Trading Corner: Score Fat Profits with this Diet Manager

Melvin Pasternak's picture

Sunday, January 3, 2010 - 8:39pm

by Melvin Pasternak

This Los Angeles-based company sells weight-management shakes, snacks, and nutritional supplements, but its diet aids reach well beyond Hollywood's slimmest stars.

One obvious target audience is the whopping 66.7% of Americans who are overweight. And as people in the United States deal with obesity, their appetite for diet products expands: In the calendar year just ended, U.S. consumers are estimated to have spent $60 billion on diet management products, more than double the amount spent in 2002.

But if you think the United States has a monopoly on obesity, think again. According to the World Health Organization, one-third of all adults across the globe are overweight. By 2015, this number is expected to reach 2.3 billion people—equal to the current combined populations of China, Europe and the United States.

All of which bodes well for diet management company Herbalife Ltd. (NYSE: HLF), which sports a network of about 1.9 million distributors in 72 countries. Since bottoming near $12 in early March, share prices have beefed-up, more than tripling in value to $40.57. That performance is far superior to the S&P 500, which is up about +70% since its March low.

An examination of the weekly chart shown below shows a very strong uptrend for HLF, which closed the year Thursday at $40.57.

Here is the technical case for Herbalife:

  • HLF shares are above a rising 30-week moving average. They're also trading well above the "accelerated" trendline which currently intersects the chart near $35, about $5 below current prices.
     
  • Indeed, HLF is likely to find support at an even higher level. A major downtrend line can be drawn connecting the March and February 2008 peaks in the mid-40s. This downtrend line was broken in October 2009. According to technical analysis theory, a broken downtrend line should provide subsequent support.
     
  • Note also how the broken downtrend line has done just that. The line currently intersects at $40, which is also a round-number support level. HLF has formed two doji candles at that level and the bears have not so far been able to push the stock below this psychological and trendline support.
     
  • RSI analysis, which determines overbought and oversold conditions, also leads to a bullish conclusion. HLF approached overbought levels on RSI as early as May. But instead of correcting lower, RSI has held over the key 50 linternational fundel for about seven months, a symptom of a strong stock. The sideways price consolidation of the past several weeks means the stock is no longer overbought and could be poised for a move higher.

Herbalife's fundamentals are also supportive:

  • In the five years ended in 2008, revenues exploded nearly +85%, surging to $2.4 billion from $1.3 billion in 2004. Because of the weak world economy, revenues will likely have faltered in 2009, dropping about -5%. However, in 2010, analysts expect HLF to be back on a growth track with revenues rising about +11% from 2009.
     
  • Earnings have also dramatically increased during the five-year period ended in 2008. The company lost -$0.27 per share in 2004, but by 2008 earnings ballooned to $3.36 a share.
     
  • Earnings in 2009 are expected to slip about -4% to $3.23, but are seen rebounding to $3.68 in 2010. That's an earnings growth rate of nearly +14%. With a trailing price-earnings ratio (P/E) of 14, the company is attractively priced with a price/earnings-to-growth ratio (PEG) of just about 1.
     
  • And these estimates may be on the low side. During the last three quarters, HLF has reported positive surprises of 15%, 8% and 23%. HLF’s return on equity (ROE) is also an incredible 59%. In comparison, the S&P’s ROE is approximately 15%.

Because of its solid fundamentals, I anticipate HLF will break free from its consolidation formation in early January as volume returns to the market. My only reservation is that the S&P 500 fell sharply in the last hour of trading on December 31st. I would not want to immediately execute this trade if the S&P fell back into its previous support zone at 1111 and then sold off sharply to begin the New Year.

If the S&P holds firm or rises, I think HLF's valuation supports a test of the highs near $48 and an ultimate penetration of them. My target on HLF is $49.95. The stop loss will initially be set at $37.95, below key support at $40. The risk reward ratio is about 2.3:1.

I am placing a buy-on-stop order at $41.55, just above the high of a recent 10-day consolidation period. The buy-on-stop order means I will enter the position only if HLF touches this level and will stay out of the trade if the S&P experiences weakness at the beginning of the New Year. Any major broker is likely to accept a buy-on-stop order.

Action to Take: Based on the analysis above, here's how I plan to trade HLF:

  • Buy HLF with a buy-on-stop order at $41.55 (Good until January 15th.)
  • Set an initial stop loss at $37.95
  • Target price = $49.95
  • Potential profit = +20.2%

Update on Dr. Melvin Pasternak's previous "Trading Corner" Trades

Company (Ticker) Recommendation Date Recommendation Price Current Price Potential Gain
MS Municipal (NYSE: IQM) 12/07/09 $13.11 $13.21 +0.8%
Covance (NYSE: CVD) 12/10/09 $51.50 $54.57 +6.0%

Morgan Stanley Quality Municipal Securities (NYSE: IQM) is a muni-bond fund that has a strong seasonal pattern of bottoming in October-December and rallying into mid-February. I believe IQM is following this pattern again in 2009-2010. It hit a low of $12.31 in October and rallied into the low $13 range. In December, the fund moved in a very narrow trading range, with roughly $13.25 as resistance and $13.00 as support. IQM closed near the top of this range at $13.21 on December 31st. Click here to see the original "Trading Corner" recommendation on IQM.

Covance Inc. (NYSE: CVD) continues to test its intermediate downtrend line from the mid-September peak at $58.95. At least one technical indicator has moved swiftly from "oversold" to "overbought," and it would not surprise me to see CVD stall here. However, I am keeping my $56.95 target steady and moving the stop loss to $51.95 to protect profits. Click here to see the original "Trading Corner" recommendation on CVD.

Melvin Pasternak does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of CVD, IQM in one or more of its “real money” portfolios.