Should Investors Bet on More Growth at Nu Skin?

Should Investors Bet on More Growth at Nu Skin?

Investors have been well rewarded for betting on Nu Skin over the past five years, with the personal care product manufacturer's stock up nearly 1,000%. The company has generated growth through geographic expansion, especially in the Asia-Pacific region, as well as by maintaining a large, motivated workforce to distribute its nutrition and anti-aging products. Despite criticism of the direct-selling model, which has led to controversy at competitor Herbalife , Nu Skin has outrun its critics and posted consistent annual increases in overall sales. So, is it still a good story for investors?

What's the value?
Nu Skin has benefited from increased global interest and spending on wellness because of the prevalence of obesity-related diseases around the world, which has expanded the market for its nutrition and personal care products. The company has also bet big on China, which accounted for roughly 26% of sales in its latest fiscal year. While China has placed limitations on direct-selling practices, mandating the use of retail stores and traditional compensation structures, the country's favorable demographics provide a fertile ground for Nu Skin's product portfolio.

In fiscal year 2013, Nu Skin has generated strong results with a top-line gain of 36.6% paced by a doubling of sales in its China region. Overall growth has been aided by a double-digit increase in the number of the company's sales leaders, as well as the introduction of new products like the TR90 weight management system.

As a direct-selling company, Nu Skin relies on an independent, motivated workforce to drive sales, which it cultivates through periodic new product launches and the use of discounted limited-time offers, or LTOs. While the LTOs lower the company's new product margins, they lead to cross-selling opportunities with older product lines and enhance overall profitability, as shown by the company's operating margin expansion over the past five years.

Of course, Nu Skin's upside may be capped by its use of the direct-selling model, which has been dogged by critics as a potential pyramid scheme. Competitor Herbalife has rung up a pretty hefty price tag, roughly $20 million at last count, fighting allegations of accounting improprieties, mostly from investment manager Bill Ackman and his Pershing Square hedge fund. Fortunately, the company also has its defenders, led by legendary investor Carl Icahn, who has been building a significant stake over the past year.

In the midst of the hubbub, Herbalife's operations have been generating similar, if less impressive, growth compared to Nu Skin, with an 18% increase in fiscal year 2013. While Herbalife is more U.S.-centric than Nu Skin, with the North America region accounting for roughly 20% of sales, it is similarly focused on growth in China through retail store openings and the procurement of direct-selling licenses. More important, Herbalife continues to generate strong operating cash flow, which it is using to support shareholder value through stock repurchases.

A less controversial alternative
Given the risks surrounding the use of the direct-selling model, investors might want to participate in the wellness arena through a more traditional player, like GNC. The company dominates the retail health and wellness space with a global network of more than 8,000 locations in 55 countries. It has also successfully expanded its brand through partnerships with general line retailers, principally its more than 2,000 Rite Aid in-store boutiques.

In fiscal year 2013, GNC continued to build on its growth track record. GNC reported an 8.1% revenue increase that was equally supported by higher comparable-store sales and an expansion of its store network. Despite a slight hit to the company's gross margin during the period due to the costs of its new member pricing rollout, GNC's operating margin ticked higher as a result of economies of scale from its larger store base, as well as its decision to outsource its transportation needs to third-party fleets. GNC's improved profitability is also leading to gains in its operating cash flow, which it is using to enhance its competitive advantage through selective acquisitions and additional store openings.

The bottom line
Nu Skin seems to be firing on all cylinders. It recently raised its financial guidance for the year, which included the projection of its first quarterly result that will include a billion dollars in sales. However, given the risks of the company's selling model and its outsize exposure to the Chinese market, prudent investors might want to avoid the downside risk of Nu Skin and opt for the slow and steady growth at GNC.

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