That Supposed Herbalife Miss

Herbalife results was a miss on volume growth. And first I was disappointed - but as I read the 10-Q carefully I became more and more cheered.

The last post outlines what the range of outcomes on Herbalife is.

On the binary issue of the FTC inquiry we have no explicit news. As stated in the last post (and I think most shorts would agree with me) the earnings power of this company is completely secondary to whether the company is allowed to operate.

The real debate which is about the legality of the business model will continue.

The secondary debate is about the profitability of the company.

Most of this post is about the secondary debate - and the entire stock movement is about the secondary debate.

Slowing growth

In the third quarter of 2011 (as the last post makes clear) the company had volume growth like this:

This was astounding growth. Normal companies do not grow sales volume at 23.4 percent for long.

In that quarter sales volume (23.4 percent) was very closely correlated to the growth in the number of active sales leaders (23.6 percent). This correlation should be expected.

And whilst the correlation was not perfectly accurate by region - it was pretty close and remained close for a long time.

Over time sales growth slowed. However as recently as the first quarter volume growth was 9 percent (off very big numbers) and sales-leader growth was 11 percent. These are still perfectly adequate numbers.

In the second quarter Herbalife had its first miss in recent years. Here were the numbers for sales growth and volume growth:

The 5 percent sales growth number is by far the worst the company had seen. However active sales leaders continued to grow at 9 percent. There was a question as to whether you believed sales leader growth led volume growth - because if it did volumes will rise over time.

More on that later.

Some of this poor volume results in the first quarter was Venezuela - and for reasons explained in the last post declines in Venezuela are good news not bad news. Net of Venezuela sales growth was probably 7 percent - still a very acceptable rate - albeit a definite slowing.

I stated in the last post that the fair value for Herbalife (assuming an FTC clearance which the shorts think is unlikely) depends critically on the volume numbers.

If volume growth resumes as 8% plus (consistent with the number of active sales leaders) then the stock was worth something around $200.

If the volume growth declined from the growth above then assuming FTC clearance a number around $80 was fair value. [And $80 is about the 12 month high - and predates the FTC inquiry. As someone who still held stock at $80 I would be disappointed.]

Alas for the longs the numbers came in and volume growth declined further.

Here they are:

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Disclosure: The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog ...

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