The Strong Pull of the Nutrition Market

An undervalued sector? Also, three methods companies use to account for investments in other firms.
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Thanks to everyone for all the meaty questions and positive response as of late. We've got a lot of ground to cover today, so let's dig right in.

NBTY (NBTY) , Twinlab (TWLB) , General Nutrition (GNCI) and Rexall Sundown (RXSD) have suffered stunning drops in their prices that do not appear to correspond to earnings surprises. They all project, and for the most part demonstrate, fairly substantial earnings/revenue growth. Heck, they even gained a little legitimacy in my mind today when I saw a version of Gingko Biloba, marketed by Warner-Lambert (WLA) , advertised in this month's

Smithsonian Magazine

(full page ad). I have joined the ranks of the middle-agers looking for all available fixes, and this industry offers quite a few. Yet, most of these stocks are off their 1998 peak by 60%+. I fancy myself rational, I've done a little research, and they look like bargains with significant upside potential near and short term. It appears that a lot of volume would reflect day traders on these stocks. What's missing, or, better put, what am I missing in my analysis? -- Jeffrey Libert

Jeffrey:

Call them what you will. Snake oil, placebos, backwater folklore, or effective remedies. Over recent years, sales of vitamins and "nutritional supplements" have catapulted a ragtag band of manufacturers and retailers into a $14.6 billion industry driven largely by aging Boomers like yourself searching for the quick-fix cure-all to the cruel ravages of nature. While I can't tell my Ginseng from my Echinacea (I'm still firmly in the balanced diet and exercise camp myself) I can tell you that most of these stocks look pretty solid from a fundamental perspective.

Let's take NBTY (formerly Nature's Bounty) as an example. Starting with the balance sheet, NBTY sports a debt to equity ratio of 0.75 well below the diehard fundamentalist's limbo bar of 1.0. They also have a current ratio that's steady around 2.0. Combined, these factors indicate that the firm has got their liabilities well under control and could weather some hard times without fear of default. Furthermore, its price to book ratio rings in at a relatively low 2.05 -- 80% of the drug-related industry average according to RapidResearch.

Turning to the income statement, NBTY's EPS growth seems strong and steady at around 30% in recent years. Profit margins look stable at more than twice the industry average while the P/E is a scant 12.7. Overall, the company looks like a good value at its recent price, assuming it can continue to realize the same kind of profitability it has in recent years.

So what's responsible for the major price relapse in recent months that saw NBTY slip from a healthy 24 3/8 to its current sick bed in the mid 7's? Ironically, the very factor that gave the industry a credibility boost in your mind might account for a big portion of the drop -- namely the entry of big drug giants into the growing field. The fear is that once a $9 billion giant like Warner Lambert starts feasting on the herbal remedy picnic basket, there won't be much more than a few crumbs left for tiny ants like NBTY.

Other factors could be things like the fear of another FTC crackdown that cost the company a quarter mil in 1995 to settle charges of deceptive product claims. I wouldn't be surprised to see the FDA take a more active interest in the largely unregulated market in the future, either.

In short, what you're "missing" is the story that goes beyond the hard science of number crunching into the art of soft analysis. So while I wouldn't exactly expect NBTY to be a ten-bagger in 1999, if retail sales continue at a decent clip, you might be looking at a solid value play here over the next 12 months.

Hi Andrew, I never miss a column. I have a question about how companies with subsidiaries and affiliates account for the earnings these companies produce. For example, if a company has a 25% stake in another, how is this 25% accounted in net earnings of the parent? Does this affect cash flow at all? -- Mark Montpetit, Fonthill, Canada

Mark:

Always good to hear from our brothers to the north (reminds me that some folks are freezing more than I am).

Firms generally have three methods for accounting for investments in other corporations, so the answer to your question depends greatly on the percentage of ownership the parent currently holds.

Minority Passive Investment

: When a firm owns a non-controlling stake in another company (generally 20% or less), it carries the investment on the books as an individual investment. That is, it records dividends received as dividend income for the period while the gain or loss of the security only affects income at the time of sale.

Minority Active Investment

: When a firm exerts significant influence over another company (generally between 20-50% ownership), it's presumed that the investor has some control over the investee's dividend policy, and therefore, has the ability to manipulate their own earnings. As a result, firms with an active minority interest are required to record a proportional amount of the investee's earnings (not dividends) as income for the period.

Majority Active Interest

: When a company is owned by another firm (over 50% stake) it's considered a subsidiary of the parent company. Though legally separate entities, the parent reports its financials on a "consolidated" statement reflecting the control that it exerts over its affiliate, effectively combining the two companies on paper.

Occasionally I use www.quote.com to watch action in some equity or another, they have this nice "live charts" thing where you can watch the action go by. Along with sales, bid/ask events, and some other miscellany, they show two events they call "uptick" and "downtick". Here are the explanations from their FAQ, at http://www.quote.com/live/charts/overview.html:

Downtick:

Short sale indicator for security. Shows downtick on the current inside bid from the preceding inside bid.

Uptick:

Short sale indicator for security. Shows uptick on the current inside bid from the preceding inside bid. This is greek to me.... Is there a fundamental question there? Cheers, Tim Bray

Tim:

It seems you've run headlong into a controversial throwback from the Depression-era known as the "up-tick rule." Sometime after the great crash, the Securities and Exchange Commission imposed restrictions on when a short sale may be executed in an attempt to prevent speculators from "destabilizing" the stock.

Though it doesn't make a lot of sense to me (some argue it's just vindictive persecution of those "un-American" short sellers who don't buy into the bull market party line), here's how it works: A short sale can only be executed when either (1) the sale price of the stock is higher than the last trade (up-tick trade), or (2) the previous trade price is higher than the trade that preceded it (zero up-tick). The indicator on

Quote.com

simply tells when a stock is eligible to short.

Andrew Greta is a business student and onetime stockbroker who lives in West Lafayette, Ind. At the time of publication, he held no positions in the stocks discussed in this column, though positions can change at any time.