GNC Holdings: An Obsolete Business Model Facing Industry Headwinds (NYSE:GNC-DEFUNCT-3363) (2024)

Headquartered in Pittsburgh, Penn., GNC Holdings (GNC) -- the leading global retailer of wellness products and nutrition -- is illustrative of a growth company that previously delivered stellar earnings, yet is now transitioned into a declining phase. Consequently, the share price has been trending down to match its degrading intrinsic value. Accordingly, the stock traded more than 70% lower in the past year. Despite exhaustive efforts by stellar management, the supplement business is undergoing a fundamental shift, thus hampering any chances of a successful turnaround.

Source: StockChart

About GNC

As a prominent global retailer of nutrition, vitamin, herbal supplement, and weight loss products, GNC has built a dominant presence in North America with 3,400 corporate stores. There are also 1,164 domestic franchises, 2,371 Rite Aid stores-within-a-store, and 1,949 international units.Source: GNC

In "One Up On Wall Street," the illustrious investor Peter Lynch urged shareholders to pay attention to two key metrics -- same-store sales growth (SSSG) and the expansion of new units -- to gauge the prospects of a retailer. That said, despite GNC's large market share, its SSSG is on a decreasing trend since 2015. The figure further declined to 3.9% two years later. In addition, the firm is downsizing rather than adding more units. While the company is suffering from a catastrophic sales decline, a competing peer like Usana Health Sciences (NYSE: USNA) is enjoying a 9.5% sales increase for 2016. All that said, we shall explore the industry fundamental shifts that are decimating the company's traditional bricks-and-mortar business model.

Source: GNC

Industry Headwinds

In contrast to GNC's traditional bricks-and-mortar store -- which is costly with rent, staffing, and other overhead -- the wellness products market is undergoing a fundamental change due to the increasing prominence of e-commerce and multi-level marketing (MLM) operators. Accordingly, MLM is legal, cost-effective, and intrinsically has the strong sales advantage. Notably, sales leaders make a living through commissions, thus having extreme incentives for transacting a sale.

"It is the making of a sale that is the most basic single activity of any business. Without sales, survival is impossible. It is the making of repeat sales to satisfied customers that is the first benchmark to success. Yet, strange as it seems, the relative efficiency of a company's sales, advertising, and distributive organizations receive far less attention from most investors, even the careful ones, than do production research, finance, or other major subdivisions of corporate activity," stated the Father of Growth Investing, Philip Fisher.

Heeding the advice of Warren Buffett's teacher, we conducted field research using Fisher's "scuttlebutt" method to directly gauge the sales motivation of GNC vs. its peers. We found that the sales leaders of Nu Skin Enterprises (NUS) and Herbalife (HLF) are strongly motivated to recruit us as potential clients. However, the staff operating GNC's store were less interested in getting us to purchase the shakes. It appeared as if GNC's employees simply performed their nine-to-five duty rather than be motivated to advance their prospects like the sale associates of their peers.

MLMs aside, the other threats to GNC include online sales channels from small firms and independent sellers. This is due to the low barriers to entry inherent to the supplement business. One just needs a website, contract a manufacturer, and voila: Sales, sales, sales! Furthermore, the digital technology advancement is converting the population to e-commerce shoppers, thus strengthening competing peers' moat while weakening GNC's. To add further injury to the insult, there is seemingly no indication that this trend will reverse anytime soon.

In addition, grocery stores, Wal-Mart (WMT), and Amazon (AMZN) are exerting intense pressure against the traditional bricks-and-mortar businesses. These giant retailers can afford to lower product prices while still enjoying sizable profits to due larger sales volumes. Ultimately, these mammoths have shrunken the profits margin of GNC (as well as its competitors).

Turnaround

In the valiant efforts to turn GNC around, senior management has been quite transparent about existing problems and is launching various programs, including sales promotion and store associates incentives. Notably, being open when there is trouble is characteristic of good management, according to Warren Buffett. Furthermore, Peter Lynch believes that having specific plans (as GNC executives have outlined) is another successful trait. Hence, the company has the right formula for a comeback. The question is whether or not it can trump an industry that is undergoing fundamentals change.

Source: GNC Investor Presentation

Financials and Valuations

GNC had been posting increasing annual sales growth up until 2013. Thereafter, growth decreased to the meager 1.1% figure for two consecutive years. Fiscal 2016 marked the revenues decline of 5.3%. Moreover, net income decreased from +$219M to -$286M. Notably, the earnings loss was due to a one-time, goodwill non-cash impairment charge of $471M in Q4 2016. Despite its downtrend, Q1 2017 reported $24M net profits and $33M free cash flow. Furthermore, cash and equivalents came in at $40M.

With the $1.4B total debts to $469M equity (3x debts/equity ratio), the company is quite leveraged, thus risking turnaround failure. Assuming that earnings stay constant at $25M quarterly, annual earnings should amount to $100M, and thus it would take more than 14 years to pay off the debts on one's investment. Consequently, that raises the question of whether or not this speculation is worth it. Notably, if the company can generate increasing earnings to deleverage debt, we can expect to see a reversal in share price. However, it is highly unlikely that sales can be ramp up to previous highs due to industry headwinds.

Source: Finbox

Valuation-wise, Wall Street believes that GNC is a bargain at $7.56 (22% upsides from its $9.22 potential true worth). In contrast, Finbox valued the company at fair value to the market. Facing what can be insurmountable problems, we appraised the firm at $3 (as we ascribed 80% chances of comeback failure).

Source: Finbox

It is important to be cognizant that whether the firm's intrinsic value is a bargain or premium depends on its turnaround. If efforts bear fruits, the true worth will increase significantly (and investors can potentially earn multiple-fold capital appreciation). On the other hand, if campaigns fail to stimulate sales growth, the stock will experience drastic degradation of intrinsic value (and subsequently, share price).

Potential Risks

Similar to other turnarounds, there are substantial risks and high uncertainty associated with GNC. As previously mentioned, if efforts to ramp up sales failed, investors can expect the stock to shed most of its current value. While most turnarounds will eventually fail, the few that succeed usually enjoy multi-baggers returns. Accordingly, if a comeback is to bear fruit the management tends to be the cream of the crop, which is arguably the case for the firm's senior team.

Insider Transaction

In putting their money where their mouth is, senior management --notably, CEO Robert Moran -- bought more than $2M worth of shares in the open market on May 12, 2017. Moreover, Director Michael Hines purchased more than a million dollars in stocks. Other executives also accumulated significant stakes this year. Perhaps the insiders are highly confident in their ability to right the ship. It's either that or the captains are willing to go down with shareholders.

Source: Openinsider

Conclusion

In all, our research suggests that GNC's days of promising growth are long gone. The company is now forced into what can ultimately be the final phase of its life cycle due to industry fundamentals shift, amid what is seemingly an obsolete business model. The traditional bricks-and-mortar business, which used to work quite well in the past, catapulted the firm to be a leader in North America. However, the increasingly dominant e-commerce players and MLMs are far more competitive than storefronts. These peers are delivering significantly better earnings due to low operating expenses and strong sales motivation.

Despite valiant efforts from management, it's not far from the truth that comeback campaigns will nonetheless fail. In one scenario, if the company cuts stores to reduce costs, sales would shrink. In another situation, if more incentives are given to sales staff and store associates, profit margins would decline. If the company switches to MLM and/or focuses on e-commerce, it would still lag behind competitors. We expect the stock to decline further,and the company's intrinsic value to decay over time. As a final note, while the situation for GNC is a difficult one to improve, the company seemingly has the right team to solve this quandary.

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BioSci Capital Partners