Summary
- GNC's third quarter results continue to be in line with expectations.
- The company's debt levels, refinancing schedule, and financial metrics are largely tracking our projections from the end of last year.
- The company's free cash flow metric continues to benefit for working capital changes which obscure underlying free cash flow generation of the business.
- The recent acquisition speculation provides a not altogether pleasant trip down memory lane for the company's long time followers.
- Ultimately, our view on the company has not materially changed as we update our financial models and valuation.
GNC (GNC) has been an infrequent subject of our attention over the last several months as the company has performed much as we expected although the transitory financial impacts of corporate dispositions and restructurings have muddied the fiscal waters. The company’s third quarter results included no real surprises other than slightly weaker than expected same store sales performance for the year to date and somewhat better than anticipated operating margins. Arguably, the only surprise was that management did not appear to make any outlandish financial commitments or projections which it would almost certainly fail to achieve, an unforced error that had been a recurring feature of the company’s quarterly earnings calls for nearly two years.
We’re currently updating our financial models based on the third quarter results and extending our projections into the coming year at which point we will present an updated valuation for the company. However, the company’s results so far this year are tracking quite closely with our expectations presented at the end of last year with the added benefit of additional clarity around the financial impact of the myriad corporate transactions over the last year.
Operating Performance
GNC’s operating performance has been slightly ahead of our expectations on the operational side while falling somewhat short of our expectations on revenues and same store sales results. The larger impact of operating margins versus revenues has caused the company to marginally outperform our expectations for the year despite the sale of the company’s manufacturing business. Nonetheless, adjusted earnings per share (i.e., excluding special items related to the debt refinancing, etc.) seem unlikely to fall far beyond our expectations of around $0.40 for the full year.
In terms of free cash flows, the company is also nearly right no target with our expectations for the full year with one exception. We’d projected free cash flows to be about $74 million for the year versus the company’s current estimate of $90 million to $100 million, both of which exclude the cash flow impact associated with the sale of the manufacturing unit. The difference is primarily related to the exceptionally large increase in accounts payable over the course of the year – nearly $49 million during the first three quarters – while contributions from inventory reductions associated with store closures are running behind our expectations even though the company has closed slightly more store locations this year than anticipated in our models.
The increase in accounts payable is partially attributable to the sale of the manufacturing segment but, in the face of declining overall inventory levels, is not a sustainable source of free cash flow. We’ve commented in the past on the company’s reliance on one time adjustments in working capital accounts rather than recurring sources of cash flow to achieve stated free cash flow targets. The results are still, in our view, a significant consideration for prospective investors due to how such adjustments obscure underlying cash flow performance especially as large cash generative adjustments often appear in the company’s fourth quarter results.
In terms of EBITDA adjusted for special items related to the debt refinancing, etc., the company appears to be on track to report $210 million to $230 million in the current year versus our initial estimate for the year of $227 million. The slightly lower midpoint rate is largely associated with the impact of the sale of the manufacturing segment, which occurred after our projections and reduced EBITDA, partially offset by somewhat better than expected performance in operating margins. However, again, the projected result for the year is more or less on track with our expectations.
GNC is thus tracking well with our year ahead projections despite the various business adjustments reinforcing our often stated view that the company’s business is typically surprisingly predictable.
