Quiver Quantitative - With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Medifast Inc. (NYSE: MED). Firms such as Renaissance Technologies, Citadel, and Point72 Asset Management have all added to their MED positions recently. Most notably, Renaissance Technologies increased shares held by 4.55% (as filed on 6/30), bringing their total MED holdings to 680,610 shares worth $55.3 million dollars (approximately 6.25% of Medifast’s market capitalization) at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Medifast Inc.
In August, Medifast reported second quarter earnings results for fiscal year 2023. Revenue for the second quarter came in at $296.2 million dollars, a 34.7% YoY decrease that was largely driven by a decrease in the number of active earning OPTAVIA coaches and a decline in productivity per active earning OPTAVIA coach. The average revenue per OPTAVIA coach was $5,578 dollars in the second quarter, a 16.3% YoY decline, which can largely be attributed to continued pressure on customer acquisition. Additionally, the total number of active earning OPTAVIA coaches decreased 21.9% YoY to 53,100. On a more positive note, Medifast’s superb capital allocation priorities continued throughout the quarter. They announced a quarterly cash dividend of $1.65 dollars per share, while also announcing that the business currently has $147.4 million dollars in cash on the balance sheet, with little to no debt. This can be compared to the end of last year (December 31st, 2022), where the business only had $87.7 million dollars in cash and equivalents on the balance sheet. With this earnings result in mind, we believe that Medifast is a compelling long-term investment opportunity currently trading at a very fair valuation.
Medifast Inc. is the company behind OPTAVIA, one of the fast-growing health and wellness communities. Medifast’s growth over the last few years is a reflection of the business’ unique Coach-driven approach, which stands out in a health and wellness world that is often a lonely and difficult journey. Medifast is often compared to diet and weight-loss only companies and multi-level-marketing companies, however, their business model is much different. By revenue, OPTAVIA was named the #1 weight loss program in the United States in 2021. Medifast’s OPTAVIA brand offers a highly competitive and effective lifestyle solution centered on developing new healthy habits through smaller, foundational changes called micro-habits. This program offers a more attractive and effective alternative to quick fixes and outdated programs, and is centered around four key components that help their customers achieve their health goals. These components include independent OPTAVIA coaches (coaches provide individualized support and guidance to customers on the path to optimal health), the OPTAVIA community (a community of like-hearted people providing each other with real-time connection and support, while also giving Medifast a networks effect moat), The Habits of Health Transformational System (a proprietary system which offers easy steps to a sustainable lifestyle), and Products & Plans (clinically proven plans and scientifically developed nutritional products that are backed by dietitians, scientists, and physicians).
Medifast operates within the weight-loss industry, an industry that is very competitive and encompasses various weight-loss products and programs. This includes commercial weight loss programs, pharmaceutical products, surgical interventions, books, self-help diets, dietary meal replacements, and appetite suppressants, along with wearable trackers, wellness monitoring solutions and digital tools. Management identifies that USANA Health Sciences Inc, WW International Inc, Herbalife (NYSE:HLF) Nutrition Ltd, The Simply Good Foods Co, The Hain Celestial Group Inc, BellRing Brands Inc, and Beyond Meat are Medifast’s publicly traded peers and competitors within the general health and wellness diet industry.
Management believes that Medifast has a competitive advantage over traditional diet companies. This is because the OPTAVIA model promotes a program that focuses on holistic wellness (viewing weight loss as a catalyst for greater changes), offers personalized, empathetic support from Coaches, offers lifelong habit development supported by a proprietary integrated system, and Medifast has a vibrant health and wellness community that has impacted more than 2 million lives (as mentioned above, this acts as a network effects moat as this community continues to grow). Additionally, management believes that the business has a competitive advantage over traditional direct selling companies. This is because OPTAVIA’s innovative model is customer centric and only has one sale price (there is no tiered pricing). Additionally, OPTAVIA boasts a health and wellness community where 90% of OPTAVIA coaches come from the customer base and offers a differentiated direct-to-consumer model, with 100% of products shipped directly to customers.
Management is solid, and their capital allocation priorities do a good job of creating excess shareholder value. Despite Medifast having a very low amount of shares outstanding (10.89 million shares outstanding), management likes to aggressively repurchase shares, creating excess shareholder value. In 2020, management repurchased 57,144 shares. In 2021 and 2022, management repurchased 125,133 and 199,581 shares, respectively. As we can see, despite the business’ low number of shares outstanding, management likes to return excess cash to shareholders via share repurchases. In addition to share repurchases, Medifast also offers a quarterly cash dividend, further showcasing the business’ superb capital allocation priorities that return excess cash to shareholders and create excess shareholder value.
In terms of incentives, Medifast’s management team is incentivized well, with compensation structures that do a good job of aligning shareholder and management interests while also doing a great job of retaining executive talent over the long-term. 83% of the CEO’s total compensation is “at-risk”, with 64% of all other NEO’s total compensation being “at-risk”. The CEO’s compensation structure is made up of a base salary (17% of total compensation), target bonus (19% of total compensation), and a long-term incentive (64% of total compensation). On the other hand, all other NEO’s have a compensation structure that is made up of a base salary (36% of total compensation), target bonus (25% of total compensation), and long-term incentives (39% of total compensation). With a large percentage of their pay at-risk, the CEO and all other named NEOs are incentivized to perform well on the business’ pre-determined business goals. Additionally, with such a large portion of total compensation being paid out in the form of long-term incentives and equity, management is further incentivized to ensure long-term performance of the company’s stock. As we can see, this compensation structure does a great job of aligning shareholder and management interests. Additionally, with management building up equity in the business over time from long-term incentive rewards, it incentivizes them to stay at the business, retaining executive talent over the long term. We believe the best business’ treats shareholders like a partner in the business, and we believe that this is the case with Medifast.
Medifast is an extremely efficient business. The business currently operates at a LTM ROE of 84.4% and a LTM ROIC of 82.7%. With a WACC of 10.4%, Medifast operates at a ROIC to WACC ratio of 7.94x, showcasing the business’ ability to generate returns on cash reinvested back into the business at rates of return far higher than the business’ weighted average cost of capital. Businesses that are able to efficiently reinvest cash back into the business at favorable rates of return are considered to be compounders, businesses that are able to rapidly compound intrinsic value over the long-term, handsomely rewarding shareholders. Looking further at efficiency metrics, we can see that ROIC has handsomely expanded within the last few years, possibly showing that Medifast has a strong competitive advantage or moat within the industry that it operates in. In 2013, Medifast operated with a ROIC of 36.3%, compared to today where the business operates at a LTM ROIC of 82.7%.
Analyzing Medifast’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Medifast has grown revenue at a CAGR of 14%, with gross profit growing at a CAGR of 13.6% in that same time frame. It must be noted that Medifast operates at a very high margin business. Currently, Medifast operates with a LTM gross margin of 70.9%, showcasing the business’ ability to generate large amounts of profit from its revenue. In terms of earnings, Medifast has grown EBITDA at a CAGR of 13.4% since 2013, with EPS growing at a CAGR of 19.4% in that same time period. This growth in EPS can largely be attributed to share repurchases. Medifast is a cannibal, decreasing shares outstanding by 18% since 2013.
Looking at Medifast’s balance sheet, we can see that the business operates in good financial health. Medifast currently holds $147.4 million dollars worth of cash and equivalents on hand, with no short term borrowings or long-term debt. With a net debt of -$123.7 million dollars (meaning that the business currently has $123.7 million dollars worth of excess cash on the balance sheet compared to debt), Medifast has plenty of runway to cover their debt obligations. Additionally, with little to no debt on the balance sheet, Medifast has plenty of runway to repurchase more shares, reinvest more cash back into the business, or increase / offer a dividend, all of which help drive increased shareholder value.
Looking at Medifast’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ increased operational efficiency. Since 2013, Medifast has grown net income at a CAGR of 16.9%, with free cash flow growing at a CAGR of 18.5% in that same time period. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2013, Medifast operated with a free cash flow margin of 9.6% of revenue, compared to today where the business operates at a free cash flow margin of 14.5% of revenue. As we can see, expanding free cash flow margins are acting as catalysts for growth in free cash flow generation. As free cash flow margins begin to expand, Medifast will likely be able to generate more and more free cash flow from revenue, allowing them to reinvest cash back into the business, repurchase shares, or offer / increase a dividend.
After conducting a reverse discounted cash flow analysis, we can see that Medifast Inc. is trading at share prices that imply a -17.77% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate 10%. Medifast is a quality business, and we believe that this valuation is extremely low, especially based on the business’ ability to generate free cash flow. While this is a cheap valuation, it makes sense given a tough macroeconomic environment that has hurt Medifast’s business in the short term. While past performance is not indicative of future performance, Medifast grew free cash flow at a CAGR of 18.5% within the last decade, while also expanding free cash flow margins during that time. At a conservative free cash flow growth estimate over the next 10 years (3%), our models place an intrinsic value of $265 dollars per share on Medifast, implying a 226% upside from current market prices. While we believe that Medifast is undervalued currently, that is just based on our models. We encourage every investor to do their own due diligence on the business and come to their own conclusions on valuation and other factors important when making an investment.
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This article was originally published on Quiver Quantitative