Why Are These Health Stocks Feeling Under the Weather?

Shares of several health-related companies are receiving a workout this week. The tone was set on Friday when the Food and Drug Administration announced it sent warning letters to ten companies that make or distribute dietary supplements that contain an ingredient called dimethylamylamine, or DMAA. The FDA explained that the ingredient cannot be used as the active ingredient in nutrition supplements because manufacturers have not provided evidence that it is safe. First introduced by Eli Lilly (NYSE:LLY) decades ago, DMAA was originally marketed and sold as a nasal decongestant, but is now used in popular energy enhancers and weight loss products. The agency said DMAA is known to cause heart problems from chest tightness to heart attacks.

“Before marketing products containing DMAA, manufacturers and distributors have a responsibility under the law to provide evidence of the safety of their products. They haven’t done that, and that makes the products adulterated,” Daniel Fabricant, Ph.D., director of FDA’s Dietary Supplement Programs, said in a statement, according to Investor’s Business Daily. Retailers of health and wellness products such as GNC Holdings Inc. (NYSE:GNC) and Vitamin Shoppe Inc. (NYSE:VSI) have both seen their shares decline more than 5 percent since late Friday. However, DMAA is estimated to account for only a small portion of products sold at retailers such as GNC. Charles Grom, analyst at Deutsche Bank (NYSE:DB), says the company receives around 2 percent of its total revenue from DMAA related sales. J.P. Morgan (NYSE:JPM) analysts also place the number in the single-digits.

While the companies on the receiving end of the FDA warning letter have 15 days to respond, some outlets are already taking action against GNC and Vitamin Shoppe. On Tuesday, Amazon.com Inc. (NASDAQ:AMZN), the world’s largest online retailer, told CNBC it is in the process of pulling products containing DMAA from its website ahead of any possible action by the FDA. The company has around ten products online that contain DMAA.

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Investors also dialed in on Herbalife Ltd. (NYSE:HLF), which sells nutrition and weight management products through a direct-selling model. Although the company recently reported a 23.6 percent increase in first-quarter net income from a year earlier, investors  were alarmed by the earnings call. During the conference call, Herbalife received unexpected questions from Greenlight Capital fund manager David Einhorn, the investor known for shorting companies such as Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) and Lehman Brothers.

Einhorn asked simple questions in regards to how many of the company’s products are actually sold to consumers, rather than just distributors. Herbalife did not have an exact percentage because it does not have “visibility to that level of detail,” said Herbalife President Desmond J. Walsh. However, Herbalife has a rule of thumb that claims 70 percent of sales are to customers or distributors for personal use. Einhorn also asked why the company did not provide a breakdown of three groups of distributors at the low-end, as done in the previous 10-K statement. Herbalife responded that it did not view this information as valuable to the business or to investors, but offered to do so going forward.

Herablife shares closed almost 20 percent lower on Tuesday. After the closing bell, the company released a statement explaining, “To be clear: Mr. Einhorn’s questions raised no new subjects or concerns. They were elementary questions usually asked by investors new to our industry. These are issues that have been thoroughly addressed before.” On the back of the best quarterly financial results in 32 years, the statement also called the sell-off in shares a buying opportunity.

Going forward, it will be very interesting to see if Einhorn releases more thoughts on Herbalife. It seems unusual that a fund manager with the resources of Einhorn would take the time to ask such basic questions that one of his analysts could research if he did not have an alternative motive. Perhaps Einhorn is gearing up for a bigger revelation for his speech at The Sohn Conference Foundation on May 16?

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