# NutriSystem (NTRI) Still A Candidate For A Buy?

September 27th, 2012 Posted by criseldar Investment Valuation No Comment yetNutrisystem (NTRI), headquartered in Fort Washington, Pennsylvania, is a commercial provider of weight loss products and services. Initially, the company offered weight loss counseling and products in brick and mortar centers. Wikipedia

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

**The Investment in Enterprise Value**

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

Enterprise value and the market capitalization was high during 2007 and 2009. Enterprise value had an erratic movement from 2007 to the trailing twelve months (ttm6). The total debt represents 2 percent of the enterprise value, while cash represents 9 percent thus making the enterprise value lower than the market value. The stock value of NutriSystem Inc. dropped down from 2010 to 2012 ttm6 by 39, 39 and 19 percent, respectively.

The buying price for the entire company would be $253 at $9.37 per share for ttm6. For the recent updates in market value, buying the entire business would cost $243 at $9 per share for 2012 ttm8. The investor would be paying 100 percent of NTRI’s because cash and cash equivalent are greater than the total debt.

**Benjamin Graham’s Stock Test**

** Net Current Asset Value (NCAV) Approach**

The Net Current Asset Value (NCAV) is a method from Benjamin Graham it is to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks is trading in a bargain, and it is worth buying.

Using Benjamin Graham’s Net Current Asset Value Method, it shows that the stock of NutriSystem Inc. was overvalued from 2007 to the 2012 trailing twelve months. Therefore, the stocks did not pass the stock test because 66 percent of NCAVPS was lesser than the market and enterprise value. In other words, the stocks are selling above the liquidation value of NTRI.

The stock price of NTRI was considered expensive and is not a candidate for buying but the stock calls for selling because the market value was 1051 percent above the liquidation value.

**Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation**

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV). The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.

The MC/NCAV valuation tells us that the stock price of NutriSystem Inc. was trading at the undervalued price because the ratio did not exceed the 1.2 from 2007 to 2012 ttm6. Therefore, the price is considered cheap.

**Benjamin Graham’s Margin of Safety (MOS)**

The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety.

The question is, “How large of a margin of safety is needed for a stock to be considered a true value investment?” Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.

#### Explanation

The average margin of safety was 38 percent during its 6 years operation. It tells us that buying the stocks of NTRI at the current date, 2012 ttm6 is not recommended because theremarginsero margin of safety. As we can see in the table above, the intrinsic value was negative in 2011 and 2012 ttm6. This is due to negative sustainable growth rate and annual growth rate. If you walk with me further, you will find out why is the growth negative but before that, let us see first the intrinsic value and how it is calculated.

*Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)*

The table below will guide us along the intrinsic value and the trend from its 5 years of operation.

#### Explanation

The explanation for the calculation of intrinsic value was as follows:

EPS | the company’s last 12-month earnings per share. |

G: | the company’s long- term (five years) sustainable growth estimate. |

9: | the constant represents the appropriate price to earning ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, instead, we use 9) |

2 : | the average yield of high-grade corporate bonds. |

The trend in the intrinsic value was erratic but overall it was dropping from 2007 to 2012 ttm6. Intrinsic value was negative during 2011 and 2012 ttm6, due to the negative sustainable growth rate (SGR), thus giving us a negative annual growth rate. The root of this is, NutriSystem Inc. paid a cash dividend to its investors greater than the return on equity during these periods. The dividend payout ratio was greater by 895 and 8760 percent in 2011 and 2012 ttm6, respectively than the return on equity (ROE).

**Sustainable Growth Rate (SGR)**.

SGR shows how fast a company can grow using internally generated assets without issuing additional debt or equity. The sustainable growth rate for NTRI was erratic from 2007 to 2012 ttm6. It showed that the payout ratio from 2009 to 2012 ttm6 was higher than the return on equity. During 2011 and 2012 ttm6, NTRI paid a cash dividend higher than its net income, thus resulted to negative SGR as well as its annual growth during these periods.

Return on equity (ROE) is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. Below is the formula to use.

#### Intrinsic Value

I will show you the relationship of intrinsic value or the true stock price for NTRI. The Intrinsic Value Graph below will make you fully understand.

The true value or the intrinsic value line was far above the enterprise value line in 2007, then a sudden fall at $374 at -82 percent. The falling line continues up to 2012 ttm6 and the intrinsic value was constant at -5 in 2011 and 2012 ttm6. The price remains constant between $9 and $30 from 2007 to 2012 ttm6.

As we can see in the table, using the average ratio, the return on equity and the intrinsic value was higher than in using the relative ratio. While the sustainable growth rate (SGR), annual growth rate and the margin of safety had a higher result than in using the average ratio. In overall view for NTRI, using the relative ratio is favorable because it has a higher result for MOS and growth.

**NTRI Relative Valuation Methods**

The relative valuation methods for valuing a stock, are to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

**Price to Earnings/Earning Per Share (P/E*EPS)**

Using P/E*EPS ratio for NTRI, the result showed that stock was trading at the undervalued price from 2007 to 2012 ttm6 because the enterprise value per share was lesser than the P/E*EPS result. Thus, it indicates that the price was cheap. Let me show you if by using the average price to earning ratio will produce a more favorable result for NTRI.

#### Explanation

The price to earnings, the relative ratio was greater than average price to earnings, while the result for P/E*EPS, the average ratio has the greater result. The enterprise value represented 18 percent while the P/E*EPS results represented 19 percent average using the relative ratio. While on the other hand, using average price to earnings, EV represents 18 percent and the P/E*EPS represents 23 percent, thus, the price is lesser than the P/E*EPS result, meaning the price was cheap.

**Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)**

The use of this ratio is to separate price and earnings in enterprise value. By dividing the enterprise value to projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

The price represents 162 percent average and the earnings represent -270 percent average, the enterprise value is 100 percent. The earnings were negative because, in 2009, 2010 and 2012 ttm6, the net earnings are lesser than the number of shares outstanding. The net earnings of NTRI decreased almost tripled down in 2011 and 2012 ttm6, so the downfall was high. As to overview, it tells us that the stock of NTRI was trading at overvalued price because the price was more than 100 percent, therefore, the price was expensive.

**Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) or (EV/EBITDA).**

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

#### Explanation

The EV/EBITDA was 0.32, in other words, buying the entire business. An investor will wait only a quarter of a year to cover the cost of buying NTRI. Or it means it will only take no more than one year of the earnings of the company to cover the cost.

This valuation can also be a measure of the financial health of the company because it factors the accrued accounts. One valuation is not enough to gauge the stock of a company. That is why in this valuation, there are at least 5 evaluations.

**In Conclusion**

Overall, the price was expensive therefore I recommend a** HOLD** on the stocks of NutriSystem Inc.

Research and Written by Criselda