Last Tuesday, after the U.S. Justice Department leveled charges against the dietary supplement industry, shares of GNC (GNC) and Vitamin Shoppe (VSI) fell 24% and 8%, respectively, even though neither was mentioned specifically in the indictment. The charges against the industry targeted the mislabeling of ingredients from China used in a supplement that was banned in 2013.
These allegations appear to be yet another nail in the coffin of an industry that already has had a bad year due to similar allegations elsewhere and challenges to their business model, and as more people buy their supplements on Amazon (AMZN). GNC shares are down 38% year to date and Vitamin Shoppe stock is down 39%.
Looking back even further, Chris Versace, columnist for Real Money and porfolio manager for Growth Seeker and Trifecta Stocks predicted the decline of GNC and Vitamin Shoppe in December 2013 as evidence emerged that users of supplements found no improvement in cognitive ability when compared to placebo groups.
At the time, Versace said, "it would be prudent for investors who have been in the shares of GNC, Vitamin Shoppe, Nu Skin (NUS) and Vitacost for several quarters to trim back positions and take some profits off the table as Wall Street looks to recalibrate its growth expectations for these companies." Since then, shares of GNC and Vitamin Shoppe are down 49% and 43%, respectively.
Tuesday's charges, however, represent the first time Chinese ingredients were mentioned in an investigation of this scale. While the indictment did not list GNC or Vitamin Shoppe, it did call out USPlabs, which produced OxyElite Pro, a supplement that was sold in GNC and Vitamin Shoppe stores until 2013. On Thursday, GNC announced that it would no longer sell products made by USPlabs.
The Justice Department indictment alleges that USPlabs "engaged in a conspiracy to import ingredients from China using false certificates of analysis and false labeling and then lied about the source and nature of those ingredients after it put them in its products." Also, "USPlabs told some of its retailers and wholesalers that it used natural plant extracts in products called Jack3d and OxyElite Pro, when in fact it was using a synthetic stimulant manufactured in a Chinese chemical factory."
The Justice Department's case raises questions as to whether GNC and Vitamin Shoppe have more mislabeled products -- possibly made in China -- sitting on their shelves undiscovered. Both companies have a history of pulling products from the shelves due to safety concerns but not pulling similar products from their shelves at the same time. For example, in the wake of the issues surrounding Jack3d and OxyElite Pro, GNC and The Vitamin Shoppe continued to sell Redline White Heat and Oxy Therm Pro, which contained DMBA, a similar stimulant to the DMAA found in USPlabs products. The DMBA-containing products were pulled from shelves late in 2014 following pressure from U.S. senators and scientists.
For its part, GNC said in a statement that it "provided its full cooperation to the authorities" and that it was "committed to maintaining the trust and confidence of our customers." Meanwhile Vitamin Shoppe offered the following: "The Vitamin Shoppe continues to support strong steps by the appropriate regulatory bodies in oversight and to ensure compliance to protect consumers."
The continuing threat of tainted Chinese imports, as well as falsely labeled vitamins, is likely to continue to weigh on GNC and Vitamin Shoppe as more details emerge. For a quick refresher as to why there is growing concern about ingredients from China, recall several incidents that made headlines. Earlier this year, Lumber Liquidators' (LL) laminate flooring made in China was found to contain formaldehyde, a known carcinogen; in 2014, Petco stopped selling pet food made in China following an FDA investigation that found contaminants in vegetable proteins imported from China; in 2007 lead paint was found in Mattel (MAT) toys made in China. With respect to Lumber Liquidators, shares of the company's stock are down 73% since March, when "60 Minutes" aired its report about the laminate flooring made in China.
A cynical person would say the business model of GNC and Vitamin Shoppe consists of making money before they get caught for putting the lives of its consumers at risk.
The threat from China was enough for Perrigo (PRGO), a manufacturer of generic healthcare products, to announce in October that it was getting out of the vitamins, minerals, and supplement (VMS) business. During the company's first-quarter earnings call, Perrigo CEO Joe Papa spoke of pricing pressure the company face from oversees.
"There is product coming in from China into the United States that at this time we do not believe is properly labeled, made in China, and it's being sold in the U.S.," Papa said. "That's something that we do think we will get resolved, but I don't want to put a specific time on it because things like that take quite a long time. But that pressure on products coming in from China has been noticed in our pricing for our VMS category in the competitive side. So that is clearly an issue."
On Thursday, Jim Cramer advised on "Mad Money" that investors in GNC may want to look to Perrigo as an antidote to GNC's falling shares.
For everyone else -- vitamin users and potential investors alike -- it may just be best to stay away from GNC and Vitamin Shoppe.
