Herbalife’s Gross Margin: “Coincidence” or Too Good to Be True?

(Disclaimer: This post, like all of my posts, is subject to my “Terms of Use,” which is linked above. I urge you to read my TOU at length, and embrace the many, many, many times I note that I have been wrong before and can be wrong again. I am not an accountant, CFA or CPA and all this post is based on my internal calculations, which I’ve checked several times over with people much smarter than I am. This post is solely to create a discussion about what appears to be some interesting “coincidences” with Herbalife’s gross margin. There very well may be a reasonable explanation for this that I am incapable of coming up with. Or, there are some major questions that need to be asked of the company by PwC. I urge you to get an independent opinion on this.)

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Coincidence or red flag – that is the question. Now, I need you – the reader – to let me know what you think.

Here’s an interesting exercise:

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1) Take Herbalife’s gross margin for the last 31 quarters (almost 8 years) and lay it out on a spreadsheet. You’ll wind up with something like this:

dhtst

(top row from left to right is Q1 2007 to Q1 2010 – bottom row is Q2 2010 to current).

2) Now, take gross margin over the last 31 quarters from every other company in the entire S&P 500. That looks something like the photo below. Below is a snapshot of the spreadsheet I used profiling a small section of the “A”s. Rest assured, I have the whole enchilada, provided by S&P Capital IQ. If you want the full spreadsheet, you can get it from Bloomberg or Cap IQ. One click from there and you can punt it into an Excel spreadsheet and do this with me.

etc

3) Discover that out of 500 S&P companies, Herbalife appears to have the lowest gross margin variance over the past 17 quarters out of every company in the entire S&P 500 and the fourth lowest over the last 31 quarters. By my calculations, the company’s gross margin variance for all quarters dating back to Q1 2007 (all of the data points in the above photo) is 12%. If you need help with variance vs. spread, check this out. In the last 17 quarters, the lowest Herbalife’s gross margin has been is 79.5% and the highest its been is 80.7%. That’s a 120bps spread on their gross margin for 17 quarters. That seems remarkably consistent to me.

4) In the time period of 31 quarters, there appear to be only three companies who have a lesser variance in their gross margin out of the S&P 500 (yes, that’s four HUNDRED and ninety nine other companies). They’re three retail companies that are diversified through a portfolio of products in a variety of locales –  according to my calculations, Costco’s margin variance is 3%, Wal-Mart’s is 9%, Home Depot’s is 11%.

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“OK, Quoth,” you’ll say to me. “Have you been drinking? Why is this interesting?”

This is interesting to me for a couple of reasons:

– It’s interesting because Herbalife is in 90+ countries and recognizes revenue in a ton of currencies. Forex markets over the last 30 quarters have gone to outer space and back. Imagine trying to balance 20 major currencies with Forex futures over the course of 30 quarters. Yes, there’s a chance the company is properly hedged or is doing some type of per market price engineering that keeps the margins this tight, but I’m not qualified to dive into it and to me it just seems – weird.

– In addition to the currency markets being extremely volatile, you have to remember that this company isn’t holding steadily in each country that it sells in. Remember the pop and drop charts? Over the course of seven or eight years, one country’s contribution in terms of sales can rapidly increase and then instantly decrease. Look at these markets for instance. Not only are their currencies volatile over this 13 year period, the sales are extremely volatile:

pop

– It’s interesting because Herbalife’s margins (~80%) are numerically much higher than its three closest comparables in Costco (~13%), Wal-Mart (~25%) and Home Depot (~35%). The higher the gross margin number, the more exposed it should be to bigger moves, theoretically.

– It’s interesting because these retail names are theoretically diversified through a ton of products. At a Wal-Mart, you can buy cocoa beans, a t-shirt, and DVDs. The price of one commodity doesn’t effect these companies as they’re often balanced out by other commodities. So, in essence, if coffee spikes, the price of your Folgers moves a small notch within a sea of other items that theoretically offset and create a cushion. It’s no surprise that’s why Costco and Wal-Mart are on this list. They’re each one company, but they’re theoretically diversified through a million products. This gives them stability.

Herbalife? They have one main commodity that gets pushed, mostly with the business opportunity, rarely without it. Generally, Herbalife has one main product (a business opportunity stapled to some protein powder) and this one product is sold in 90+ countries with tons of whack currencies that you’ve never heard of (like the South Korean Won).

Pops and drops, huge sales shifts, 20 major currencies, and crazy FX markets. Seems like a lot to juggle in order to keep margins so consistent.

juggle

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Along these lines, I’ve often wondered why Herbalife doesn’t have any operating leverage. At 80% margins, what keeps the SG&A expense moving in lock step with revenue. When the revenue grows, why does the SG&A have to move with it? What is being booked under SG&A?

I know that this is extraordinarily unique, but I also know there could (I guess?) be some legitimate reasons for this. But, alas, I am not a forensic accountant, so I’m deferring to you, the reader, to do your own research from this point further.

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