Durig Fixed Income Bond Review
For this week’s bond review, we look to a dietary supplement company who has just implemented major changes with encouraging results. GNC Holdings carefully studied its business model and decided to make changes to its basic business model in late 2016. Now, with its Q1 results just in, the company appears to be moving in the right direction.
Q1 showed transaction growth of 9.3%, a level not seen in years.
GNC generated free cash flow in Q1 of $33.4 million.
The company’s new customer loyalty program has attracted over 5 million users since the first of the year.
For Q1, GNC had outstanding interest coverage of 3.8x.
GNC’s 2020 convertible bond is currently selling at a large discount, giving these 1.5 % couponed bonds a current yield to maturity of about 14%. Investors looking to add diversification in the retail sector would do well to consider these short 38-month bonds. Although the convertible feature on these bonds may not result in the possibility for increased returns, its yield to maturity is very attractive. In light of these factors, we have marked these bonds for addition to our FX2 high yield global income portfolio. The aggregate performance of our FX2 portfolio is shown below.
The Remaking of a Company
In late 2016, GNC implemented some major changes that it hopes will signal a new dawn for the supplement company and its customers. After spending two years studying its business model and its customer base, GNC revealed some sweeping changes to address some of the biggest concerns from its customers – its prices were too high and its product pricing was confusing. To address these concerns, GNC implemented One New GNC, a sweeping change in its basic business model. As part of this change, the company lowered prices on at least half of its products and it simplified its pricing. Gone are the days when there were up to four prices for a product – Gold Club price, non-member price, suggested retail price and sale price. Instead, there is now only one price per product, whether it’s in-store on online.
The early results from this program are encouraging – GNC had transaction growth that was up 9.3% – a level of growth that it hasn’t seen in a long time. Also, the company generated free cash flow in Q1 of $33.4 million. To add to that, in its last earnings conference call, the company’s CFO revealed that the company expects to generate free cash flow of $250 million in 2017.
A New (and More Successful) Rewards Program
In addition, the company has revamped its customer loyalty rewards program. In place of its Gold Card program, it now has myGNC Rewards. Since implementing this new rewards program earlier this year, it has accumulated more than 5.4 million users. In Q1, myGNC customers shopped more frequently and spent more than the previous Gold Card member. The new loyalty customer, on average, visited a GNC store 1.5 times in the first three months of 2017. This equates to the myGNC customer visiting the store six times per year, versus the four times a year (on average) that Gold Card members visited the stores. Perhaps the biggest win for GNC from this new rewards program, is the fact that it captures each customers’ email address as a part of signing up for the program. This has proven extremely effective in GNC’s target marketing efforts since the first of the year. With its massive online marketing campaign in Q1, the company saw an outstanding 3-to-1 return on investment for its online marketing.
About the Issuer
In 1935, David Shakarian opened a small health food store in Pittsburgh, PA. Even though health food was considered to be a passing fad back then, people welcomed Shakarian’s store. In the 60’s, as people began to accept natural foods and better nutrition, Shakarian met the demand by opening more stores in additional states. It was at this point when he changed the name to General Nutrition Centers, and began producing his own vitamin and mineral supplements.
GNC Holdings, Inc., still headquartered in Pittsburgh, PA, is now a leading global specialty retailer of health and wellness products, including vitamins, minerals, and herbal supplement products, sports nutrition products and diet products. The company’s shares trades on the New York Stock Exchange under the symbol “GNC.”
The Company – which is dedicated to helping consumers Live Well – has a diversified, multi-channel business model and derives revenue from product sales through company-owned retail stores, domestic and international franchise activities, third party contract manufacturing, e-commerce and corporate partnerships. GNC’s broad and deep product mix, which is focused on premium, value-added nutritional products, is sold under GNC proprietary brands.
The Health Supplement Industry
The global dietary supplements market is being driven by increasing awareness on the part of the consumer, who is seeking preventative healthcare. In addition, it is also being driven by the growth of the aging population. According to a Zion Market Research report, the global dietary supplements market, valued at USD $132.8 billion in 2016, is expected to reach USD $220.3 billion in 2022 and is anticipated to grow at a compound annual growth rate of 8.8% between 2017 and 2022. In 2016, Asia Pacific made up the largest market for dietary supplements, accounting for more than 31% of the total volume of the dietary supplements market. This trend is anticipated to continue into the coming years. The second largest market was North America, with 28% of the total market. Most of the growth in the North American market is projected to come from products that are related to weight loss and weight maintenance.
Liquidity and Interest Coverage
As of March 31, 2017, GNC registered cash of $39.4 million. In addition, it had $194.3 million available on its Revolving Credit Facility.
For the company’s latest reported quarterly results (Q1 2017), the company had operating income of $53.6 million with interest expense of $15.9 million. This calculates to an outstanding interest coverage of 3.8x.
The risk of default on these convertible bonds is directly related to GNC’s ability to continue the promising results it saw from its One New GNC program in the first quarter of 2017. The company’s transaction growth in Q1 was impressive and at a level that CEO Robert Moran says the company hasn’t seen in years. Its new customer rewards program is allowing the company to apply more personalized and cost-effective marketing to its customer base. In addition, reward plan members are on track to visit stores more frequently than the previous Gold Card members, which will result in additional sales and revenue for the company. The company’s estimated 2017 free cash flow generation of $250 million would absolutely be the stamp of approval on GNC’s company transformation. The 10.5% yield to maturity on these 39 month bonds appears to outweigh the risks identified.
GNC has a large loan due in 2019 of approximately $1.13 billion. This loan is related to the company’s stock buyback in 2013. GNC is currently in talks to extend the maturity of this loan from 2019 to 2022, but there is no certainty that the company will successfully navigate this deferment. If it is not able to do so, the company could find it challenging to pay off this large loan come 2019.
Summary and Conclusion
GNC has reinvented itself. The early results from its transformation are encouraging: 9.3% transaction growth in Q1, outstanding participation from its customer base in its new customer appreciation program, fantastic interest coverage of 3.8x and a projected free cash flow in 2017 of $250 million. While the retail industry can be tricky, GNC has gone back to the basics of catering to the customer, and the customer looks to be responding. These relatively short-term convertible bonds are a healthy portfolio addition for investors looking to add diversification as well as increase portfolio returns. Therefore, we are adding these 14% YTM GNC bonds to our FX2 global high yield income portfolios.
Issuer: GNC Holdings
Price: $7.27 (as of 5/25/2017)
Conversion Price: $66.06/share
Yield to Maturity: ~14.04%
To learn more about this bond, call our fixed income specialist at: (971) 327-8847
Always putting your interests first,
Registered Investment Advisor
DIR (971) 732-5119
Ask a question, or, tell us what you’re looking for:
About Durig Capital
At Durig Capital, we provide investors with a specialized, transparent fiduciary service at a very low cost. To obtain higher yields and keep costs as low as possible, we typically bundle smaller retail orders into larger institutional sized orders with many global trading firms and bond platforms. Our professional service enables access to a greater spectrum of bonds, higher yields, and lower price points. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured.
We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful. Our main priority is to provide the best opportunities for our clients. Our bond reviews are published on the Internet and distributed through our free email newsletter to thousands of prospective clients and competitive firms only after we have first served the needs of our clients. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients.
When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.
Disclosure: We believe that accounts under our discretionary management have significantly outperformed those that require clients to make their own investment decisions.
Disclosure: Durig Capital and certain clients may have positions in GNC Holdings August 2020 bonds.
To learn more about this bond call our fixed income specialist at 971-327-8847
Always putting your interests first,