Supplement Industry "Dramatically Undervalued" By Investors - Analyst

Nutritional supplement companies will provide "significant investment opportunities over the next decade," Adams, Harkness & Hill Managing Director of Research Matthew Patsky said at the Council for Responsible Nutrition annual conference in Palm Springs, Calif. Oct. 4-6.

Responding to concerns regarding the recent downturn of dietary supplement company stocks, Patsky maintained "the industry is dramatically undervalued at [present]."

Some of Wall Street's reactions may be attributable to declining sales across broad supplement categories. For example, ginkgo biloba and St. John's wort sales declined 12.9% and 33%, respectively, at food, drug and mass outlets in the 12-week period ended Aug. 8 compared to year-ago sales, according to Information Resources, Inc. data supplied by Pharmavite Corp. The data reflect the herbal supplement categories as defined by Pharmavite.

However, most portfolio managers at investment banking firms also are "watching between 100 and 200 stocks," Patsky noted. As a result, they typically are not able to make well-informed purchasing decisions. "The bottom line is investors try to buy stocks that are going higher - period - and they just don't really care much about why," he said.

The trend of "momentum investing," which Patsky noted has recently increased dramatically among institutional investors, plays a large role in this pattern. Portfolio managers are "buying stocks because they're going up [and] they're selling them when they're going down and they don't ask any questions, they don't care" if a stock's recent performance may be unrelated to the company's operations.

"What's needed in order to get" investor interest rekindled "is a period of less volatile growth, more stable growth and consistent earnings results in the companies that are public," Patsky continued. He pointed out, though, that "most of the companies that are public are smaller and will inherently have higher volatility with operating results than obviously Wall Street likes."

Patsky, however, supported his belief that the nutritional supplement industry continues to be a wise investment by citing some promising figures. The investment banker noted that despite the sector's unpredictability, "one truth that is not going away is that people are more likely to use nutritional supplements on a regular basis as they age."

Besides studying general trends, Boston-based Adams, Harkness & Hill conducted a consumer survey of 400 people in March to substantiate the theory. With the size of the elderly population constantly growing, the trend bodes well for the industry, Patsky maintained.

Moreover, using the performances of pharmaceutical companies' product lines as a gauge for the industry is misguided, he added, noting the higher prices of Bayer's One-A-Day Herbals, Warner-Lambert's Quanterra supplements and Whitehall-Robins' Centrum Herbals have impacted initial sales of the lines.

"The pharmaceutical companies...seriously misgauged consumer willingness to pay a premium for a brand they know" when other established products are already on the market, he said.

Patsky also speculated that consolidation will begin to occur at an increasing rate. Noting that most consumer products categories contain roughly four companies controlling 80% of the market, Patsky asserted this "is not true of nutritional products." However, "it will be, it's just a matter of time," he stated.

"My guess is it will be the multinational corporations in Europe that are more aggressive in actually doing something first and...then you'll see the other players realize that they're missing something," Patsky said.

In July, Dutch conglomerate Royal Numico announced it had reached an agreement with General Nutrition Companies to acquire the firm for approximately $2.5 bil. (¹ (Also see "GNC To Gain Broad R&D Pipeline From New Owner Royal Numico" - Pink Sheet, 12 Jul, 1999.)). Although that particular transaction has not spurred other acquisitions, Patsky contended it is due to a lack of interest in retail-oriented businesses on the part of most pharmaceutical companies.

"I'd be willing to bet money that by the end of the year at least one of the major brands that we have, whether it's Rexall Sundown, Twinlab or NBTY" will be acquired "by a pharmaceutical company," he stated.