The Skinny on Weight Watchers

Popular low-carb diets have dented its stock, but stout fundamentals and a solid long-term outlook may make this a buying opportunity

By Eric Wahlgren

Weight Watchers International's (WTW ) stock has gone on a diet. Shares of the weight-loss services outfit slimmed to a yearly low of $36.10 on Nov. 4. Though the Woodbury (N.Y.) company's stock has rebounded to around $38, it's down 21% from its 52-week high of $48.37, hit on on December 9, 2002.

Making investors nervous is the impact of low-carb diets such as the Atkins and South Beach regimes on Weight Watchers' business, which involves running some 44,000 weekly weight-loss meetings around the globe. The low-carb craze appeals to millions because the diets basically let people pig out, as long as they avoid sugary and starchy foods.

SHRUNKEN ATTENDANCE.

  By contrast, Weight Watchers adherents can dig into just about whatever they want, carbs or otherwise. But portions are more limited because devotees must stay within a certain number of "points" -- determined by a food's calories, fat, and fiber content. The method isn't for couch potatoes as it encourages exercise: A workout allows dieters to swap points for food.

Still, the Atkins fad has dented Weight Watchers' performance. In the third quarter ending Sept. 27, attendance at company-operated meetings in North America fell 2.4%, excluding acquisitions. "It has been more difficult for us to generate word-of-mouth interest in this environment of media hype around carbs and low-carb dieting," conceded Linda Huett, Weight Watchers president and chief executive, in a Nov. 5 conference call with investors.

Despite the challenges, investing pros remain bullish on Weight Watchers, which logged $809.6 million in revenues in 2002. According to analysts, it has only begun to tap the $80 billion global dieting industry.

"COMPELLING VALUATION."

  What's more, analysts say the low-carb movement appears to be peaking. A growing number of low-carb "refugees" are showing up in Weight Watchers meetings, complaining that they can't keep the weight off on the other diets, analysts say. "While low-carbohydrate diet popularity remains a pressure, its growth trajectory also appears to have stabilized," Andrew McQuilling, a UBS analyst in New York, wrote in a recent research note to investors.

The recent decline in Weight Watchers' stock may actually represent a buying opportunity, according to McQuilling and other Wall Street pros. "We see valuation as compelling, given Weight Watchers' high-return business model and bright secular growth outlook," says McQuilling, who has raised his rating to buy from neutral and assigned a $45 target price, which represents a 25% appreciation potential in the next 12 months. (UBS has done banking with Weight Watchers.)

A closer look at the third-quarter results suggests that the 42-year-old outfit, which went public two years ago, has solid fundamentals. For starters, analysts had been expecting a drop of more than 6% in North American attendance at company-operated meetings (excluding acquisitions), so the 2.4% dip came as something of a relief. Overall, North America grew 14% when the Weight Watchers franchises in its $181.5 million purchase of the WW Group earlier this year are included. International operations, which includes 30 countries, saw attendance increase 7%. By Eric Wahlgren

FAT CHANCE.

  In the third quarter, net revenues climbed 15%, to $217.5 million, from $189.2 million in the year-ago quarter. (Meeting fees accounted for about 65% of revenues, with sales of books, "points" calculators, and other products making up 29%). Operating income was essentially flat, meeting Wall Street estimates of $74 million, or 38 cents a share, vs. $74.4 million, or 35 cents a share, in the year-earlier quarter. Net profit, however, fell 69% as Weight Watchers reduced debt.

As the novelty of the low-carb diets wear off, "attendance will come back," says Kathleen Heaney, an analyst with Maxim Group in New York. "Obesity is not going to go away." Heaney, who has no ties to Weight Watchers, rates the stock a buy with a $44 target price.

If anything, Heaney thinks Weight Watchers' potential market is underestimated. In the U.S., 64% of adults are now overweight, vs. 47% some 20 years ago, she says. Current Weight Watchers membership in the U.S. is about 9 million, but it's potential is about 100 million clients, Heaney adds. (Only about 5% of members are men.)

WORLD OF OPPORTUNITY.

  What's more, Weight Watchers is the leader in most of its markets and has strong brand recognition, analysts say. Other companies such as Jenny Craig (JCGI ) and NutriSystem are more focused on prepared meals and aren't direct competitors, Heaney notes. Consumers "typically end up at Weight Watchers after several other diet attempts have failed," she wrote in a recent research note.

Over the next five years, Heaney sees Weight Watchers sustaining top-line growth in the mid-teens and earnings-per-share gains of greater than 20% a year. Weight Watchers has room to expand, Wall Streeters say. Robert Craig, an analyst with Legg Mason in Cleveland, believes it can increase revenues by buying franchises, since costs to run the centers are low. Geographic expansion is a possibility, too: Asia, where obesity is beginning to be a problem, is largely untapped.

And Weight Watchers can get more heavily into licensing. Food company HJ Heinz (HNZ ), which sold Weight Watchers in 1999, has a royalty-free right to use the Weight Watchers name only on frozen foods and a few other products. That gives Weight Watchers an opening to cash in on its brand. "The long-term opportunity for the company based on the size of the market and reputation in the market is very compelling," says Craig, who has a buy rating on the stock and a $48 price target. (Neither Craig nor his firm has ties to Weight Watchers.)

DELAYED GRATIFICATION?

  All the same, investing in Weight Watchers has its risks. In the short term, competition from other diet programs could crimp attendance at meetings, from which Weight Watchers derives the bulk of revenues. Down the road, an obesity wonder drug could be a long-term threat. Says Craig: "We're concerned about a genetic solution to obesity and about other pharmaceutical solutions to the problem." So far, a safe fat-buster isn't in sight, however. Once-popular diet drug fen-phen was pulled from the market in 1997 after it was linked to heart problems.

Weight Watchers says it's going to be around for the long haul, despite the current, low-carb diet onslaught. "These other diets come and go," a company spokesman says. "Weight Watchers has a 40-year-plus track record of success in providing members with a balanced diet option that includes exercise."

A final word of caution: The stock may tread water for a while, analysts say. So, before scarfing it down, most investors will want to see North American meeting attendance rise, which analysts expect to see early next year. Still, with a key diet "season" not far away -- a big one begins in January after holiday splurging -- interested investors may not want to wait too long.

Over the long haul, the payoff could be delicious. "We believe the stock has good long-term growth potential," Heaney says. "But you have to be patient." That's good advice, not just for investors but for dieters as well.

Wahlgren covers markets for BusinessWeek Online in New York and writes for the Street Wise column

Edited by Beth Belton

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