Medifast: GLP-1 Fears Are Overblown, But Proof Points For Turnaround Are Still Missing (2024)

Medifast (NYSE:MED) is a leading company in the health and wellness industry, specializing in weight management through a range of portion-controlled meal replacements, snacks, and nutritional products, predominantly sold under the brand OPTAVIA. They operate primarily through a direct-to-consumer model and a network of independent OPTAVIA coaches who provide personalized coaching and support to customers.

Thesis

After years of strong double-digit revenue growth and market outperformance relative to the SP500 and key competitors like WW International (WW) and Herbalife (HLF), Medifast has suffered material revenue declines since the second quarter of 2022. The combination of inflation, the re-opening of restaurants and travel post lock-downs, and the rise of GLP-1 drugs for obesity have caused demand for dietary weight loss solutions to plummet. Meanwhile, the OPTAVIA coach network, which Medifast still relies on heavily for revenue generation, got decimated in the process. It is down to 37,800 coaches at the end of Q1 2024, from 68,000 back in Q2 2022.

With a market capitalization around $210 million and an enterprise value of just over $50 million, MED stock is very much priced for disaster. In this article, I discuss in detail why I do not think that GLP-1 drugs will be the end of dietary weight loss plans, and why at the same time, uncertainties about the viability of Medifast’s business model continue to fuel the stock’s downward spiral, although fears seem overblown.

Management has initiated a turnaround plan that aims at combining the proven OPTAVIA offerings with direct access to GLP-1 medication in an affordable package, leveraging the recent partnership with LifeMD (LFMD). The stated goal is that instead of competing against GLP-1 drugs, Medifast will grow alongside them. If successful, MED could be up for an amazing comeback.

However, I am rating the stock a HOLD for two reasons: first, I could not yet find proof points that the turnaround plan has legs. Second, the stock price momentum is so negative that in the absence of proof points, the probability of losing another 20-30% by inertia on top of the 71% lost YTD is much higher than the probability of a sudden trend reversal.

I will watch this stock closely for signs of stabilization in the OPTAVIA coach numbers, adoption of new GLP-1 support products & services, and for evidence that Medifast is able to acquire GLP-1 users via LifeMD in a profitable way.

Medifast’s Once Very Successful Business Model

The chart below shows that MED has been a market beating investment for most of the past decade, starting to significantly outperform in 2017. This is when Medifast launched its OPTAVIA range and coach centered business model. Even more impressive is how the company outperformed its direct competitors, including WW International, formerly known as Weight Watchers, and Herbalife.

Before taking a closer look at the drivers for the stock’s plunge over the past 24 months, let’s briefly review the core components of the company’s business model to understand what made the company so successful in the past. If you go to the company’s website, you will find that OPTAVIA relies on four core pillars: meal replacements, a lifestyle program, a coach network, and community support.

Meal Replacements

OPTAVIA provides a variety of meal replacement products, known as "Fuelings". These include bars, shakes, soups, and snacks, all designed to be nutritionally balanced and convenient. The Fuelings are formulated to support weight loss and maintenance by providing the right balance of protein, carbohydrates, and fats while being low in calories.

Fuelings are a central component of each of Medifast’s weight loss plans, although the company also promotes so-called Lean & Green^TM meals, for which it provides over 200 recipes in collaboration with The Culinary Institute of America [CIA].

Lifestyle Program

The OPTAVIA program goes beyond meal replacements by emphasizing long-term behavioral changes. It includes educational materials and resources on healthy eating, physical activity, and mindset, aiming to foster sustainable lifestyle changes. The "Habits of Health" system is a key component, helping clients develop healthy routines.

Coaching Network

A distinctive feature of OPTAVIA is its network of independent coaches. According to Medifast’s latest 10-Q report, about 90% of their coaches are former clients who have successfully used the program themselves. They offer personalized guidance, support, and accountability to clients. This direct selling model became a flywheel driving both client acquisition and retention, but also continuously expanding the company’s primary revenue channel at a very low cost for Medifast.

OPTAVIA coaches’ primary compensation is the commission earned based on their own product sales to clients, and to a lesser extent, on sales of lower-level coaches who they have recruited. They can also get bonuses for client acquisition, team building and sponsorship. Importantly, Medifast is not a pyramid scheme, and complies with U.S. direct selling regulations and standards. The company sells legitimate, effective products, and the majority of its coaches’ compensation comes from product sales, not from the recruitment of more coaches.

Community Support

Finally, the OPTAVIA program leverages a strong sense of community, with online forums, social media groups, and local events where clients and coaches can share experiences and support each other. This community aspect enhances client engagement and motivation.

In summary, the former success of Medifast’s business model primarily relies on tasty, simple-to-use meal replacements generating about $400-500 per month per active client at attractive gross margins (over 70%). The combination of quality products with coaching and community support historically drove higher customer satisfaction and retention. In turn, many satisfied clients became coaches themselves, thus continuously expanding the coach network (until 2022). This direct selling model proved to be very cost-effective, keeping most of SG&A Opex variable in the form of coach commissions, while customer and coach acquisition costs remained low.

Now that we better understand the traditional OPTAVIA business model, let’s take a closer look at what caused its rise and fall.

Macro Headwinds & GLP-1 Drugs Weigh On Results

Leveraging the OPTAVIA business model, Medifast has demonstrated strong and consistent revenue growth between 2016 and 2022, with annual revenue soaring almost 6x from $275 million to almost $1.6 billion (a 34% CAGR). During this time, Medifast was able to rapidly expand its network of OPTAVIA coaches, which constitutes its primary revenue generation channel, from just 12,600 in Q1 of 2016 to a whopping 68,000 at the peak in Q2 of 2022. The fact that about 90% of the coaches are former customers underlines the virtuous cycle the company went through, as it gained more clients that turned into coaches reaching even more new clients, and so on.

Starting in the second half of 2022, this virtuous cycle has been broken. Instead, Medifast entered a downward spiral of lower demand and client attrition driving a dramatic reduction in the coach network size, with only 37,800 coaches left at the end of Q1 2024. This again leads to less demand generation opportunities going forward. The below chart shows just how fast the OPTAVIA coach network grew between 2017 and 2022, and how fast it has been plummeting ever since.

Translating this to revenue, the below chart shows the rise and fall of the OPTAVIA business model, with revenue decline still expected to accelerate going into 2024.

But what exactly happened in the middle of 2022 to cause such a dramatic reversal? Two main drivers stand out as culprits, which combined literally led to an implosion of demand: post-Covid macro-headwinds and the rise of GLP-1 weight loss drugs.

Looking back, 2021 and 2022 were anomalies from a demand standpoint, fueled by a combination of government-infused liquidity (“parachute money”), the lack of spending opportunities outside the house, and last but not least, the fact that being locked created a situation where many had “nothing better to do” than a diet. As free money dissipated, high inflation started taking its toll on consumers’ purchasing power, while the re-opening of restaurants and travel after months of lockdown provided for much desired opportunities to spend money outside the house and to simply enjoy life with family and friends. None of the above fit well with spending $500 a month on small rations of food.

By the way, $500 (+/- 10%) a month only gets you the Fuelings (and, of course, access to recipes, coaching and community). You still need to buy the ingredients for the daily Lean & Green meal(s). Assuming you can do that for $10 per day, your total food cost will be around $800 per month while on an OPTAVIA plan. According to the U.S. Department of Agriculture (USDA), Americans on a “low-cost food plan” spend around $250 to $300 on groceries each month, while those on a “liberal plan” spend around $400 to $450. So regardless where you sit on the food plan spectrum, OPTAVIA is quite the investment.

Investing in your health and wellbeing is a great thing, no doubt. So, while the above macro factors would most likely have brought OPTAVIA sales back to pre-pandemic levels, it is unlikely that they would have caused the crash we are seeing right now (note: sales are headed back to 2018 levels). This is where GLP-1 weight loss drugs come into the picture.

While Novo Nordisk (NVO) launched Wegovy in the U.S. as early as June 2021, it took them until December 2022 to provide good coverage, due to initial supply issues. Eli Lilly (LLY) launched Zepbound a year later, in late 2023. For people looking to lose weight quickly, these new drugs meant that all of a sudden, there was a seemingly more convenient and effective alternative for weight management up for grabs.

While the rise of GLP-1 drugs may seem daunting, I do not think it will mark the end of dietary weight loss plans. Here is why.

Weight Management Remains An Attractive Market Beyond GLP-1 Drugs

According to Pharmiweb.com, the global weight management industry, exclusive of anti-obesity medications [AOMs], is expected to grow to $725.6 billion by 2032. This implies a CAGR of about 7.7% from the $345.5 billion in 2022. According to the report, this valuation encompasses weight management by diet (meals, beverages & supplements), weight management by equipment (fitness & surgical), and weight management by services (fitness centers, slimming centers, coaching & medical services).

This market projection was published in November 2023, so after the launch of major GLP-1 drugs for obesity treatment. I am highlighting this fact because a specific fear amongst Medifast investors is that GLP-1 medication marks the end of "traditional" weight management.

According to Goldman Sachs (GS), the global AOMs market had just exceeded $6 billion on a rolling twelve-month basis at the time the above report was published. GS projects the global AOMs market to reach as much as $100 billion by 2030, driven mainly by the new GLP-1 prescription only medication. JPMorgan (JPM) estimates the U.S. share to represent about $44 billion by 2030. If you believe the Pharmiweb report, this astounding growth will not come at the expense of existing weight loss management solutions.

Based on my research, I believe that we will continue to see a negative impact to traditional weight management options in the short term. From the millions of people who are and will be on GLP-1 treatments, some are likely to at least temporarily pause or drop out of traditional weight loss programs as they see their weight drop rapidly. However, there are good reasons to believe that the mid- to long-term impact of the growing adoption of GLP-1 drugs may be neutral, or even beneficial, to the traditional weight management industry.

There is a strong consensus among medical staff, pharmaceutical companies and health insurance companies alike that "anti-obesity medications do not replace physical activity or healthy eating habits as a way to lose weight", to borrow the words of the American Medical Association [AMA]. The AMA also acknowledges that effective weight management will not only require a physician to prescribe GLP-1 medication, but also close collaboration with "dieticians, behavioral health specialists, pharmacists and other health professionals". These claims are research-based and provide diet and lifestyle focused weight management providers with a scientific reason to remain relevant not in spite of GLP-1 drugs, but alongside them (we will talk more about that in Medifast’s turnaround plan).

Additionally, research shows that it is common for individuals who stop using GLP-1 medication to regain weight. A clinical trial from 2022 shows they could regain up to two thirds of the weight previously lost within one year. This is why GLP-1 medication is designed for long-term use (potentially life-long), rather than for short-term weight loss. However, people will sometimes have to drop out, either due to severe side effects, cost, or simply lack of access. This is when having adopted healthy habits while using GLP-1 drugs, including a healthy diet and sufficient exercise, becomes essential.

Putting 1 and 1 together, there will be a space for providers of traditional weight management solutions to both complement the use of GLP-1 and provide critical support in cases where the use of GLP-1 drugs must be stopped, interrupted, or is simply not possible.

Indeed, we should not forget that GLP-1 medication for obesity is not (and never will be) the solution for everyone and anyone who seeks to lose weight.

Doctors are supposed to prescribe the drugs primarily to obese people, which, according to the World Health Organization [WHO], are people with a Body Mass Index [BMI] of 30 or above. That’s over 90 million American adults. JPMorgan estimates that up to 30 million Americans could be using GLP-1 drugs by 2030. This may sound like a lot, but let's put things in context: this means there will still be 150 million American adults that are either overweight (33%) or obese (24%) and that will NOT use GLP-1 drugs. That's a lot of people who could choose a diet instead.

Finally, the new GLP-1 medication for obesity is very costly ($1,000 to $1,500 per month), and usually not covered by health insurance. While we are likely to see continued improvement in the affordability profile of these new drugs as the supply situation eases, new competitive products launch, and health insurance providers negotiate with manufacturers, cost will remain a key reason why GLP-1 will not become "mainstream".

In summary, GLP-1 drugs are unlikely to be the end of traditional weight management. However, providers of conventional weight loss solutions, notably dietary programs, are well advised to adapt their business models to the rise of GLP-1. This is precisely what Medifast is aiming to do with its turnaround plan.

Turnaround Plan: Grow With, Not Against GLP-1 Medication

Medifast’s turnaround plan pursues one overarching goal: re-aligning its business model following the fundamental changes to the weight loss industry caused by GLP-1 medication, with the goal to grow alongside GLP-1s drugs, rather than just competing with them. In order to achieve this, management is primarily doing two things:

• First, it is working to amend their product and service line with a tailored offer for GLP-1 users, to provide fit-for-purpose dietary offerings and leverage the coach network to promote healthy habits for people using weight loss medication.
• Second, it announced in December 2023 a partnership with LifeMD, a telehealth platform that offers a GLP-1 enrollment program, with the objective to tap into the growing pool of GLP-1 users right at the source, co-promoting a healthy diet and healthy habits alongside the use of medication.

Based on my industry research and the benefits of combining weight loss medication with a healthy diet and exercise (so-called "GLP-1 support goods & services"), both the strategic objective and critical steps taken by management make directional sense to me. However, the key to success will be execution, and comes down to:

• how well Medifast can position itself as the dietary products & services provider of choice for GLP-1 users,
• how many GLP-1 users it can add to its client base leveraging its partnership with LifeMD,
• how profitable it can remain, while offering attractive pricing.

To finance the required marketing efforts, which management stated during its Q1 2024 earnings call will be mostly spent in the third quarter for the current year, as well as its investments in LifeMD, the company continues to execute on its Fuel For The Future initiative. This productivity program brought $45 million savings in 2023 and is expected to drive further cost reductions in 2024, notably through procurement and automation initiatives. As part of the program, Medifast also stopped international operations in Hong Kong and Singapore in July 2023, refocusing 100% of its efforts on the United States. On a separate note, the company also discontinued dividend payments at the end of 2023 to re-invest in the business until it returns to a clear growth path.

Given the recent drop in revenues, cost savings are clearly a necessity to preserve profitability, while the company needs to make significant marketing investments to drive "GLP-1 consumer" awareness. I also believe that cash preservation through dividend discontinuation was a wise move, until management has proof that their turnaround efforts bear fruits. Finally, the focus on the U.S. is also a no-brainer call, as illustrated by the below chart, which shows obesity rates for top-10 countries by GDP and GDP per capita.

The key takeaway here is that the U.S. are by far the country with the largest number of obese adults with the ability to pay for weight loss programs, including medication and support products & services.

To conclude, the strategic direction of the turnaround plan makes sense, although the watch-out is for Medifast not to de-prioritize its (larger) non-GLP-1 user target group. As it comes down to execution, let’s look for proof points that the turnaround plan is working by reviewing progress made to date, notably with partner LifeMD.

LifeMD: Interesting Partnership, But Not A Game Changer (Yet)

During their latest earnings call, LifeMD management announced that:

Medifast OPTAVIA Coaches are now able to work with LifeMD affiliated providers to provide patients with an integrated solution and holistic approach to Weight Management. Medifast will also be investing at least $25 million in consumer marketing to support growth of this program for the balance of 2024, which we expect to have a meaningful increase in the volumes of new patients acquired from this program. We are pleased with the collaboration to-date and look forward to providing more updates on this integrated offering as it is fully rolled out in the coming months.

While the opportunity for co- and cross-promotion is clear, the key question is to what extent LifeMD will be a source of new customers/business for Medifast.

During my research, I was very surprised that I could not find (as of today, end of June 2024) any reference to Medifast or OPTAVIA on LifeMD’s website, even on the very page where LifeMD explains everything about weight loss and how to sign up for their GLP-1 weight loss program. Conversely, you will find a very explicit reference to LifeMD on the OPTAVIA site, including when you try to sign up for a new program. Medifast directly refers you to LifeMD if you indicate interest in weight loss medication as a complement to an OPTAVIA diet, and they even offer a compelling combo package (more on that later) if you sign up for both.

So why is this nowhere to be found on LifeMD’s website? At the very minimum, a specific mention of the OPTAVIA plan as a tool to use in conjunction with LifeMD’s GLP-1 weight loss program would be a simple and effective way for Medifast to generate leads from the growing number of people searching for GLP-1 medication. Paired with the countless studies claiming that the use of GLP-1 is most effective in conjunction with a healthy diet and exercise, it would be ideal if LifeMD actually returned the favor and offered their GLP-1 program with an upsell option to include OPTAVIA. So far, LifeMD’s "holistic weight management" program does not mention a word about Medifast.

While LifeMD’s clinicians may refer clients to OPTAVIA during consultations, I sincerely hope (for Medifast) that LifeMD will start co-promoting OPTIVIA more publicly soon, or else this partnership will be far more valuable for LFMD than for MED.

Meanwhile, Dan Chard, CEO of Medifast and Observer on LifeMD’s Board, just introduced Medifast’s latest combo offer during their latest earnings call. The offer is inclusive of both the products & services from the OPTAVIA program, as well as the LifeMD GLP-1 program (excluding the cost of medication), altogether priced at $282 per month. The CEO explained that Medifast will record $217 of monthly revenue for the OPTAVIA product (whey protein supplements & Fuelings), coaching and community bundle with no minimum duration, while LifeMD will record the remaining $65 and require a six-months commitment.

Besides the fact that, once again, it is baffling that this offer is not available on LifeMD’s website, let’s take a look at the financials involved.

Traditionally, Medifast sells OPTAVIA programs for around $500 per month, with the introductory offer selling at a $100 discount. Since the above combo offer is also meant as an introductory offer, let’s assume it will ultimately sell at $217 + $100 = $317 at the full price. For napkin math, let’s assume that the product cost associated with one month of OPTAVIA fuelings is 30% x $500 = $150 (70% gross margin). That leaves a product margin of $317 - $150 = $167, or 53%, on an OPTAVIA + GLP-1 combo offer sold at full price. That is materially less than Medifast’s current 70+% average gross margin.

Quoting another Seeking Alpha author, Deep Value Ideas, coach commissions represented on average historically (based on MED 10-K reports). With total SG&A representing about 60% of sales, this implies that commissions are 42% of sales and other marketing and general administrative cost are 18%. Assuming Medifast can adjust its fixed cost base to the new revenue levels over time, the company will have to cut coach commissions for the GLP-1 combo offer in order for it to contribute positively to its bottom-line. Based on above assumptions, if Medifast wants a 10% operating margin, the maximum commission it can pay for a coach is 25% of sales. This may be appropriate if the "lead" comes from LifeMD or Medifast’s website. However, coaches are still expected to actively engage with clients, so time will have to tell if this compensation is compelling enough.

Meanwhile, I assume that LifeMD will want to pocket the full $129 per month after the initial 6-month commitment at $65, a 50% discount on the program they sell on their website. This pushes the total cost of the combined program to $317 + $129 = $446, excluding the cost of GLP-1 medication. As mentioned earlier, medication cost ranges between $1,000 and $1,500 per month. In other words, (broad) adoption of the new combo offers essentially relies on the medication part of the package to be covered by insurance, which for the most part is not the case at this time.

Bottom-line, while the combo-offer sounds promising on the surface, there are still many question marks and little proof points that GLP-1 support offerings will gain adoption and be profitable. First and foremost, LifeMD has to become a new cost-effective source of new clients for Medifast, which starts with LifeMD advertising OPTAVIA as part of their GLP-1 program as much as Medifast does it the other way around. Second, Medifast will have to sort out how it can maintain profitability despite compressed gross margins, without alienating its already shrinking coach network.

With all that in mind, let’s move to valuation and stock price momentum.

Ultra-Cheap Valuation, Ultra-Negative Momentum

MED is ultra-cheap by (almost) any measure right now, which earns the stock an A+ rating grade according to the Seeking Alpha’s factor grading. Only forward P/E measure are slightly elevated, driven by low earnings expectations for the current year. However, some of that is due to investments management is planning to make in the second half of 2024 to drive adoption of its new GLP-1 support offerings.

On another positive note, the company’s robust balance sheet will enable management to execute their turnaround strategy without having to worry about raising capital and taking on debt. With $156 million of cash and no debt, the company would have to consistently generate negative operating cash flows for an extended period of time, and/or invest large amounts of capital into negative return opportunities to get into serious trouble.

I trust management not to do anything "stupid" based on their track record of building up a very successful and profitable company. That said, this turnaround plan is no slam dunk. Most notably, Medifast will not only need to prove that there is demand for the new combination offer. It also needs to prove it can make money with it. These are, to some extent, valid concerns for investors that explain why MED is trading below its early 2016 valuation, even though its rolling twelve-month revenues back then were less than half the $640 million expected for 2024.

What is interesting in light of all the fears surrounding the "GLP-1 revolution" is that fundamentally, Medifast may not even need GLP-1 support services at all to justify its current valuation. Using a perpetuity growth model with a WACC of 8% over 50 years, we can see from the table below that MED is currently priced for generating about $5 million in annual free cash flow [FCF] for 50 years.

To be honest, I was hard-pressed to imagine a scenario in which Medifast could not justify its current valuation even without any contribution from GLP-1 users. The below table provides annual revenue and FCF scenarios depending on the number of monthly active clients (= non GLP-1 users).

I assumed that each monthly active client pays $450 per month on average (average of full price and introductory offer, assuming clients regularly come on and off programs). I also assumed 70% gross margin in all scenarios, with SG&A exceeding 60% once revenues fall significantly below $250 million (due to fixed cost). Based on that, $100 million in annual revenue, which would be a third of what Medifast sold back in 2014, would be enough to generate $5 million of FCF and justify a $20 share price.

We established above that 150 million overweight or obese Americans are unlikely to use GLP-1 even by 2030. Out of those, a report from 2020 asserts that about 1 in 5 may have used diets for weight loss: that’s 30 million people. If Medifast can attract or retain just 1 in 1,600 Americans interested in dieting for weight loss to use OPTAVIA, that's about $100 million annual sales.

Anything beyond that is upside from here: if Medifast is able to stabilize its core business at $250-500 million annual revenue, the stock could double or triple. If on top of that, management is successful with their turnaround plan pursuing GLP-1 users as a new client base, the upside is even bigger.

So why not buy head of heals right away? I have to say, it is tempting. However, I think it is most often wise to stick with the old age "don’t catch a falling knife". As Seeking Alpha’s momentum grade of F shows, the stock price performance of the past 3, 6, 9 and 12 months has just been a disaster. So, while I believe that GLP-1 concerns are overblown and that the current valuation is ultra-cheap based on fundamentals, the momentum will most likely remain negative until Medifast delivers first proof points of stabilization in the core business and progress on the GLP-1 plans.

In summary, although it does not take crazy assumptions to see the stock return to the $40 to $60 range over the next 24 months, it is possible that we see it enter the $10 to $15 range in the next 3 to 6 months first.

Conclusion

On the Stock Research Platform, I am looking for asymmetric low risk, high reward opportunities. Medifast clearly has the potential to land an epic comeback, if management is able to stabilize the core OPTAVIA business, and/or demonstrate that the partnership with LifeMD can help the company return to profitable growth with GLP-1 support offerings. At the current price, any proof that the business can remain cashflow positive in the future will drive a bounce back. However, there are no concrete signs of recovery yet, and stock price momentum has been disastrous for months. For these reasons, I initiate coverage with a HOLD rating despite its very attractive valuation.

For full transparency, I sold MED puts at the $12.50 strike, which is a way to go long MED with a significant margin of safety (no investment advice). In fact, $12.50 is 10% below the $14+ net cash per share Medifast is holding on its balance sheet.

Stock Research Platform (SRP) is run by an experienced full-time CFO and equity investor with a passion for researching stocks to find asymmetric investment opportunities. SRP is screening the market for companies with a strong balance sheet, a sustainable growth pathway, and a valuation that offers significant upside potential with limited downside risk. SRP articles reflect the author's personal opinion on stocks at the time of research, and are not investment advice. Everyone’s investment goals and risk tolerance are different, so please do your own due diligence.