Herbalife: Should You Dare Invest in This Controversial Company Going Into Earnings?

Herbalife , the global supplier of nutritional products, has been in the news quite a bit over the last few years. The headlines have been more negative than positive as of late, however. Here are a few events from April alone:

  • April 11: The F.B.I. begins a criminal investigation into Herbalife's business practices over claims of it being a pyramid scheme.
  • April 14: New York Attorney General Eric Schneiderman begins an investigation into Herbalife over claims of it being a pyramid scheme. 
  • April 17: Illinois Attorney General Lisa Madigan begins an investigation into Herbalife over claims of it being a pyramid scheme that targets minorities. 

There is obviously a theme here, and the company's stock has reacted by falling approximately 30% year-to-date. With all this negativity in the air, the company has announced that earnings results for the first quarter will be released on April 28. Let's take a look at the most recent quarterly earnings, expectations for the upcoming report, and one of its top competitors, Nu Skin , to determine if we should be buying or avoiding an investment right now.

Source: Herbalife

A fruitful fourth quarter
On Feb. 18, Herbalife released its fourth-quarter report to cap off fiscal 2013. The results exceeded analyst expectations; here's a breakdown:

Earnings Per Share$1.28$1.25
Revenue$1.27 billion$1.25 billion

Source: Benzinga

Source: Herbalife

Earnings per share increased 28% and revenue increase 19.8% year-over-year, resulting in the best fourth quarter in Herbalife's history. Worldwide volume rose 13% and sales grew in all but one of Herbalife's six regions, led by growth of 121.2% in China and 42.9% in South and Central America. Operating income increased 13.8% to $181.86 million, but the operating margin took a slight hit; it declined 76 basis points to 14.33%.

These strong results and the ample free cash flow generated allowed Herbalife to repurchase roughly $30 million of common stock and maintain its quarterly dividend of $0.30. This showed that the company is still fully dedicated to maximizing shareholder value.

Overall, it was a great quarter for Herbalife. Shares reacted by rallying at the open of the next trading session, before falling about 4% on the day. Shares have continued lower on the news of the multiple investigations, and now sit more than 18% below the level they were at before earnings were released.

Expectations & what to watch for
First-quarter results are due out after the market closes on April 28. Analysts currently expect growth on both the top and bottom lines. Here's an overview:

MetricExpectedYear Ago
Earnings Per Share$1.30$1.27
Revenue$1.23 billion$1.12 billion

Source: Estimize

These expectations call for earnings per share to increase 2.4% and revenue to increase 9.8% year-over-year. This growth is well below what we are used to seeing out of Herbalife, but would still result in the best first quarter in the company's history. Other than the key metrics, there are three updates and statistics that will be important to watch for:

Source: Herbalife

  1. First and foremost, it will be absolutely crucial to watch for comments about the effects, if any, that the ongoing investigations will have on earnings going forward. With the investigations being in the pubic eye, it may prevent new independent distributors from signing up and it may cause slowed ordering from existing distributors and customers. If this is the case, we could see major weakness in the stock.
  2. With the previous idea in mind, it will be very important for Herbalife to provide guidance for the second quarter that is within analyst expectations. Currently, the estimates call for earnings per share of $1.54 and revenue of $1.34 billion; this would represent year-over-year increases of 9.2% and 9.8%, respectively. 
  3. While second-quarter guidance will be important, so will Herbalife's guidance for the full year of fiscal 2014. Watch and make sure the company reaffirms or raises the guidance it provided in the fourth-quarter report, which projected earnings per share in the range of $5.85-$6.05 on revenue growth of 7.5%-9.5% from fiscal 2013. 
If Herbalife can attain analysts' earnings expectations and satisfy the three factors above, and I think it will, it would result in a great quarter. However, unless Herbalife makes incredibly positive comments about the investigations, the company's stock will likely show very little movement to the upside. Federal investigations cast a dark cloud over everything for a public company, even the most bullish of earnings announcements, so I would avoid an investment until the investigations are completed and the public is informed of the findings.

A competitor who faced similar issues

Source: Nu Skin

One of Herbalife's largest competitors, Nu Skin, has faced its fair share of adversity over the last few quarters, but the situation has finally taken a turn for the better. Let me explain.

It all began on Jan. 15 of this year when the People's Daily, a communist newspaper in China, accused Nu Skin of operating as an illegal pyramid scheme. Does this sound familiar? When the story broke, it caused Nu Skin's stock to fall 15.56% in the trading session, but the company responded by saying the accusations were both inaccurate and exaggerated. However, the decline only worsened the following day when Chinese authorities announced that an investigation had been opened.

Although it may have seemed like Nu Skin was doomed to be shut down in China, the investigation turned up very little wrong-doing. Here's a summary of the fines that were handed down on March 24:

  1. Nu Skin must pay $524,000 for products that were not permitted for sale by independent distributors. The products in question were approved for sale in the company's retail locations in China, but not for the direct selling channel.
  2. The company must also pay a $16,000 fine for product claims that lack sufficient data to support them. Nu Skin will either have to obtain support for the claims or the products can no longer be sold in China.
  3. Six members of Nu Skin's sales team will have to pay fines of $241,000 for "unauthorized promotional activities." The company itself will not have to pay any fines for the actions of these six sales representatives, but it has been asked to enhance the education and supervision of its sales team.

Source: Nu Skin

For a company that did over $3 billion in sales during fiscal 2013, fines of $540,000 are pocket change. I believe this was arguably the best possible outcome for Nu Skin and the market agreed, sending its shares soaring over 18% in the trading session that followed. This may be the start of a run back toward its 52-week high, which it still sits more than 35% below.

Herbalife can only hope that the investigations into its business turns out as well as Nu Skin's did, but it is still a situation that investors should steer clear of. Yes, the reward could be great if the investigations turn up little wrongdoing. It could also devastate the company if the opposite were to happen. Due to the risk alone, I would avoid an investment in Herbalife for now and would instead consider Nu Skin the better option because its situations are resolved and it is back to focusing on growing its business.

The Foolish bottom line
Herbalife may be under pressure from U.S. regulators right now, and it is for this reason that it is not a great time to invest in the company's shares. First-quarter results will be announced shortly and analyst estimates seem doable, but I think even blowout numbers would cause little movement in the company's stock due to the pending investigations. After all, G.A.A.P. earnings matter little if your company is found to be an illegal pyramid scheme. Foolish investors should wait for all of the investigations to be completed before considering an investment. If you are looking for an immediate entry into the industry, take a deeper look into Nu Skin.

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The article Herbalife: Should You Dare Invest in This Controversial Company Going Into Earnings? originally appeared on Fool.com.

Joseph Solitro has no position in any stocks mentioned. The Motley Fool has the following options: long January 2016 $57 calls on Herbalife. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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