Weight-Loss Drugs, Digital Apps Could Test Medifast's Dividend Commitment
Founded in 1980, Medifast sells subscription-based diet meals and relies on direct selling via "coaches" to attract new customers.
Sales surged more than 50% during the pandemic as housebound consumers put on extra pounds and used some of their excess savings on solutions to help manage their weight.
But over the past year, acquiring new customers has proved much more challenging. Management expects sales in the second quarter to decline over 40% compared to the prior year, citing everything from shifts in consumer spending to changes in social media algorithms.
However, the biggest concern to Medifast's long-term outlook is the rise of new medicines and digital technologies that threaten its core business (emphasis added):
Sales surged more than 50% during the pandemic as housebound consumers put on extra pounds and used some of their excess savings on solutions to help manage their weight.
But over the past year, acquiring new customers has proved much more challenging. Management expects sales in the second quarter to decline over 40% compared to the prior year, citing everything from shifts in consumer spending to changes in social media algorithms.
However, the biggest concern to Medifast's long-term outlook is the rise of new medicines and digital technologies that threaten its core business (emphasis added):
"The business environment for our model changed significantly beginning in Q2 of last year. First, when customer retention was impacted and then subsequently with increasing pressure on customer acquisition. While customer retention levels have returned to historical norms, customer acquisition in the current environment remains challenging with coaches taking more time to engage new customers. We believe this is due to changes in customer spending, changes in the ways that social media algorithms make coach's messages visible to prospective customers and more recently, a changing competitive landscape that includes new technologies and medical interventions."
– CEO Daniel Chard, 5/1/23 Earnings Call
Most notably, weight-loss drugs have taken a big step forward. While some consumers will prefer to avoid drug therapy in favor of lifestyle changes, many others will take the easier path, reducing demand for Medifast's weight-loss program and meals.
The Wall Street Journal recently covered a powerful medicine Mounjaro that could finally unlock the dream of losing weight by taking a drug:
The Wall Street Journal recently covered a powerful medicine Mounjaro that could finally unlock the dream of losing weight by taking a drug:
The drug Mounjaro helped a typical person with obesity who weighed 230 pounds lose up to 50 pounds during a test period of nearly 17 months.
No anti-obesity drug has ever safely made such a difference. In the coming months, it is widely expected to get the go-ahead from U.S. health regulators to be prescribed for losing weight and keeping it off...
The advance of Mounjaro, which is already on the market to treat Type 2 diabetes, has excited doctors and patients who have been waiting decades for effective treatments, while helping turn its maker, Eli Lilly & Co., into the most valuable standalone pharmaceutical company in the U.S.
Making matters worse for Medifast, behavioral-focused weight-loss apps like Noom are adding prescription drugs to their platforms. Without selling meals and shakes, these highly popular, coach-led subscriptions cost hundreds of dollars less per month than Medifast's core offering.
While the market for weight management solutions is huge (roughly two out of three U.S. adults are overweight or obese), these growth headwinds seem unlikely to abate. And they could force Medifast to take more aggressive actions to evolve.
Management will step up growth investments through the rest of 2023. From more training for coaches to expanding into adjacent product categories and developing a service for the U.S. Hispanic market, Medifast's initiatives will pinch profits and send the firm's payout ratio to around 100%.
Despite this pressure, management on Medifast's earnings call in May said they believe Medifast has "significant funds that should cover the dividend. As we invest in growth and get back to growth, we believe that the dividend is not at risk at all."
With a debt-free balance sheet and $124 million of cash, Medifast does have flexibility to maintain a high payout ratio and defend its dividend, which costs around $70 million per year.
However, we would not be surprised to see the firm eventually spend some of this money on new products and technologies (e.g. a telehealth platform) in an effort to stay relevant.
In recognition of Medifast's deteriorating dividend coverage and the challenges posed by the shifting competitive landscape, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.
While shares look cheap at a glance, Medifast could be a value trap that will one day be forced to lower its dividend if weight-loss drugs and a growing number of rival digital apps continue to make customer acquisition harder to come by.
We will continue to monitor and provide updates on Medifast's turnaround plan, which seeks to return the company to 15% annualized revenue growth and a 15% operating margin by 2025.
