HAIO – Fundamental Analysis (25 Jun 2015)

About HAI-O

The Company is principally engaged in the wholesaling and retailing of herbal medicines and healthcare products, investment holding and property holding.

Operating Segments

The following summary describes the operations in each of the Group’s reportable segments:

  1. Wholesale – Includes wholesaling and trading in herbal medicines and healthcare products, herbs and tea.
    1. The sole distributor for over 50 renowned brands
    2. Hai-O supplies to more than 100 wholesalers and 2,000 retailers, including Chinese medical halls and Chinese medicine clinics, restaurants, mini markets, as well as supermarkets
  2. Multi-level marketing – Includes operating multi-level direct marketing of health food, healthcare, wellness and beauty products.
    1. 140,000 distributors throughout the country, and 52,000 core distributors
    2. About 80% of its members are Bumiputera and approximately 2,500 new members join its network each month
    3. high payout ratio of 60% to its distributors and no breakup period
  3. Retail – Includes operating retail chain stores.
    1. 69 retail stores and 9 franchise outlets throughout the country

Ownership

Top 5 Shareholders

Holder

Common Stock Held

As At Date

% of Total Shares Outstanding

Kai Hee Tan

22,697,606

27-Mar-2015

11.6%

Akintan Sdn Bhd

15,108,209

27-Mar-2015

7.7%

Siow Eng Tan

13,474,154

27-Mar-2015

6.9%

Excellant Communication Sdn Bhd

10,365,786

22-Aug-2014

5.3%

Kee Siong Chia

6,479,448

22-Aug-2014

3.3%

Ownership Summary

Investor Type

Common Stock Held

% of Total Shares Outstanding

Public and Other

94,566,459

48.5%

Individuals/Insiders

71,099,360

36.5%

Corporations (Private)

27,973,995

14.3%

Institutions

1,372,080

0.7%

Total

195,011,894

 

Holdings of institutions in HAIO is very small. Liquidity of this counter is not bad, but volatility sometimes is quite large. This is a typical pattern of a counter where majority of shareholders are individual and public.

Having say that, HAIO management has been issuing many share buy-back, in order to increase treasury shares. This corporate exercise also provided some good supports too, which the market sentiment is not so positive. Besides, key members in the management also regularly increase their holdings. These actions sent a good message to the minority shareholders that prospect of this company still promising.

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Economic Moats

Cost Advantage

Moat: Narrow

  • HAIO enjoys high gross profit margin above 30% in average.
  • The issue is the strengthening of USD against MYR will result in higher cost of material.

Switching Costs

Moat: No

  • Various of choices in market

Network Effect

Moat: Wide

  1. Wholesale – Includes wholesaling and trading in herbal medicines and healthcare products, herbs and tea.
    1. The sole distributor for over 50 renowned brands
    2. Hai-O supplies to more than 100 wholesalers and 2,000 retailers, including Chinese medical halls and Chinese medicine clinics, restaurants, mini markets, as well as supermarkets
  2. Multi-level marketing – Includes operating multi-level direct marketing of health food, healthcare, wellness and beauty products.
    1. 140,000 distributors throughout the country, and 52,000 core distributors
    2. About 80% of its members are Bumiputera and approximately 2,500 new members join its network each month
    3. high payout ratio of 60% to its distributors and no breakup period
  3. Retail – Includes operating retail chain stores.
    1. 69 retail stores and 9 franchise outlets throughout the country

Intangible Assets

Moat: Not Applicable

  • Not available or not applicable

Efficient Scale

Moat: Not Applicable

  • Not available or not applicable

Profitability

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From FY11 to FY15, FY13 recorded the highest revenue (FY13: 266 mln). However, its revenue dropped -4.9% in FY14 and further -5.3% in FY15. This is mainly due to the following challenges/issues:

  1. A slowdown in the global economy, which will cut the purchasing power of consumers.
  2. HAIO’s sales will be challenged by the rising cost of living coupled with implementation of GST in 2015, which will lead to lower consumer spending and hence will put some pressure on its wholesale and retail divisions.
  3. Stiff competition among MLM players
  4. Its MLM division continued to struggle with the new product strategy of focusing on ‘small ticket’ items instead of ‘big ticket ‘items. (Kenanga 25 Sep 2014)

The following chart shows revenue by operating segment. Deteriorating of HAIO revenue mainly attributed to the poor performance in MLM segment. To address this issue, Hai-O is undergoing a transformation to reduce dependency on big ticket items and moving to health supplements, personal care and cosmetics which started in 2014. Since then, it has introduced new small ticket items regularly. As a result, revenue contribution from repeated sales items has doubled over the past year to 60% in 2015, reflecting the success of the transformation effort. The strategy also saw an increasing young and affluent Malay female population in its distribution network. This also bodes well for distributors as the current economic conditions have become increasingly difficult for them to finance the purchase of big ticket items with loans. The long-term outlook for MLM remained positive. (iCapital 3 Jul 2015)

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Despite declining revenue, HAIO gross margin still maintain above 30%. The downtrend of gross margin is mainly attributed to its declined revenue and the strengthening of USD against MYR. The strengthening of USD against MYR will result in higher cost of material.

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It is very important to evaluate execution ability (EBIT to Avg. Book Capitalization) of HAIO. This factor tries to measure how efficiently a company utilizes its capital employed. It aims to measure return on the company’s total capital investments, including real estate, intangible assets, and working capital. This factor is equivalent to ROIC, but this factor is tailored for the retail and distribution industry. By Moody’s standard, for FY15, HAIO’s execution ability is rated as A. If we look back 10 years history, HAIO’s execution ability ranged from A to A+.

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According to quarterly report for FY15 Q4, FY15-Q4 revenue rose 13.7% to RM70.4m, driven by growth across all divisions with retail registering the biggest jump of 56.8% thanks to the timing of Chinese New Year and pre-GST stock up activities. Nevertheless, its cost of sales increased 10% (FY14-Q4: 40 mln; FY15-Q4: 44.8 mln) due to the strengthening of USD against MYR. PAT increased from 12.5 mln (FY14-Q4) to 15.4 mln (FY15-Q4), but income tax paid increased 63.4% QoQ.

Because of Chinese New Year and pre-GST stock up activities, I think HAIO yet to fully turn around, and its coming quarters may not be impressive. With the USD still staying strong, HAIO might face difficulty in sustaining the profitability in this division.

Leverage & Coverage

The following charts show leverage and coverage of HAIO from different aspect. Position of HAIO in leverage and coverage is outstanding.

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Liquidity

HAIO’s Cash Conversion Cycle (CCC) has been increasing since FY13. In theory, increasing CCC is not good. However, we have to drill in which aspect caused this. As we can see from the following chart, "Days in Receivables" and "Days Payable Outstanding" do not change much, but "Days in Inventory" increased drastically since FY14. Two reasons:

  1. The strengthening of USD against MYR resulted in higher cost of material.
  2. Increase of inventory – This may be attributed to the transformation in reducing dependency on big ticket items and moving to health supplements, personal care and cosmetics which started in 2014

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Returns to Shareholders

Besides the share buy-back, HAIO also committed to nearly 100%  dividend payout. In FY14, the dividend payout was approx. 50%; in FY15, the dividend payout increased to approx. 97%.

I attended HAIO AGM twice. Mr. Tan Kai Hee and Tan Sri Osman S Cassim gave me very good impression, where they trying their best to maximize returns to shareholders. I believe that HAIO has very good management stewardship.

This is a company I feel safe to invest.

Growth Drivers

The recent growth drivers:

  1. 19 Sep 2014 – The Group has been awarded a sole distributorship of Maotai, a famous Chinese liquor.  We reckon that this will be the another source of income for the division. However, the reception of the product remains to be seen as whether the drink will be popular among the local community as compared to western liquor.
  2. 20 Nov 2014 – The Company also shifted its focus from big-ticket items, such as water filters, to consumer-centric products like beauty and health products, of which sales have been largely consistent and recurring in nature.
  3. In FY15, CapEx increased 137% if compare to FY14. The retail division has been looking for high traffic location for its new outlets and will enhance its CIS image by refurbishing its existing outlets.

Issues/Risks/Challenges

  1. A slowdown in the global economy, which will cut the purchasing power of consumers.
  2. HAIO’s sales will be challenged by the rising cost of living coupled with implementation of GST in 2015, which will lead to lower consumer spending and hence will put some pressure on its wholesale and retail divisions.
  3. Stiff competition among MLM players
  4. HAIO’s MLM is strong in Chinese modern medicine, but as for other products, it has weaker brand name compared to other MLM players.
  5. Margins erosion due to the weakening of Ringgit against USD
    1. This risk started effectively to reduce HAIO’s margins in FY15 Q2.
  6. 25 Sep 2014 – Its MLM division continued to struggle with the new product strategy of focusing on ‘small ticket’ items instead of ‘big ticket ‘items.

Valuation

Despite the current slump in its earnings, coupled with the possibility of longer-than-expected effect from the strategy shift, HAIO’s attractive dividend will be the main catalyst for the stock. Its dividend yield is 6.7%.

In terms of fair value, I believe that HAIO fair value range from 2.6 to 3.0 where its uncertainty of fair value is low.

Historical EY%:

  • Trailing:
    • FY15 (EPS: 0.154) – 2.59 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.154) – 2.58 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY16 (EPS: 0.161 ± 5%) – From 2.57 to 2.84 (Uncertainty Risk: LOW to MEDIUM)
    • FY17 (EPS: 0.174 ± 5%) – From 2.78 to 3.07 (Uncertainty Risk: LOW)
  • EPS applied to reach the current stock price (2.21): 0.131

Industrial Avg. EY%:

  • Trailing:
    • FY15 (EPS: 0.154) – 2.61 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.154) – 2.60 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY16 (EPS: 0.161 ± 5%) – From 2.59 to 2.87 (Uncertainty Risk: LOW to MEDIUM)
    • FY17 (EPS: 0.174 ± 5%) – From 2.80 to 3.10 (Uncertainty Risk: LOW)

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Going Forward

Next financial year will remain challenging in view of weakening domestic purchasing power and high costs of living, resulting consumers more cautious in spending. Furthermore, weakening of MYR against USD currency will increase the cost of import purchases.

Despite the current slump in its earnings, coupled with the possibility of longer-than-expected effect from the strategy shift, HAIO’s attractive dividend will be the main catalyst for the stock.

I will continue to hold and accumulate HAIO as I believe that HAIO has the ability to overcome the challenges ahead.

For Reference

Excel – http://1drv.ms/1LFoo0b

Notes – http://tinyurl.com/nr8hftv

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