News Analysis date published New: 
Thursday, July 26, 2012 - 14:30
New Date created: 
Thursday, July 26, 2012 - 15:33
New Date last updated: 
Thursday, July 26, 2012 - 14:30

This Respected Hedge-Fund Manager is WRONG About this Stock

Thursday, July 26, 2012 2:30 PM

Going against the herd is a great way to score big gains in the stock market.

And right now, with investors fleeing from shares of one of my favorite companies, a huge opportunity is at hand. The mass exodus from this high-growth mid-cap stock was triggered in early May after hedge-fund titan David Einhorn pulled a cameo at the company's first-quarter earnings call and asked questions that led Wall Street to believe he was in the process of accumulating a short position.

The famed short-seller simply asked questions about the company's distribution channels and business model, and about some metrics it had stopped disclosing. Keep in mind, though, this is a textbook play from Einhorn, the same manager who released a scathing report on Green Mountain Coffee Roasters Inc. (Nasdaq: GMCR) last fall and began shorting shares before they crumbled from more than $111 to a recent low of $17.11 in July. These are the kind of trades that get the Street watching your every move.

Sure enough, investors panicked and shares of this stock fell from just above $72 on April 26 to $46.20 on May 3, a spiraling loss of more than 36% in less than five days. Take a look at the staggering fall in the chart below.

A 36% decline in five days
But in a dramatic twist to the story, in the weeks following the sharp decline, it was revealed through regulatory disclosures that Einhorn had passed on shorting this stock. The market had wrongly speculated that his comments on the earnings call meant he was planning a short- position. In spite of this seemingly bullish revelation, shares are still trading at rock-bottom levels.

Does this mean you should avoid this stock?

I think there's a nice profit opportunity here...Let me tell you why...

The company in question: Herbalife Inc. (NYSE: HLF), a network marketing company that sells weight management, nutritional supplement and personal care products worldwide. The company's network marketing business model is similar to the one Avon Products Inc. (NYSE: AVN) and Tupperware Brands Corp. (NYSE: TUP) use, where individual distributors pay a small upfront fee for a starter kit for the opportunity to sell its goods and recruit other sales agents.

Herbalife made an incredibly bold statement when its share price fell in May. The board of directors announced just days after the price plunge that it was capitalizing on the opportunity to buy shares at a lower price, executing a whopping $482 million buyback that represented close to 10% of the entire value of the company. Those are not the actions of a company lacking confidence, and they say plenty about management's bullish outlook for sales and earnings.

But beyond the company's own response to a crisis of confidence, there are still a few more reasons that Herbalife will likely return to its old high.

The company continues to see impressive growth internationally, led by huge gains in emerging markets like China and Latin America. In its most recent quarterly results, Herbalife's consolidated revenue jumped an impressive 21% from the same period last year, climbing to $964 million. From a geographic perspective, these gains are being fueled by impressive growth in emerging markets, with sales up 31% to $259 million in Asia-Pacific, now the largest revenue region for the company at 27% of total sales. But the company's biggest growth market remains Latin America, where its South and Central American regions saw 32% revenue growth to $165 million, comprising 17% of total revenue.

Herbalife should also continue to benefit from its network marketing business model, where the company essentially charges potential distributors to become employees. That has helped to juice Herbalife's margin profile, with net margin of 11.9% well above the mere 3.5% industry average. This dynamic also shows up in the company's return on equity (ROE), currently at an eye-popping 76% against the industry average of just 21%.

All of these bullish factors are showing up in earnings estimates, with the full-year 2012 estimate up 16 cents in the last 90 days to $3.80, a 15% growth projection from 2011. The full-year 2013 estimate has also been on the move, up 24 cents in the same time to $4.35, another solid growth projection of 15%.

Do the analysts who follow this company every day seem concerned about growth? Hardly.

This bullish movement in estimates ahead of the company's second-quarter earnings release set for July 30 suggests the group is optimistic Herbalife will deliver another solid quarter, where it has an average earnings surprise of 15% over the last four quarters.

Risks to Consider: With the Asia-Pacific region becoming Herbalife's highest source of revenue, the company will be susceptible to a slowdown in emerging-market growth, on display last week with China's weaker-than-expected read on second-quarter gross domestic product.

Action to Take --> Shares of Herbalife were rocked after Einhorn spooked investors into thinking he had a short position on the company. But that big one-day drop did wonders for the valuation picture. If Herbalife simply returns to its historical valuation of the past 10 years, shares would jump back to $72, a sharp 30% increase from current levels.

Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.