Credit Suisse bullish on GNC

Market position and go-to-market strategies cited as key positives

NEW YORK — Credit Suisse on Wednesday initiated coverage of General Nutrition Centers, the specialty retailer of supplement and nutritional products and partner with Rite Aid in a store-within-a-store program across more than 1,000 drug store locations.

Credit Suisse characterized the GNC stock with an “outperform” rating and a $24 price target, noting that the retailer's evolution into multichannel retailing along with a strong management team bodes well for the future of the specialty retailer. The fact that GNC is part of the vitamins/supplements industry — projected to grow 6% over the next five years — doesn’t hurt, either.

“Since [Joe] Fortunato’s ascension, the company-owned domestic store base has grown 10% while net income has quintupled,” Credit Suisse research analyst Gary Balter said. Fortunato assumed the GNC CEO position in 2005. “Annual square footage growth will likely be in the 3% to 4% range for domestic stores, which, when combined with our expectation of low single-digit same-store sales growth, equates to high single-digit top-line growth.”

GNC, however, is not without risk. The product mix still skews heavily against diet aids and sports nutrition, and any disparaging news around one of those products could prove devastating. In the fall of 2002, for example, when criticism around the diet aid ephedra was at its height, GNC's (then owned by Royal Numico) same-store sales dropped an estimated 7% across its entire store base. Numico reported a $1.45 billion loss that fall.

That loss prompted Numico to sell GNC to Apollo Management in 2003 for $750 million, a deep discount to the $1.8 billion Numico originally paid to acquire GNC. Apollo again sold GNC to Ares Management in 2007 to the tune of $1.7 billion, an indication that the specialty retailer had successfully recovered its corporate value. Rite Aid also could become a negative factor, Balter noted. “Although GNC has predetermined volume and expansion agreements with Rite Aid, the drug store chain has a high debt load and is relatively poorly positioned in the segment,” he wrote. “Rite Aid accounted for 3.5% of GNC’s total sales in 2010. In a worst-case scenario in which all of that revenue is eliminated, we estimate GNC’s EPS hit may be 10 cents (assuming a 25% contribution EBIT margin).”

And retail mall traffic may become a risk given that GNC operates approximately 1,000 mall locations, Balter added. “During the economic downturn, mall stores were hit harder than non-mall stores due to declining mall traffic. We view inflation/deflation as a minor threat, as the company has proven adept at managing the business in volatile pricing environments.”

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