-Since our report ran 12 months ago WW’s stock has sharply outperformed the market

-COVID-19 is accelerating WW move to digital subscriptions, which could help margins

As US economy recovers, if subscribers continue to rise; WW stock could rise 30%-40%

A year has passed since I wrote about WW International (WW), formerly Weight Watchers (A Battered Weight Watchers Stock Looks Inexpensive, July 10, 2019).  I’m happy to report that since our piece was published its stock is up 20% to $25.73 recently, outperforming the Standard & Poor’s 500 index, up 8% over the same period.

Of course, the 12 months in between has been hair raising.  While the broad market, down 35% in March, has recovered most of its losses, WW hasn’t. It is off 45%, mostly on COVID-19 fear, from $47 in January. I should have taken a victory lap then! 

I still favor WW shares and it could return to the mid $30s, or up 30%-40%.  (More on the valuation below.) The company continues to make slow but steady progress under CEO Mindy Grossman, who came aboard three years ago and is modernizing WW to a “wellness” firm from an old-fashioned “diet” company.  WW was already moving to a big emphasis on a digital approach from the traditional studio approach—where customers would physically come in—even before coronavirus hit. 

Here are WW’s latest results:  The company finished 2019 with 4.2 million subscribers, a record level for a year-end and up 8% from the end of 2018, with subscriber growth in all its major geographic markets. Revenues in fiscal 2019 were $1.4 billion, down 5%, while net income was $120 million or $1.72, down from $224 million or $3.19 in 2018. The profit comp is skewed by a higher tax rate, 21% in 2019 vs 8% in 2018, and one-time benefits/charges swing of 55 cents favoring 2018. 

Slow and steady improvements are seen in the first quarter, as subs rose 9% year-over-year to 5 million, an all-time Q1 high. Revenues rose 10% from the year ago quarter to $400 million. Operating income rose 14% to $25 million, primarily driven by leverage on higher revenues from digital subscriptions. The net loss narrowed to $6.1 million, or 9 cents, from to $10.7 million, or 16 cents, in the prior year period. Debt net of cash was $1.4 billion at March end and adjusted Ebitda for the past 12 months was $358 million. Debt/Ebitda leverage has fallen to about 4 times from 4.5 and will likely drop further. WW is introducing cost cuts of $100 million in reaction to COVID-19.                                                                                                                                                                      

As you might expect, COVID-19 is not helping WW’s studio/store business, as is plain from this statistic: in the first quarter digital subscribers rose 16%, but studio plus digital subscribers, fell 5%. The unforeseeable spread of COVID-19 put a small dent in my thesis, at least to the extent that studio visits and attendant product sales are down. It forced the company to withdraw its previous February 2020 guidance of revenues approaching $1.6 billion and EPS range of $2.15 to $2.40. 

However, I think the guidance—even withdrawn—is instructive for an investor who wants to get a fix on WW post COVID-19.  Indeed, I think that COVID-19 will speed up the move to digital at WW and more quickly improve results long term.  For example, Zacks Investment Research, in a June 16 report, pointed out that WW “robust” digital business is courtesy of the social distancing and the focus on digital transformation.

On June 15, WW said that it had 4.9 million subscribers as of June 6, up 7% from June 8, 2019, consisting of 3.8 million digital subs and 1.1 million studio plus digital subs. (Please note WW’s business is seasonal, with results trailing down from the typically strongest 1Q.) The company also said that starting mid-April, digital recruitment trends returned to growth and have accelerated, and are now trending ahead of the first quarter, prior to the escalation of COVID-19 mid-March. Approximately 90% of recruits since mid-March come from the digital business. Though the studio business continues to see significant declines, WW has begun reopening locations in a phased manner and anticipates 400 reopened in the U.S. last month.

WW is increasingly transforming into a capital light business, with three main tailwinds, says Marshall Kaplan, who leads the Fundamental Equity Advisors, a team at Ingalls & Snyder, LLC, which recently bought WW shares.  It’s a timely idea because the pandemic has focused Americans on health and weight control, he notes.  As I wrote last year, obesity is a worldwide problem and getting worse. The Centers for Disease Control and Prevention estimates over 36% of US adults are obese.

Kaplan’s view is seconded by a recent report from Morgan Stanley, which said the accelerating digital business is driven by consumers’ increasing wellness focus post COVID-19 restrictions. It cited a Nutrisystem-sponsored survey of 2,000 Americans, which found 63% of people place more of a priority on improving their diet and 76% of Americans say they gained up to 16 pounds during isolation. Wow!

Second, adds Kaplan, WW’s focus on its digital business shows.  2Q is usually a slower period for WW, and the 3Q might be difficult too, given COVID-19, yet the company’s recent update shows downloads of its app are strong. Thirdly, Kaplan likes the company’s plans to launch virtual group coaching worldwide, probably in the fourth quarter.  If it significantly supersedes full time studio coaches, it could improve margins through higher utilization of coaching and potentially significant savings in real estate, if fewer physical locations are needed.

Though the stock is up from a year ago, the valuation is not. It trades at 11.7 times consensus EPS of $2.21 next year (vs $1.73 this year), compared to a 12 times PE one year ago. If the company progresses on its plans, its PE could approach its historical PE median of 14-15 times. If applied to the EPS consensus of $2.46 in 2022, that could yield a $35 stock price longer term. Meanwhile, shares of weight loss product distributor Medifast (MED) have tripled since March lows, but WW’s have only doubled from lows. 

Then there is the not so secret weapon Oprah Winfrey, who actively markets WW and will likely continue that. She is a director with about an 8% stake. Our head of global portfolio analysis, Brian Rauscher, says his Analyst Sentiment Measure (ASM) at WW has positively inflected, and analyst EPS reductions continue to get smaller. The combination of these two metrics historically has boded well for a stock. 

Where I could be wrong: No one can predict how the COVID-19 spread will play out or when it will end. Even with strong cash flow, WW remains somewhat leveraged.

Bottom Line: COVID-19 is accelerating a move to digital subscriptions. As WW continues its modernization to a “wellness” and digital company, the EPS should rise and the share price along with it.

Prior “Signals”