Retailer Shows Off Muscles Amid Nutritional Supplement Boom

• Amy Reeves
• On 5:48 pm EDT, Monday October 26, 2009

VS Holdings Inc.

North Bergen, N.J.

(201) 868-5959

vitaminshoppe.com

Lead underwriters:

JPMorgan, BofA Merrill Lynch and Barclays Capital

Offering price: $14-$16

Expected date: week of Oct. 26

Ticker: VSI

THE BUZZ

It's not surprising that two years have passed since a retailer dared to come out on the U.S. market. Yet the two retailers that debuted in that long-ago era, Ulta Salon, Cosmetics & Fragrance (NasdaqGS:ULTA - News) and Lumber Liquidators (NYSE:LL - News), are now among IBD's top-ranked stocks.

It shows that, even in this environment, a retailer can succeed if it nabs the right niche. VS Holdings, the parent of Vitamin Shoppe, claims to have one.

The nutritional-supplement business has held up pretty well through the downturn, as seen by the performance of such firms as NBTY (NYSE:NTY - News) and Medifast (NYSE:MED - News). The Nutrition Business Journal says U.S. sales in the sector have grown more than 4% a year since 2001 and that the trend should continue through 2014. Vitamin Shoppe's same-store sales have slowed in the recession, but haven't gone negative like so many other retailers' have.

"It is a decent store-expansion story," said analyst Nick Einhorn of Renaissance Capital. "Even though it's a very competitive market, the whole market is growing. Maybe that will support a lot of growth."

Market competition is more worrying to Morningstar's Erin Swanson, who wrote in an Oct. 16 report that Vitamin Shoppe "is highly dependent on the perception of its brands among consumers, which could prove to be its Achilles' heel."

The regulatory and health debates around some of these supplements, such as ephedra a few years ago, add risk to the company's outlook, Swanson wrote.

THE COMPANY

Vitamin Shoppe started in 1977 with one store in New York City. It has since grown to 434 locations in 37 states, as of Sept. 25. It launched a mail-order catalog in 1981 and an e-tail site in 1998. In 2002, a private-equity division of Bear Stearns, now Irving Place Capital Partners, bought the company.

Vitamin Shoppe sells 20,000 distinct products under 700 brands, including its own private label. It groups the products into four categories based on target market.

Sports nutrition is the largest segment, accounting for 29% of sales last year. These include products such as protein powder, sports drinks and supplements aimed at boosting energy and performance.

Specialty supplements provided 27.4% of sales last year. Products in this line, such as "super antioxidants," omega-3, acai and so on, are taken to help with sleep, memory, pregnancy, menopause and specific health problems.

Herbs and botanicals cater to natural-medicine fans, using traditional remedies such as gingko, milk thistle, turmeric and black cohosh. And then there are the basic vitamin and mineral supplements, which the company says it is not focusing on because the margin is low. The prospectus didn't give sales percentages for either of these products lines. There's also an "other" category, including diet products and toiletries.

Vitamin Shoppe has opened 34 stores so far this year. It says it plans to grow the store base 10% annually, including possibly outside the U.S.

A new store is about 3,600 square feet in size, normally in a highly visible free-standing location.

The firm says its target operating model, based on past experience, assumes a net investment of $230,000 per store and a break-even cash flow after about a year.

RISKS/CHALLENGES

Nutritional supplements exist in a sort of regulatory gray area. They are not as stringently regulated as actual drugs, but their health-conscious buyers tend to react badly to signs of danger.

Ephedra, a folk remedy for colds and allergies, was banned in 2004 on evidence that it caused fatal heart attacks. Since ephedra accounted for 4% of Vitamin Shoppe's sales, that hit the firm pretty hard.

For similar reasons, the firm is currently engaged in several different lawsuits related to its labeling. A former employee is also suing over its business practices.

After the offering, Vitamin Shoppe will have $133.6 million in debt.

The company faces competitors on several different fronts.

There are some other retail chains, such as NBTY and GNC, that are similar in format. Many grocery and big-box stores also sell nutritional supplements. And there are a multitude of online retailers providing the spam that fills up your inbox.

Irving Place Capital will remain largely in control of the company after the offering. Five members of the partnership sit on the board.

THE RESULTS

Sales in the first half of the year totaled $343.7 million, up 12% from a year earlier. Same-store sales rose 4.7%. Net income grew 56% to $8.8 million.

USE OF PROCEEDS

Vitamin Shoppe will sell about 7.7 million of the total offering of 9.1 million shares, raising about $107 million.

Some $63.6 million will go toward redeeming stock from the current shareholders, including both Irving Place and Blackstone Group (NYSE:BX - News).

Most of the remainder will go toward repurchasing outstanding notes.

THE MANAGEMENT

Richard Markee

Chief executive and chairman

Joined the board in 2006 and became CEO in September 2009. Previously he worked at Toys "R" Us, acting as interim chief executive in 2005 and 2006 and president of the Babies "R" Us division from 2004 onward.

Anthony Truesdale

President and chief merchandising officer

Joined in 2006 after heading merchandising and supply-chain management at PetSmart (NasdaqGS:PETM - News), where he had worked since 1999. Before that, Truesdale spent two years at Sainsbury's and 16 years at Shaw's Supermarkets.

Michael Archbold

Executive vice president, chief operating officer and chief financial officer

Joined in 2007 after two years as CFO of Saks (NYSE:SKS - News). Before that he was chief financial officer of AutoZone (NYSE:AZO - News) for three years.

Buzz up!