Weight Watchers (NYSE:WTW) has declined more than 50% in the last 12 months, but the fundamentals have continued to improve all the time. Investors have been quick to dump Weight Watchers' shares despite the favorable macroeconomic environment, improving fundamentals, and stellar performance in the recent past.
(Source – Koyfin)
This recent decline provides an attractive investment opportunity for growth-oriented investors, and the cyclical nature of subscriber growth might lead to another pullback when the company reports Q4 results, which would be a great entry point for investors.
Company overview and business strategy
Weight Watchers International Inc. is the largest provider of weight control programs in the world. The company is focused on promoting weight loss through exercise, nutrition, and portion control. The core business model of Weight Watchers includes providing 24/7 chat support and access to personalized features such as personalized coaching.
Weight Watchers is increasingly working toward differentiating their services from that of mobile healthcare applications and calorie counters.
Weight Watchers offers three pricing options to choose from.
(Source – Weight Watchers)
While the company offers a digital-only subscription which comes with options such as calorie counting, diet management, and healthy meal recipes, the standout offering of the company is the Studio+Digital plan, which comes with weekly insightful lessons from an expert and the ability to network with fellow members on a weekly basis.
Weight Watchers has not only expanded their reach in the U.S., but has worked toward making an impact on a global basis. Global expansion activities would be vital for the future growth of the company, as the U.S. market is becoming increasingly competitive, which might lead to a loss of market share.
(Source – Company presentation)
The core business strategy of the company is to increase its recurring revenue base by attracting new subscribers, for which there are plans ranging from marketing activities to loyalty programs.
Over the last few reporting periods, the company management placed a special emphasis on the importance of effective cost management as well, which is another business strategy of the company.
On top of these strategies, what stands out as the most important strategic initiative is the shift toward providing more personalized services. The healthcare industry is embracing personalized solutions, which has not only created new pathways for companies to grow, but has also given rise to new challenges for companies operating in the healthcare industry. I believe the company is certainly taking the correct steps toward becoming a more personalized weight loss solutions provider, which might provide the company with an edge to stand out as the leader of the pack.
These future plans will be discussed in more detail in the next segment.
Industry analysis and future outlook
The weight management industry has gained traction over the last few years, and is now a major focus area of healthcare solutions providers. In line with the growing popularity of weight management, the demand for healthy food has soared.
Not surprisingly, the results of a survey involving 2,000 Americans provide proof that eating healthier is one of the most important objectives of majority of participants.
(Source – Statista)
Another important development is the popularity of healthy eating among millennials, who are more inclined to embrace tech-based solutions to maintain a healthy lifestyle.
(Source – Statista)
The improving outlook of the industry provides healthcare companies a massive growth opportunity, which could translate into billions of dollars in profits if exploited correctly. Weight loss and healthy diets are at the forefront of the changing industry outlook, and companies are already lining up to serve the demand for weight loss and healthy eating solutions. Therefore, industry-wide competition is expected to increase in the future, which could result in an uptick in spending for marketing along with the possibility of price wars. This can be considered a negative development, but in my opinion, there is still room for companies to grow exponentially before reaching a stage of measured growth.
Weight Watchers has made a couple of strategic moves to benefit from the expected industry-wide growth. Some of these key initiatives are discussed below to provide some color on the future outlook of the company.
SmartPoints is an alternative method of counting calories that we intake, and is intended to change the traditional method of counting calories with a view of maintaining or losing weight. SmartPoints system emphasizes the need to eat healthier food rather than to intake a specified amount of calories per day, which is on par with the latest industry trends. I believe a system like this has the ability to engage more users with the platform, which would eventually result in a higher customer retention ratio for the company. An engaged user base is more likely to go for annual subscription options as well, which would boost revenue for Weight Watchers.
(Source – Company website)
Beyond the Scale
Beyond the Scale is a platform launched by Weight Watchers to add a touch of personalization to its offering. The platform is based on a personal assessment that captures information regarding lifestyle, goals, and challenges to provide a personalized action plan for users. The platform integrates SmartPoints to provide more insights into daily calorie intake of users as well, and is designed to provide a totally automated experience to its users.
(Source – Brand Channel)
Beyond the Scale will be a driver of growth in the coming years, as this provides users with the all-important touch of personalization, which is becoming a theme in the healthcare industry. In addition, this platform does not urge its users to commit to a fixed diet, but rather, provides an automated solution which develops long-lasting habits. Weight Watchers is using Beyond the Scale platform to guide its users to shift their lifestyles toward a healthier one, which I believe is a strategy that will drive future revenues for the company.
Networking has never been any popular than it is today, and Weight Watchers is focused on using this to their advantage. Not only does it provide users with a platform to connect with like-minded people, but also addresses a key development of the modern society; social interactions taking the center stage.
In my opinion, the Connect community is slowly building a network effect, as the growing community adds value to existing users.
(Source – Weight Watchers)
As the community grows, switching costs will eventually increase, which will result in a higher percentage of retained subscribers. The move to develop a platform to enable networking among users is a commendable measure, as this has the potential to create value in the long run.
Rewards and loyalty programs are instrumental in building a loyal customer base, which is true for almost all companies. A retained customer base is likely to drive repeat sales, and in addition, will be a key growth factor in a macroeconomic environment where competition is heating up.
(Source – Zinrelo)
WellnessWins is a free to participate loyalty program established with the aim of engaging its user base and keeping them motivated through attractive rewards. The mere fact that subscribers are rewarded for shifting for a healthier lifestyle is sufficient to drive user engagement with solutions provided by Weight Watchers, which will be a key in achieving future growth targets.
The tiered rewards structure promotes more user engagement with the solutions range marketed by the company.
(Source – Weight Watchers)
Weight Watchers has entered into a couple of partnerships to provide a more streamlined, innovative experience to its users.
The company has partnered with Aaptive, which is a platform that provides personalized audio workouts led by expert trainers, and a free 90-day membership to Aaptive is bundled with Weight Watchers subscriptions.
Headspace is another platform which Weight Watchers has partnered with to provide guidance on meditation as a means of improving mindfulness and mental health. Once again, a free 90-day membership is up for grabs for Weight Watchers subscribers.
These partnerships are enhancing the value portion of Weight Watchers’ solutions, and will be a reason for users to stick with the company. Even though the free trial is valid for a limited period of time, these partnerships will be key to becoming an all-in-one solutions provider for weight loss and healthy living.
The macroeconomic environment is favorable for Weight Watchers, and the company has initiated certain strategic programs to keep its user base involved and engaged with solutions provided by the company. Along with the industry-wide growth expectations, I believe Weight Watchers would be successful in building a loyal customer base, which would translate into higher profits along the way. Increasing competition will be an obstacle in the near term, but there is room for growth outside the U.S. as well, which will provide the company with a robust growth opportunity.
Analysis of financial performance
Despite a sharp drop in revenue in 2014 and 2015, Weight Watchers has been able to regain some lost ground over the last 3 years, and revenue has grown at a stellar rate during this period.
(Source - Author prepared based on data from company filings)
On the back of this revenue growth over the last 3 years, profit margins have improved considerably during the same period. Management initiatives to effectively manage costs, and the improving business conditions were the drivers behind this margin expansion.
(Source - Author prepared based on data from Morningstar)
A noteworthy trend is the growth seen in digital subscription revenues, which is on par with the disruptive growth seen in digital related content over the last several years. As higher competition kicks in, investors should expect a slowdown in the growth rate, but the company will still be able to grow at a better than average rate considering the initiatives taken to secure recurring revenues.
(Source – Form 10-Q)
On the back of strong top line growth over the last 3 years, Weight Watchers has been able to improve its free cash flow generating ability as well, which will help growth operations of the company in the future. In addition, growing free cash flow will prompt the company to establish a dividend policy once again, which will drive shareholder returns.
Low earnings and bleak future outlook prompted Weight Watchers to suspend its dividend back in 2013, which was a heavy blow to investors. I continue to believe that Weight Watchers might consider distributing excess returns via dividends if growth remains strong and its ability to generate cash persists.
(Source - Author prepared based on data from Morningstar)
Weight Watchers has certainly improved their financial performance over the last 3 years, and I expect the company to continue this growth in the near future.
Investors need to consider the cyclical nature of member recruitment as well.
(Source – Company presentation)
It is evident that the first quarter of each year has seen the highest growth in subscribers, which is a trend observed and acknowledged by the management. Investors who are waiting on the sidelines to invest in Weight Watchers should be encouraged by this pattern, as a possible pullback of share price will present an attractive entry point.
Despite the expected increase in competition in the industry, I believe Weight Watchers will post solid results in the coming reporting periods, which should help regain some lost momentum in the share price. Any price pullback seems to provide investors with an attractive investment opportunity, but this needs to be verified by arriving at a fair value estimate.
In order to determine a fair value estimate, I have used a two-stage Discounted Cash Flow (DCF) model, as I believe the company will grow at a high rate initially before settling down for a sustainable rate of growth.
- High growth period of 5 years.
- Revenue growth of 12% in the high growth period.
- Effective tax rate of 12%.
- Operating margins to fall close to 21% at the end of the high growth period, and remain around 20%.
- Beta of 1.5 in the high growth period, and 1.1 in the stable growth period.
- Weighted Average Cost of Capital (WACC) of 10.5% in the high growth period.
(Source - Author's assumptions and calculations)
Through this model in which I have used conservative assumptions about the future prospects of Weight Watchers, I arrived at a fair value estimate of $53.85 per share. This represents an upside of 69% from the current market price of $31.
However, my fair value estimate falls well short of the average consensus price target, which is $82.13.
(Source – Tip Ranks)
The recent share price pullback offers investors with an attractive investment opportunity, and growth investors should be keen to invest in Weight Watchers at the current market price of $32.
A fair value estimate that represents a massive upside does not necessarily equate into profits, unless otherwise there are catalysts that can drive the share price toward the fair value estimate in a given period of time.
In the case of Weight Watchers, there are few catalysts at play which might help the share price converge with its fair value estimate within a short period of time.
One major catalyst is the favorable industry outlook. As discussed earlier, most Americans are now concerned about their lifestyle preferences, and this presents a sizeable growth opportunity to Weight Watchers. The real growth factor is the interest shown by millennials to lead a healthy life. Millennials will certainly boost the demand for technology-based solutions to achieve their goal of shifting to a healthy lifestyle, and the company management has already taken steps to tackle this growing demand by younger generations. Invite a Friend is one such initiative aimed at attracting the younger generation.
The second catalyst is the networking features introduced by Weight Watchers. An opportunity to network with like-minded people not only adds value to the user, but also increases switching costs of the platform. I believe switching costs will continue to rise and these intangible assets will drive the value of the platform, eventually resulting in higher pricing power to the firm.
Growth in the international segment will be another catalyst, as regions outside the U.S. are relatively less competitive.
Finally, I believe Weight Watchers will establish a dividend policy to distribute excess returns to shareholders in the future. This will boost investor confidence, and the share price will benefit from a renewed interest from market participants.
Risks and challenges
The rise of free mobile applications that track calories and other weight-related metrics poses a major threat to the continued success of Weight Watchers. Along with this increasing competition from both free and paid solutions providers, Weight Watchers would be forced to improve their product offering to stay profitable in their business operations. In order to do this, the company would most probably engage in aggressive marketing campaigns, but results can never be guaranteed with the rise of free to use applications. A failure to secure their market share will lead to a loss of revenue and the profitability will eventually decline.
Another significant risk to the business model of Weight Watchers is the rapid improvement of the healthcare industry. Even though we might be years away from such a phenomenon, healthcare companies might come up with a faster and reliable solution to tackle obesity, which would divert users away from counting calories and sticking to a weight loss plan.
The business model of Weight Watchers depends on customer loyalty, and breakthrough healthcare solutions by large tech companies such as Apple (NASDAQ:AAPL) might prompt users to ditch Weight Watchers.
Weight Watchers has gained momentum from the lows seen in 2015, and the company has introduced a line of digital services to address the growing demand for weight-monitoring applications. Shares have plummeted in the last 3 months, and is currently not representative of the expected future growth. This provides investors with an attractive investment opportunity with an upside of 69%, and I rate Weight Watchers a strong buy at the current market price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.