Forget Amazon.com: Buy This Instead
August 17, 2010By: Frederick M. SteierArticles RSS feedPrintPrint

"The trend is your friend." And when a trend is so big that it creates multi-billion dollar businesses, you want to be invested alongside it.

And if you can find a company taking advantage of two macro trends, so much the better.

There are two obvious trends investors can take advantage of right now. One trend is global Internet retailing, which Amazon.com (Nasdaq: AMZN) effectively pioneered in the late 1990s.

The problem with Amazon is that, while it is still a growth story, it's no longer a company investors can enter on the ground floor. The biggest gains have already been made, having returned +7,300% since its IPO

, and trading at 50 times this year's earnings -- despite only having a +23% growth estimate. You want to own the stock that will return +7,300%, not the one that is trading at twice its fair value because of past performance.

Another disturbing trend is increasing obesity rates in the United States. The Journal of the American Medical Association released a report earlier this year showing the obesity rates in men and women have increased from around +27% in 1999 to as high as +34% today. That's more than 130 million Americans.

This alarming trend has led to an increased desire among many people to live a more healthy lifestyle, which I've written about before.

[Read: The Trend is Your Friend with This Healthy Stock]

Luckily, Vitacost.com, Inc. (Nasdaq: VITC) plays into both the online retailing and healthy lifestyle trends. It operates in a manner similar to Amazon, but unlike Amazon, investors can still get in on the ground floor.

Between its catalogs and online presence, Vitacost sells -- are you ready? -- more than 30,000 products across 1,600 brands. The company literally sells everything the healthy living retail world provides, including vitamins and minerals, herbal supplements and extracts, teas, cosmetics, sports nutrition, health foods, weight management products, organic specialty products and even low-mercury tuna.

Yet, when you look at the stock, you'll notice that it's nearly -30% below its October IPO price of $12. What's going on? Is this a case of an overlooked gem, or is there something deeper investors should be aware of?

The stock dropped because the company's sales and profitability took a big hit, there were manufacturing problems and its margins did not stack up against competitors. Comparing Vitacost to competitors Vitamin Shoppe, Inc. (NYSE: VSI) and NBTY, Inc. (NYSE: NTY), the company had far lower gross margins, negligible cash flow, and tiny operating margins.

Clearly, Vitacost should have been doing better than it was, but investors bailed on this stock. Looking at the market the company serves, based on its previous accomplishments, and based on what its peers are doing, the company should be able to easily achieve the following results in the near-term:

First, because it is not a bricks-and-mortar operation, Vitacost's margins should be higher and its pricing power stronger. Revenue is growing +6% quarter to quarter. That should increase to +12% during a recovery. Its competitors are wholesalers with retail stores for middlemen. Operating margins are currently a slim 2.3%, compared to NBTY's 8.9%. NBTY is 15 times larger in market cap, so it enjoys economies of scale, but Vitacost's margins should be triple what they are now.

Factoring all this in, annual revenue could be closer to $120 million, with net income boosted to $36 million, or $1.33 per share. And after assigning Vitamin Shoppe and NBTY's average multiple of 20 times earnings on Vitacost's shares, this gives us a fair value of $26.70 per share. That's a three-bagger from here.

And how does Vitacost achieve these lofty goals? New management, thanks to private equity firm Great Hill Partners.

The firm recently swooped in and purchased about 13% of the stock and won a proxy contest to throw out part of the Board of Directors. Private-equity firms will only go to this kind of trouble -- and expense -- if they believe the company should be performing better than it is and that the stock is trading far below its intrinsic value. Furthermore, a proxy contest means that a majority of shareholders agree. This more than anything demonstrates that shareholders think the company should be doing better than it is.

In addition, Great Hill could not have accomplished this without the support of two mutual fund managers that I highly respect -- Ron Baron and Charles Royce, who together control about 9% of the company.

Also, Jeffrey J. Horowtiz, the founder and former CEO of none other than Vitacost's competitor, Vitamin Shoppe was added to the Board of Directors. Mr. Horowitz literally built Vitamin Shoppe from the ground up, expanding from one store to 200. Now he's joined Vitacost.

The right people are handling Vitacost now. The company had the wrong team at the helm, a change has been made, and I expect a turnaround. The company appears to be turbocharged for growth.

Action to Take --> Buy Vitacost. The company finally has the right management in place, and two long-term macro trends in its favor.
The company is well-positioned to survive the transition in management, with $40 million in net cash and a profitable business that threw off $3.5 million in free cash flow last quarter.

The stock has a market cap of only $240 million, while competitor NBTY's is $3.8 billion -- meaning a multi-bagger is not out of the question.

Frederick M. Steier
Contributor, StreetAuthority.com
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