With 2015 drawing to a close, GNC has missed earnings estimates in each of its first three quarters, and sell-side analysts are now projecting a >2% decrease in full year 2015 comp store sales. Additionally, a lawsuit announced in October by the state of Oregon alleges that the company knowingly sold products that contained unlawful dietary ingredients. All of this combined to make for a very bad year for GNC, as its stock price dropped from almost $50 at the end of 2014 to ~$31 now, representing a decline of close to 40%. Was 2015 just an unfortunate year for GNC or is it a harbinger of worse times to come?
GNC’s business model is quite simple. In an increasingly health conscious world, it gives value to customers through providing high quality, trusted, nutritional supplements as well as helpful advice in identifying the correct supplements that fit their needs.
The way GNC reaches its customers is not much different today than it was when its first store opened in 1935. With a
network of 8,900 stores, GNC’s primary method of serving customers is through the brick and mortar channel. In fact, its online presence is so small that the company does not even disclose the amount of sales coming from that channel. However, the rationale for having a brick and mortar presence in the nutritional supplements space is becoming less and less compelling. Supplements have a long shelf life, its use is easily predicted, and there is no need to try or test the product out before purchasing. It is the ideal product for online ordering. On the other hand, GNC would argue that the value of its brick and mortar presence lies in the service and helpful advice provided by its sales staff. After all, the vast array of nutritional and dietary supplements can be quite overwhelming for the layperson to navigate.
Enter Bodybuilding.com. Sports and performance supplements represent GNC’s largest product category but Bodybuilding.com is rendering its offerings in that category obsolete. Instead of needing salespeople to explain the different supplements, Bodybuilding.com’s online community provides a wealth of knowledge that any aspiring gym rat can access. And with almost 12 million members, it’s the largest forum on the internet by membership. All of this supports a robust online store with pricing significantly below that of GNC’s. Unless GNC dramatically reverses its strategy, it will continue losing share to its online competitors.
Since having a high quality, trusted product is a key tenet of GNC’s business model, the company’s procurement strategy represents another important aspect of its operating model. The company currently self-manufactures ~50% of its product, with the remaining 50% sourced from third party suppliers. While the self-manufacturing has proven reliable and consistent, its third party products have caused multiple problems in recent years. In addition to the Oregon lawsuit this year, GNC was forced to remove all products containing the substance DMAA in 2013, causing a significant hit to sales. The damage caused by these incidents go far beyond just the in-period revenue hit, as GNC’s reputation and brand suffers as well. Rather than being proactive in preventing these events by undertaking more stringent diligence of its suppliers, GNC has been extremely reactive. In fact, even after the 2013 incident, GNC chose to continue doing business with the supplier at fault, USPlabs, and unsurprisingly, the lawsuit this year involved that exact same supplier. Finally, after two heavily publicized incidents, GNC announced that it would drop all USPlab products in November of this year. GNC’s brand and reputation are its most important assets, yet the company has been alarmingly cavalier in maintaining them.
GNC operates in the very straightforward business of delivering quality supplements to customers. Yet its flawed procurement strategy has compromised the quality of its products, and its stubborn adherence to the brick and mortar model has eroded its customer base. It comes as no surprise that 2015 was such a challenging year for the company and upcoming years don’t look to be any better.
GNC Q3 earnings release
Barclays equity research report