Watching Weight Watchers

WW is a subscription-based health-as-a-service company. 🙂

It makes money from physical meetings (60% of sales), and online-memberships (30%). Licensing and products complete the revenue mix . It is asset-light, has negative working capital, and sports extraordinary returns on capital. ROIC is often around 30%.

EBIT is approx 25% of sales. CapEx is comparable with D&A. Interest and taxes eat into half of EBIT, so FCF/sales is approx 12-13%, typically.

The company has high leverage; both operating and financial.

Sales and EBIT peaked in 2012 ($1.8B/$550M), bottomed in 2015 ($1.2B/168M), and have bounced back somewhat to ($1.5B/350M) TTM. You can see operating leverage at work. A 30% drop in sales caused a 60% drop in EBIT (2012-2015), and a 25% bounce back (2015-2018), doubled EBIT.

Financial leverage has come down 30% from its peak of $2.4B in 2013 to about $1.6B in the latest qtr. Nevertheless the company is still very levered (LT debt is about 4x EBIT; down from 12x at peak). Interest payments still eat up nearly half of EBIT (currently $2/share of interest payments). Its interest rate is high at 8-9%, probably because it doesn’t have much in the way of physical collateral. If interest rates rise at the “wrong time” it could bode trouble.

Leverage coupled with an annual cycle that relies heavily on marketing in the winter, and  exposure to dieting fads and trends (Atkins, myFitnessPal, keto etc.) guarantees drama. The stock is extremely volatile: its roundtrips between $15 – $90 are frequent, fast, and furious.

On the plus side, FCF has been positive through bad times, including the Great Recession, and during its largely self-inflicted near-death experience in 2013-2015. The business is a cash machine: FCF regularly exceeds net income. Significant portion of the stock is held by long-term holders Artal (46%) and Oprah Winfrey (10%).

WW is currently slated to year between $1.40 and $1.90 EPS over the next two years. Given the risk inherent one might want to value it at a low multiple – say 12x. This gives us a working range of $17-$23, with a mid-point of about $20 – almost exactly where WW has been trading recently. So perhaps, the market knows all.

However, there may be a way to play this if we believe that both operating and financial leverage are trending in the right direction. The volatility and spikes in short interest in the stock are insane. For example, the Jan 2020 ATM options have an implied volatility in the 50-60% range implying a +/- $10 swing ($10 –  $30 price range).

Based on fundamentals, the likely maximum downside seems to be $10-$15, unless a perfect tsunami hits (much higher interest rates, another poor recruitment year or two). So here is a reasonable scenario to bet on. FCF/share in 3-4 years rises to $3. At a 15x multiple, this thing could easily trade at $45 for an IRR of 25-30%. Of course, there is a wide range of possible outcomes; but positive surprises seem more likely than negative ones, in my assessment.

So given the upside-downside scenario, and the volatility, here’s my plan for “play” WW: Use puts to accumulate a position near $15, and write calls near $25, never letting the total position exceed 1% of assets. I’ll report on how badly I get burnt by trading this, in a year or so :).

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