NutriSystems (NTRI): A Brief Look At The Numbers

Note: To read an updated blog on Nutrisystem, please click here.

We received some interesting emails following our recent blog about Nutrisystem´s (NTRI) business prospects. The most frequent request from subscribers was whether or not the actual numbers provided by NutriSystem supported our argument. What follows is a brief quantitative look at NutriSystem´s numbers, based on publicly available information provided in NutriSystem´s SEC Filings.

As we pointed out in our first piece on NutriSystem´s (NTRI), we believe that a proper valuation for NutriSystem´s must take into account the highly cyclical nature of the weight loss business in general, as well as the extremely high customer turnover (churn) at NutriSystem, in particular. As we think that the cyclical aspect of the weight loss industry is quite obvious, we will only review numbers here that are specific to NutriSystem and its customer turnover issue.

How Long To Dieters Stay On The NutriSystem´s Diet?

The easiest issue to cover first, is the average amount of time a new customer stays on the NutriSystem´s diet. In NutriSystem´s SEC filings, the company provides a number which it refers to as revenue per customer.  This number is the revenue derived from a customer in the "initial diet cycle", which is defined for reasons which are not revealed, as a nine-month period. As the company states, "The initial diet cycle for a given month is the revenue obtained in that month from customers within nine months of their initial purchase divided by the new customer count for each of the last nine months."

For lack of any better metric, we think you can use this "Revenue Per Customer" number as a means of calculating the average amount of time a new dieter stays on the NutriSystem´s Diet. The calculation is as follows:
Revenue Per Customer, according to the latest 10-Q, is on average $623 (averaging the last two quarters).
The Cost of the NutriSystem´s Diet is on average $289 per month.

Therefore, the average customer appears to stay on the NutriSystem´s diet for a little over 2 months. Quite obviously, this customer lifecycle timpespan is ludicrously low and shows that NutriSystem´s Diet is not a sustainable lifestyle solution to an obesity/weight problem. This is of course quite understandable, as one would not expect any sane person to remain on a freeze-dried food diet for any meaningful period of time.

In most other businesses a company would never be able to make back its cost to acquire a customer in only two months. In fact, we´re not sure we know of any other business, in which this is the case. Bulls will, of course, argue that this shows the superiority  of NTRI´s business model. That may be the case at the currrent time, but we are highly skeptical that the combinations of  low customer acquisition costs and high-profit items, will be maintained in the next 12 to 18 months.

The secret ingredients to NutriSystem´s current success are: a highly aggressive marketing campaign, the huge mark-up charged on its food, and the extremely low customer acquisition costs which it has enjoyed. All three of these factors will begin to work against the company in the future, as there is absolutely no barrier to entry in NutriSystem´s business (the company uses non-exclusive third-party manufacturers to make its food). We suspect that as other smart operators enter the freeze-dried food weight loss sector, customer acquisition costs will rise and margins will fall.  At the same time, and more importantly, as more and more people discover that eating freeze-dried food for two months is not a permanent weight loss solution, it will become more and more difficult for NutriSystem´s, and other companies in this space, to generate the type of new customer growth enjoyed in recent years.

How Many Repeat Customers Does NutriSystem´s Have?

Of course, the most important metric for any business is repeat customers. Without a significant amount of repeat customers a business is simply not sustainable over a long period of time and  any such business should not be afforded a high earnings multiple, despite a recent track record of strong growth.

So what is NutriSystem´s repeat business? This is a somewhat more complicated measure to figure out, as NutriSystem´s does not provide its repeat customer numbers. The company does, however, provide a total reactivation revenue number in its SEC filings. This number refers to revenue generated by NutriSystem´s customers who were more than nine months removed from the NutriSystem program. In order to get a rough estimate of the company´s repeat customer number, we divide this reactivation revenue number by the average revenue per customer, noted above. We then compare all of these numbers over time both as a percentage of revenue and a percentage of the entire customer base.

The analysis is follows:

2003: Reactivation Revenue = $6 million or 27% of Total Sales

2004:
Reactivation Revenue = $7 million or about 15% of Total Sales
Estimated Returning Customers = 12,000 for an estimated customer abandoment rate of about 50%

2005:
Reactivation Revenue = $14 million or about 4% of Total Sales
Estimated Returning Customers = 24,000 for an estimated customer abandoment rate of about 55%

2006: Only Six Months:
Reactivation Revenue = $14 million or about 5% of Total Sales
Estimated Returning Customers = 22,000 for an annualized estimated customer abandoment rate of nearly 80%.

Bulls on NutriSystem´s will likely point out that these numbers reveal a positive trend, since absolute reactivation revenue and absolute repeat customer numbers are growing rapidly. However, we think that a better way to look at these figures, especially if you want to predict future trends, is as a percentage of sales and total customers, since one would expect these numbers to grow absolutely as the absolute number of customers grows as rapidly as it has for NTRI.

From that perspective, one can see quite clearly that NutriSystem´s repeat customer figures have been trending down sharply ever since it launched its nationwide marketing campaign several years ago. In fact, it appears that NutriSystem´s churn rate is currently at between 60%-80%, and the company needs to replace nearly 95% of its revenue on a yearly basis. For obvious economic and mathematical reasons, a business operating with such high churn rates and also offering a product that does not legitamately solve the problem it addresses, is simply not sustainable.

What Does The Future Hold For NutriSystems?

Since NutriSystem´s base business growth is simply not sustainable, for one to assign a high multiple to the current growth business, one has to believe that the management team at NutriSystem´s will be able to leverage its current success into new high-growth ventures, thereby replacing all the lost revenue. This of course is possible, and  perhaps is a decent bet, given the past success of management in growing the initial freeze-dried weight loss business.  One way the company is trying to replace lost revenue is via new demographic targeting (e.g. the Men´s Weight Loss Program). Other strategies may include international expansion or growth in the company´s Slim and Tone franchise.

However, we suspect that as the larger base business slows from its rapid growth in the next 12 to 18 months, and as competition and "weight-loss" realism set in, the company will find it difficult to replace the lost revenue via new channels at a quick enough pace. When the market realizes this, it will penalize NTRI´s stock for the slower growth via a sharp multiple compression.  We think that even assuming highly optimistic growth scenarios and incredible success in new ventures, in the best case the stock can provide 50% capital appreciation over the next two years from its current price. This is of course a very respectable return, but hardly the type of current share price appreciation momentum players are expecting. In addition, this is merely a best case scenario and  does not take into consideration the risks the company faces in developing more sustainable growth. Our own prediction is that despite a huge amount of short-term volatility, the company´s stock price will basically remain flat to down over the next two years. In addition, if the market became skeptical of new growth initiatives, the stock would clearly decline rather sharply.

Disclosure: I hold no shares in NutriSystem, either on the long or short side.