraged recap
4. Continued growth of major customers Whole Foods and Wild Oats
5. Great demographic trends