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Don't Let the Fear Hold You Back

Friday - 2/1/2013, 11:24am  ET

It has been a topsy turvy ride for the shares of Herbalife over the last one year. After hitting an all-time high of $73 in April, the stock has seen a 50% correction. Initially, it was a speculation that David Einhorn had shorted Herbalife (based on some questions he asked on the company's 1Q earnings conference call) that sent the company’s stock plummeting more than 20% in seconds. The company again became the center of attention last month after another renowned hedge fund manager Bill Ackman from Pershing Square Capital management, revealed a large short position in the stock. Just when the company seemed to be recovering from the setbacks, the shares toppled 8.2% after the Federal Trade Commission announced that it is shutting down Fortune Hi-Tech Marketing for being a pyramid scheme. Although the FTC announcement did not have anything to suggest that Herbalife is doing anything wrong (there was no mention of Herbalife in the FTC’s conference), the back to back attacks have triggered uncertainty and negative sentiments among investors. But being too fearful can be just as costly as being too greedy.

Whether Herbalife is indeed operating in a pyramid structure is difficult to say at this point. What cannot be overlooked is the fact that the company has posted a phenomenal revenue growth of 25% per annum over the last 32 years. From a relative valuation standpoint, Herbalife's appears significantly undervalued based on the company's solid financial performance relative to its peers. Let’s compare the valuation metrics, dividend yield and growth rates of Herbalife with Nu Skin Enterprises and Church & Dwight .

Based on these metrics, Herbalife is the clear winner. Herbalife is trading at a 62% discount to Church & Dwight despite having a significantly better expected growth rate. Thus, the stock appears to be highly undervalued on a PEG basis. Nu Skin is also worth a look given a PEG ratio of just 0.77 and an expected EPS growth of 38% in the recent quarter. Both Herbalife and Nu Sin score over Church & Dwight in terms of margins. Church & Dwight’s gross margin (~40%) are almost half of Nu Skin and Herbalife (~80%).
Herbalife also offers the maximum dividend yield among these companies which is a good luxury to have in this world of low interest rates. The following are some other reasons that make me bullish on this stock.

Exposure to highly attractive nutritional supplement market
The worldwide supplement industry has seen tremendous growth over the last decade (growing at nearly ~10% annually over this period) and its current market size is estimated to be close to $180 billion. As a result of consumer education campaigns emphasizing general health and well being, Nutrition supplements now enjoy wide acceptance in the United States with more than half of adults taking vitamins and supplements each day and around 10% of the population popping more than five supplements a day. Going forward, I remain confident about the growth story that is emerging in the nutritional supplement market given favorable macro factors (like aging population and rising obesity rates), increasing acceptance of non-traditional therapies and growing demand for lower-cost alternatives as a quick nutritional fix. Thus, I remain confident about the company’s growth prospects given its portfolio of affordable products.

Huge long term growth opportunity in China
In my opinion, China can be a potential game changer for the company. While its peers generate a large chunk of their revenues from China, Herbalife lacks penetration in this geography. China still represents Herbalife's smallest region sales-wise and thus, I see a huge opportunity for additional expansion. Encouragingly, the company is doing well in China, with net sales and volume point growth of 39% and 41%, respectively, in the third quarter compared to the prior-year period and I expect the trend to continue for many years to come. 

There is no denying the fact that the wellness industry is growing at a rapid pace and Herbalife looks well positioned with its portfolio of affordable products. The company has a vast scope for additional expansion and China could prove to be the potential game changer. I would recommend investors to exploit the short term negativity around this stock and grab this buying opportunity backed by strong future prospects.

This article was originally published as Don't Let the Fear Hold You Backon Fool.com

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