The South Beach Diet's Success Fattens Nutrisystem's Share Price

Following NutriSystem Inc. NTRI's first-quarter results, Wunderlich said it believes part of the current premium valuation is attributed to expectations South Beach can develop into a sizeable revenue platform.

A Briefing On The South Beach Diet

Nutrisystem acquired South Beach Diet from SBD Holdings for $15 million in December 2015. South Beach Diet, created by Arthur Agatston, M.D., a cardiologist from southern Florida, is meant to help overweight patients improve their health by prescribing a safe diet for them.

Agatston's book "The South Beach Diet" became a runaway bestseller, boasting more than 23 million copies in print.

Nutrisystem revealed plans for South Beach Diet in December 2016, announcing its debut as a structured meal delivery weight-loss program.

"This past September we began our beta test of the South Beach Diet and we saw strong consumer interest in the brand and our overall opportunity to capitalize on the strong brand equity of the program," said Dawn Zier, president and CEO of Nutrisystem in December 2016.

"We will begin rolling out the all new South Beach Diet in January and it will ramp up over time, enabling us to capture a larger portion of the $10–15 billion addressable weight loss market."

Positive On South Beach Diet

Analyst Mitchell Pinheiro said he remains positive on South Beach's outlook but believes the stock price reflects the visible potential, particularly in light of its nascent stage.

In the first quarter, South Beach Diet added revenues of $8 million, $1 million above the analyst's estimate. The company also reiterated its 2017 guidance of $20 million to $25 million in revenues from this diet.

"While the program continues to be tweaked, we believe the performance was solid and expect further improvements in the product mix and marketing message as the year progresses, with an eye toward more meaningful growth in 2018," the analyst explained.

Q1 Review

Wunderlich noted the company reported first-quarter earnings per share of $0.25, exceeding its estimate of $0.10, with lower tax rate adding $0.02 relative to its estimate. Revenues rose 31 percent to $197 million, above the firm's estimate of $197 million.

The firm commended the new customer revenue, which spiked 35 percent, aided by strong new customer growth and reactivation revenue.

Other metrics:

• Reactivation Revenue: $49 million, up 20 percent year-over-year due to the growing pool of recent new customers.
• EBIT Margin: 4.4 percent, up 210 basis points, helped by higher gross margin.
• SG&A Expense: down 160 basis points.
• Marketing Expense: up 180 basis points.

Raising Estimates

Wunderlich raised its 2017 earnings per share estimate to $1.66 from $1.56, which is at the low end of the guidance range of $1.65–$1.75. The company attributed the revision to the better than expected first-quarter results. The revenue estimate is $656 million, also reflecting the first quarter strength.

"Given the momentum of 1Q, we believe this could prove conservative and represents potential upside to our estimate," the firm said.

The firm also raised its 2018 earnings per share estimate to $1.91 from $1.80 on revenues of $706 million, up 7 percent.

Additionally, the firm said its second-quarter estimate calls for 20 percent revenue growth.

"We project core Nutrisystem revenue growth of 6 percent, which we believe is conservative given the current momentum. We have left our South Beach revenue estimate unchanged at $57mm implying a growth rate of 49 percent," the firm added.

Downgrading Rating, Lifting Price Target

Wunderlich downgraded shares of the company to Hold from Buy but raised its price target to $60 from $52.

The downgrade was due to the firm's expectations that there aren't any sufficient near-term catalysts to drive the valuation multiple higher, with the firm seeing a more even risk/reward scenario over the next six months. That said, the firm remains positive on NutriSystem's fundamental outlook against a backdrop of consistently strong operating performance.

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