The Skinny on Weight Watchers

 | Sep 12, 2012 | 2:30 PM EDT
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It's much easier to evaluate a company and its stock when it offers a product or service that is highly regarded by consumers and you can see a continued demand for that product. That's what originally excited Warren Buffett about Gillette and Coca-Cola (KO) many years ago.

The company I'm looking at today is one that most everyone is familiar with -- a strong testament to its brand power and successful execution over many years. That company is Weight Watchers International (WTW). It's anything but a fad -- being in business since 1961 suggests as much. But the stock has fallen recently from about $80 a share to $50; as a result, the company is one of the better bargains in the market today. It's moved up on my watch list, and I'm going to share my basic bullish case for the stock.

We all know what Weight Watchers does: it assists men and women in eliminating unnecessary weight. I used to be a skeptic about weight-loss programs. Because I eat healthy and exercise regularly, I was of the opinion that no one needs a weight-loss program, just a little discipline to lose weight independently. But I've removed my blinders and changed my view.

What Weight Watchers does is create a clinically proven system for weight loss: eating the right foods in the right portions, along with a path to developing a healthier lifestyle. The company offers weekly support groups where members meet and provide continuous support and encouragement for the program. Each week, approximately 1.3 million members attend more than 45,000 Weight Watchers meetings around the world run by more than 12,000 leaders, each of whom has lost weight on the Weight Watchers program. This is a stroke of genius: It provides the company with a growing base of word-of-mouth advertising. To achieve weight-loss goals requires being involved with the client every step of the way, and that's what WTW does; each step is a revenue-generating mechanism.

Its proprietary PointsPlus weight-loss system is a very effective tool. Members are assigned daily point limits and all the foods they eat are assigned a point value. This system serves to easily quantify whether or not a member is consuming more than he or she needs in a given day. is experiencing the greatest growth. For a monthly fee, subscribers get access to recipes and other tools that create a virtual weight-loss coach. The company's newest spokeswoman, Jessica Simpson, should benefit the company: She relied on Weight Watchers to regain her figure after childbirth. Continued endorsements from celebrities such as Charles Barkley and Jennifer Hudson also reinforce the effectiveness of the brand.

Weight management is a growing market, estimated to be worth $60 billion in 2010. Over the past 20 years, the number of obese and overweight people has steadily increased, and Weight Watchers expects to that number to reach 3 billion by 2015. In the U.S., Weight Watchers estimates that more than 60% of the population over the age of 19 is overweight. When you consider the healthcare implications of obesity on disease risk and the costs incurred, weight management becomes a very valuable tool in reducing healthcare costs.

WTW spins off a lot of free cash flow. From 2009 to 2011, free cash flow grew to nearly $400 million from $250 million. The current market cap is $3 billion and enterprise value is $5.3 billion. WTW requires very little cash to run its business; when this is the case, it's optimal to have a levered capital structure. Recognized as the leading brand in weight management, the 40% selloff in the shares has made WTW very attractive. The stock dropped on weaker-than-expected earnings as membership numbers disappointed. Yet demand for WTW isn't going anywhere; clearly, it's the most recognized and effective brand in the weight-management industry. The website is a fast growing part of the business that should continue to drive cash-flow growth. The short-term setback severely discounts the long-term growth potential of a company regarded as best in class in a growing market.

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