Herbalife Rises on Record Earnings and Improved Outlook; Accounting Questions Remain

Herbalife HLF was among the NYSE leaders on Tuesday. The stock traded up nearly 7 percent to above $55.00 in the final hour of the trading day. This rise occurred after the company announced record second-quarter earnings, lifted its full-year earnings guidance, and announced a $1 billion buyback authorization. In light of the extremely strong results, some investors may be surprised that the stock did not rise more. Jim Cramer tweeted "I would have believed $HLF would be up more but these nagging accounting issues are behind the lack of upward jump." Investors have been concerned about the stock for a number of reasons ever since hedge fund superstar and notorious short-seller David Einhorn popped up on Herbalife's first-quarter conference call. Although the company's management called Einhorn's questions "basic," his appearance on the call was enough to spook investors. The stock tanked from around $70.00 all the way down to $46.00 within days. Einhorn's line of questioning may not have been terribly poignant, but he re-awakened some skepticism about Herbalife's business model, which is essentially a multi-level marketing scheme. Herbalife describes itself as "a global network marketing company that sells weight management, nutritional supplements, energy, sports and fitness products and personal care products through a network of approximately 2.7 million independent distributors, except in China, where the Company sells its products through retail stores." Despite the fact that Herbalife has tremendous growth metrics, makes a lot of money, has been trading on the NYSE since 2004 and has risen nearly 650 percent during that time, some investors are not comfortable with its business model and accounting practices. Furthermore, while Herbalife has a great reputation and track record, many similar companies do not. The possibility that David Einhorn is shorting the stock likely does not make anyone more comfortable with the name either. In his hedge fund's most recent investment letter, Einhorn wrote that two "undisclosed short positions" generated substantial profits in the second-quarter. One of these positions may very well have been Herbalife. On Tuesday, Herbalife CEO Michael Johnson was interviewed on CNBC. He said that he has not had any followup communication with Einhorn. In regards to rumors that Herbalife is little more than a glorified pyramid scheme, Johnson also said that the company does not pay for recruiting. He did admit, however, that "many of our distributors are customers." This was an issue that Einhorn brought up on the Q1 call. The implication is that Herbalife is generating a significant amount of revenue by selling products to its distributors and that these revenues are not a good indication of end-market demand. Despite the whiff of controversy surrounding the stock, Herbalife's financials looked great in the second-quarter. The company reported net income of $133.4 million or $1.10 per share, compared to $111.2 million or $0.88 per share in the year ago period. This came in well ahead of the Wall Street consensus EPS estimate of $0.96. Revenues for the second-quarter were $1.03 billion, rising from $879.65 million last year. This also exceeded Street consensus revenue estimates of $978.97 million. Looking ahead to Q3, Herbalife's management said it expects EPS to fall between $0.97 and $1.01. This compared to analysts' current consensus EPS estimates of $0.99. For the full-year, Herbalife said it expects EPS between $3.88 to $3.98 compared to its prior range of $3.58 to $3.74. This was above Wall Street consensus EPS estimates of $3.80 for the full-year. The company's board of directors also authorized a $1 billion share repurchase program to be utilized over the next five year period.