The recent drop in WTW’s price presents great opportunity for investors.

True, the 2Q12 earnings call revealed a downtrend in US and Int’l revenues and weeks paid. And I expect that, on the margin, WTW may continue to lose consumer customers. Let’s face it, a weight-loss program is not exactly high on the priority list when money is tight.

Focus On Wellness Programs and Preventative Care

However, the opportunity for Weight Watchers is not in building up its consumer business. The opportunity is in the health insurance business, namely wellness and preventative care programs.

United Health Group (UNH) is already incorporating Weight Watchers into their anti-obesity and wellness programs. Some employers, like United Parcel Service (UPS), chime in and offer employees additional incentive to use the Weight Watcher’s programs offered by UNH.

I believe what UNH and UPS are doing is the beginning of a big trend in health care and I think Weight Watchers, and some programs like it, will benefit significantly. Here’s why:

  1. “it costs 50% more to cover medical costs for someone who is obese versus someone who is at a healthy weight” and
  2. obesity is the leading cost of healthcare.

Weight Watchers is more than just a low-calorie diet. It also provides regular counseling and tracking of each client’s weight and calorie intake. These measures greatly enhance the effectiveness of the program and, more importantly, enable Weight Watchers to demonstrate, empirically, the ROI (return on investment) they can bring insurers.

Obesity Is a Big Expensive Problem for Insurers and Employers

According to the Center For Disease Control (CDC)’s website, 35.7% of US adults were obese in 2009-2010. Also on the CDC website:

“No state has met the nation’s Healthy People 2010 goal to lower obesity prevalence to 15%. The number of states with an obesity prevalence of 30% or more has increased to 12 states in 2010. In 2009, nine states had obesity rates of 30% or more. In 2000, no state had an obesity prevalence of 30% or more.” (Source: CDC website)

As obesity has become our nation’s top health problem, insurers and employers are forced to focus efforts on reducing the prevalence of obesity. Given the high costs of obese people, employers and insurers have a pretty big budget for investing to reduce health care costs. In other words, the cost of prescribing a Weight Watcher’s program is far less than the cost of benefits for an obese person.

As long as that is the case, then insurers and employers should be motivated to utilize programs like Weight Watchers.

Consequently, I think it is safe to say that more insurers will follow UNH’s lead and make Weight Watchers part of their health care services. Probably not all insurers will go with Weight Watchers, but chances are more than good that a least a few will choose them to help keep costs down. WTW is very well-positioned to win contracts with other insurers given their experience with UNH and the scalability of their business.

Very Large and Growing Target Audience

Weight Watcher’s is not just for the obese. It also serves the needs of those looking to improve their image by shaving off a few pounds. WTW’s advertising includes many famous celebrities (e.g. Jessica Simpson, Charles Barkley, Dan Marino) who have benefited from their product. This marketing strategy enables Weight Watchers to appeal to higher-end consumers. In an economy where consumers, of almost all spending levels, are looking to cut costs, many might turn to Weight Watchers as a lower-cost alternative to plastic surgery or liposuction.

By catering to such a wide range of potential customers, WTW’s target audience includes nearly everyone who is not already thin. That is a lot of people.

Very Attractive Valuation

WTW is a winner for investors because the valuation is cheap. The stock price is giving WTW no credit for being able to grow its business. At about $45/share the stock price implies the company’s profits will permanently decline by 30%from their 2011 level. In other words, the market is pricing in a larger profit decline than what the company’s management forecast in the 2Q12 earnings call. Moreover, the market’s current expectations (at ~$45/share) assumes a permanent decline of 30%.

That positions the stock with significant upside.

This story gets better as few investors realize the high returns on invested capital (ROIC) achieved by this company. It’s ROIC rivals that of some of my favorite tech companies like Google (GOOG) and Lam Research (LRCX). I like to think of WTW as almost like a software company. They have recipes for food (like code) that they can distribute to a nearly infinite number of customers with very low marginal costs. True, preparing and delivering a meal is more costly than copying code from one computer to the next, but not that much more. And WTW’s ROIC shows that it can prepare and deliver meals quite efficiently.

A high ROIC also translates into faster profit growth for a given level of revenue growth than lower ROIC companies. In addition, WTW’s business model can scale more easily than more capital-intensive businesses.

Figure 1 shows that WTW’s ROIC has been consistently higher than that of the market-weighted average of the current S&P 500 companies over the past 5 years. In 2011, WTW’s ROIC rose much more than the S&P 500’s ROIC. That is an impressive achievement.

Figure 1: WTW Achieves Higher Returns On Capital

Sources: New Constructs, LLC and company filings

Win-Win Opportunity For Investors

One of the best “win-win” combinations in today’s world is Weight Watcher International’s (WTW) stock. The combination of large growth potential, a cheap valuation and a highly-scalable business model make WTW a great investment opportunity. Remember this is a quote by Warren Buffett: “Be fearful when everyone is greedy. Be greedy when everyone is fearful“.

My rating on the stock is Very Attractive. It also made my Most Attractive Stocks list for July. Click here for more details on my WTW rating and my top-rated ETFs and funds that hold WTW.

Disclosure: I am long WTW, GOOG and LRCX. I receive no compensation to write about any specific stock, sector or theme.

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