Herbalife: ‘Messier Than Expected and We Had Expected Messy’

Even those who weren’t expecting great news from Herbalife appear taken aback by its results last night. Canaccord Genuity’s Scott Van Winkle and Mark Sigal, for instance, call Herbalife’s earnings “messier than expected.” They explain:

Bloomberg News

The Q3 results and guidance revisions were messier than we expected and we had expected messy. We expected that more pronounced headwinds in the US and a Venezuela devaluation could materialize and saw these items as the risks to the quarterly report. However, the negative surprise relative to our estimates wasn't confined to these two markets. Similar to Q2, China continues to drive strong growth (China was the only market to meet our revenue forecast), while underlying strength in EMEA (+15% in constant currency) is being masked by foreign exchange. Beyond these two regions, growth is modest or disrupted. The impact of the Herbalife business model debate has clearly impacted the US, but major markets outside of the US, such as Mexico and Brazil, were softer than we would have thought. The net result was a 5% miss in sales and volume points vs. us that was several percentage points worse than we expected, even after adjusting for Venezuela. Moreover, Q4/14 and F2015 guidance came in significantly softer on a volume point basis.

Van Winkle and Sigal also explain the impact of changes to Herbalife’s business that were made following allegations by Pershing Square’s Bill Ackman:

The guidance is set partly as a reflection of a phased implementation of changes to the global compensation plan (fully effective by February 2015) that are anticipated to temper near-term growth. The plan changes include a first order limitation (previously in 18 markets, now to be global), a sales leader qualification restriction whereby all volume for qualification must be purchased directly from Herbalife rather than from upline distributors (implemented November 1), and a lower threshold for supervisor qualification (4,000 volume points over a 12- month period rather than the historic 5,000-point qualification where large volume purchase were front-end loaded). The net result of these changes is greater line of sight on distributor purchases, as well as more gradual and sustained distributor participation; but of course it's a slower build. The prior roll-out of the 12-month volume point qualification program in the original market resulted in ~60% gains in distributor activity and retention for new qualifying supervisors a year later, but impacted initial volumes. Near term, these plan changes will create a sales headwind until fully anniversaried in Q1/16. But also, any compensation plan change carries disruptive risk.

Despite the disappointment, Van Winkle and Sigal maintained their Buy rating on Herbalife’s stock, though they did slash their price target to $60 from $73.

Shares of Herbalife have plunged 18% to $45.75.