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Bull of the Day

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Herbalife (HLF - Snapshot Report) dropped more then 7 points or 10.3% yesterday, and just two weeks ago it was the Bull of the Day. Since there are new developments, I thought it would be a good idea to review why the stock holds a Zacks Rank of #1 (Strong Buy) and is again the Bull of the Day today.

Herbalife Beats Estimates in 29 Straight Quarters

Herbalife has topped the Zacks Consensus Estimate in each of the last 29 quarters. Bears will point to guidance being much lower than it should be, but at the end of the day, the analysts decided where they will put their estimates.

There is a similar precedent for this. Apple (AAPL - Analyst Report) used to give guidance that was well below what would be expected for a company that continuously beats and then raises guidance. Then, as Tim Cook took over, the company removed that policy and gave a more "realistic" guidance to Wall Street. The shock to the system caused the stock to jump significantly higher.

This is an option for HLF as well.

Company Description

Herbalife is a network marketing company that sells weight management, nutritional supplements, energy, sports and fitness, and personal care products worldwide. Herbalife offers its products through sales representatives, sales officers, and independent service providers. The company was founded in 1980 and is based in Grand Cayman, the Cayman Islands.

Heavy Hitters Weigh In

In a late-December 2011 conference, Bill Ackman disclosed that he was short approximately 20 million shares of Herbalife. The total short interest as of the end of December was approximately 37 million shares. Ackman asserts that the company is nothing short of a pyramid scheme and will end up at $0.00. To further substantiate this claim, Ackman needs the FTC to investigate the company and despite recent rumors and Freedom of Information Acts, there has been no such investigation.

In early January, Dan Loeb's hedge fund Third Point filed a 13G which stated it acquired 8.9 million shares and the stock officially became a battleground stock. It wasn't long after that point that Carl Icahn became involved as well and the billionaires went at it on live television.

More recently, the CEO of POST William Stiritz also threw his hat in the ring and bought a 5% position in the company. He later added to his position and switch his investment from a passive stake to a more activist role. As an operator in the space and having done his own due diligence including becoming a HLF distributor, the bets are piling up against Bill Ackman.

In fact there have been no "big name" investors that have followed Bill Ackman on the short side of this trade. In fact, there have been several other big investors that have also taken long postition in HLF. Those big names include George Soros, Richard Perry, Stanley Druckenmiller and Kyle Bass.

Enter Senator Ed Markey

The thing Bill Ackman needs the most is an FTC investigation into HLF to determine if it is indeed a pyramid scheme. On Thursday, January 23, he recieved a little push from the Massachusetts Sentator Ed Markey.

The Senator's release noted: "One family in Norton, Massachusetts reported that it lost $130,000, including the family’s entire 401 (K), investing in Herbalife." I tried to understand how this family from Norton lost their entire 401(k) in HLF when the stock did not go to $0, but maybe they used some exotic derivatives and were in over their heads. I hardly believe that the Senator is more or less condoning that 401(K)'s and IRA's be liquidated in order to invest in business ventures... but the ambiguity is perplexing.

Sen Markey sent letters to the Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC) and to the company itself, asking for more information about Herbalife’s operations.

In particular, the letter to Herbalife bares a startling resemblance to the questions posed to HLF by Bill Ackman. This only makes one question, did Pershing Square write this letter for the office of Senator Markey? The plot thickens a bit when I read in The New York Times that : "Mr. Ackman met with members of Mr. Markey’s staff last fall, but he has not met with the senator, a spokeswoman for Mr. Markey said."

Was He Played?

Now that the damage is done, one can only start to put the pieces of the puzzle together. It may surprise Senator Markey that he might have been used in a larger game with billions at stake. I am referring to the massive short bets that were made via HLF puts on January 9 and January 10.

Seems an investor with uncanny skills and knowledge placed a $33M bet on Herbalife puts. A put is a financial instrument that will increase in value as the share price of the target company decreases in value, thus, a tool used to make bearish bets. In fact, 25,000 Jan-2015 HLF 50 puts were purchased for approximately $7.25 on January 9. Then another 20,000 were bought the next day for slightly less.

Those 45,000 puts that were trading for about $7 at the start of the year were trading at appoximately $11 yesterday... but of course that style of market manipulation is not something that is hurting any residents of Massachecuts, right? Well not unless you were the one on the other side of the bet.

I wouldn't suggest that its is illegal for members of Pershing Square to lobby a senator to call for an investigation. That is perfectly acceptable within the confines of the law... but the size of this move, which effectively controls 4.5M shares, becomes quite suspect given that Pershing Square's recent meetings with the Senators staff and the reluctance of any other big investor to come out and publicly acknowledge a short position in HLF.

Anyone guessing if there is an impending letter to the SEC from the Senator asking about the identity of the buyer? I am not holding my breath on that one either.

In the Interest of Shorting Stocks

Twice a month, the NASDAQ website posts how many shares of a stock are sold short. Some people like to point to days to cover - the amount shares sold short divided by average volume to show how many days of normal trading it would take to bring the shares short to 0. I don't like that idea, as in an active day, the measure can move substantially, and only in the most extreme cases (Like when Volkswagon bought Porsche) will shares short actually go to 0.

So lets take a look at a chart of where short interest has moved from and where it stands now.

Now lets take a quick look at chart of the stock price...

Notice how one chart is going one way and the other chart is going the other way?

That is something that is called a short squeeze, and for those that think its over, let's take a look at the short float percentage. The float is a term for how many shares are available for trading, and that number will generally be less than the total shares outstanding. The float for HLF is 92.7M, and thus the short float percentage is 21.5%. That is huge, esp when you compare it to CMG (5.8%), NFLX (9.6%), HPQ (1.4%).

Herbalife Sees Estimates Moving Higher

Estimates for Herbalife have been rising of late. The Zacks Consensus Estimate for 2013 for HLF stood at $4.66 as of February 2013. By June of 2013, the consensus had risen to $4.81. The consensus has since moved higher to $4.99 in September and is now at $5.26, up a penny from the last time I profiled the company as the Bull of the Day.

Over the same time period estimates for 2014 have moved from $5.40 to $5.52 and are now at $5.95, up from $5.77 when I last profiled the company just a few weeks ago.

Buy Back

The company recently (December 16) received a clean re-audit after an insider trading scandal forced the previous auditor to resign. With this clean audit, it is likely that the company will call on the debt market to raise capital with the intention of buying back shares and or increasing the dividend. Both or either move would result in a short squeeze, as there are still 19.9M shares sold short.

Pershing Square recently covered a portion of its short position and switched to puts, a strategy that limits risk but now includes a deadline before the buts expire worthless. It is not clear who has the other side of the put trade.

Previous Bull Of the Day

On October 2, 2013 Herbalife was written up as the bull of the day. This came just prior to Pershing Square covering 8 million shares and switching into puts. Since the end of September, the number of shares sold short has decreased from 24.4M to 19.9M. Market participants have suggested that Ackman is either doubling down on his short position if he is in fact the recent buyer of puts. Those purchases were on the open market, whereas his pervious move into puts was a private transaction.

Valuation

Herbalife trades at some very attractive multiples. The trailing twelve months PE of 14x is well below the 21x industry average. Similarly, the 12.4x forward PE multiple is also trading at a discount to the 16.2x industry average. Price to sales multiple of 1.6x has the company trading at a premium to the industry average of 0.5x. One metric I like to focus on is the net margin and HLF sports a 11.3% net vs a 3.8% industry average. Given the low multiples and substantially higher net margin than the industry, it is apparent that the valuation is still depressed based on the resistance from short sellers as investors are still cautious on the idea of the stock being a pyramid scheme.

The Chart

A quick look at the price and consensus chart shows that despite claims of a pyramid scheme and numerous bear attacks on its multi-level marketing model, the company continues to get higher and higher earnings estimates. The gaps between the colored lines show the continued growth in earnings, just what growth investors want to see.

Full Disclosure

I am long HLF.

Brian Bolan is a Stock Strategist for Zacks.com.

He is the Editor in charge of the Zacks Home Run Investor service, a Buy and Hold service where he recommends the stocks in the portfolio.

Brian is also the editor of Breakout Growth Trader a trading service that focuses on small cap stocks and also carries a risk limiting strategy. Subscribers get daily emails along with buy, and sell alerts.

Follow Brian Bolan on twitter at @BBolan1

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