RealMoney Silver - NBTY's Shares are Cheap, But it's Too Early to Jump Back In.

NBTY's Shares are Cheap, But it's Too Early to Jump Back In.
By Bill Trent
RealMoney.com Contributor
3/4/2008 10:46 AM EST

I try to eat a healthy diet, augmented by the right health supplements. And many times, the vitamins and supplements I buy are made by NBTY (NTY) . The company makes vitamins, sport supplements and other products under more than a dozen brand names including Nature's Bounty, Vitamin World, and Puritan's Pride.

I am a fan of the products. Should I be a fan of the stock? Let's take a look.

Exposed to wholesale and retail

The health food shops where I pick up my supplements (which are served through NBTY's wholesale segment) account for roughly half the company's total sales. The North American Retail segment (457 Vitamin World and 80 Le Naturiste shops) provided 11% of sales in 2007, European Retail (626 stores under a variety of brand names) was 31% of company revenues and the Direct Response/e-commerce segment provided 10%.

These are clearly consumer products, clearly discretionary, and clearly vulnerable to a consumer slowdown. Yet investors have already price this exposure into the stock: It trades as just over ten times earnings and sports a 10% free cash flow yield. Notably, shares fell to 8.8 times earnings and 0.6 times sales in 2000, so we may not have reached a bottom.

Demand has surely cooled for NBTY's products, as the company posted flat sales and falling margins in the December 2007 quarter. Management was wise enough to brace for a slowdown, as debt has been cut from $500 million to $210 million over the last two years. Moody's recently upgraded its ratings on NBTY debt to positive.

NBTY's wholesale division has been a strong point, with improving gross margins over the last year. In contrast, the retail segment has cooled in North America, and European retail sales are also falling on a local currency basis.

To trim costs, NBTY has closed 35 stores (on a net basis) and expects to close 23 more this year. NBTY also plans 10 to 12 new store openings this year, reflecting regional demand trends.

I have a few concerns over earnings quality. For example, in each of the last two years, the company has reserved less than the actual amount charged for sales returns, bad debt and promotional incentives (an under-reserving trifecta.) However, overall earnings quality measured using the accrual ratio appears strong.

NBTY Accrual Ratio

Click here for larger image.

Source: Zacks Research Wizard, compiled by William A. Trent

I'm also nervous about a stock that has had such a big run over the last few weeks. But then again, I had the same concerns about Tupperware (TUP) and it has continued to outperform after rebounding from the same January low. (As a side note, American Oriental Bioengineering (AOB) could represent a catch-up play here.)

NBTY's options aren't generating a particularly good premium right now, so there doesn't seem much point to a put-write strategy. On the other hand, buying the March $25 puts for $0.15 (as I am writing this) seems like fairly cheap insurance on a long position, given my concerns about the recent run-up.

All in all, though NTY looks fairly cheap, shares of most other retailers and consumer companies are also well off their highs. Unless we can get through another quarter without a significant earnings miss or downward revision it just seems too early to call a bottom here.