Sector financial performance:

This company, which primarily manufactures nutritional supplements and distributes their products as a form of direct selling, has been grouped into nutritional supplement – direct selling sector in natural food industry.

Our company data indicate that, in this direct selling nutritional supplements sector, the growth in sales basically has less to do with the products themselves than it is in store-based selling as the market and consumers get mature. The competition is intensive and companies are competing with each other mainly in sales force (re-sellers), which is the key determinant in performance of sales in this sector. The key to attract more re-sellers is certainly related to brands’ realization and incentives/commissions. However, to a larger extent, it is the acceptance of local consumers to direct selling to determine performance of direct selling and availability of sale force/unemployment rate.

This is particularly true in matured markets such as Western Europe, North America, South America, and Japan, where the total numbers of active sales force are limited in current favourable employment market and the demand for nutritional supplement products has been decreasing as more alternative products and concepts are available.  As our data indicate, the sales have been shrinking in those markets for years (especially in 2017) and the only way for some certain company to gain sales growth is to provide more favourable incentives than competitors. Immature markets and consumers seem to have potential to become the driver for direct selling of nutritional supplements. However, internal uncertainties in Eastern Europe and small market in Southeast Asia all create unfavourable environment for this sector. China has been contributing to growth significantly. However, the newly tightened policy of direct selling in China has made things changed and some companies have to look to channels other than sales force direct selling, such as e-commerce, to sell their products, which is completely different stories. Some of companies, who utilize agencies in Hong Kong to delivery products to their direct sales in china, seem working well even though the margins are not likely to be as high as before. In addition, this business operating gets involved with risks of more complicated policies.

High gross margin is major characteristic of this sector. The typical gross margin for company in this sector is around 79% with 42% commission as percentage of sales and 25% SG&A as percentage of sales. Therefore, they usually have operating margins of 12%. All companies have experienced decline in cash flow in 2017 due to slowing down sales/deleveraging of incentive spending in US market but positive growth in cash flow in 2018 thanks to rebounding sales.

According our analysis, a typical ratio of enterprise price/adjusted EBI is about 33 with very wide span between 10 and 65 with interest/EBI ratio of 1%. 

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Company performance:

It seems the sales of this company’s nutritional supplements have been continuing to decrease in matured markets such as North America and Western Europe. While the sales in North America (accounts for near 50% of its total sales) increased in 2015 and 2016, the number went down to the level before 2015 when entering into 2017 and continued to go down in 2018. Sales seem to be increasing in Japan &South Korea after sluggish 2016/17 and in Eastern Europe. China’s performance seems more promising as its sales number get larger and contributes more to this company to offset its decrease in North America and Europe.

For the first nine months of fiscal 2018 compared with 2017(ended 20180930)

Organic net sales increased 3.4% primarily attributable to an increase in developing market such as eastern Europe (up by about 18%), China ( up by 32%) and other Asian areas (17%) offset by decrease in developed market including about 5% down  in America and 19% down in Europe.

For fiscal 2017 compared with 2016

Organic net sales was flat primarily attributable to a decrease in developed market including about 6% down  in America and 5% down in Europe, offsetting by an increase in developing market such as eastern Europe (up by about 7%) and China ( up by 91%).

Organic net sales decreased 4.4% in the first six months of fiscal 2017 compared with the same period of time of fiscal 2016, primarily attributable to a decrease in developed market including 3.4% down  in America and 3% down in Europe and Asia, offsetting by an increase in developing market such as eastern Europe and China ( up by 1.2%).

Organic net sales increased 5.8% in fiscal 2016 compared with 2015, primarily attributable to the increase of 3.2% in China and an increase of 4.1% in developed market of Asia including Japan and South Korea, offsetting by a decrease of 1% in South America, a decrease of 0.4% in Eastern Europe, and a decrease of 0.7% in other part of Europe.

Organic net sales decreased 6.7% in fiscal 2015 compared with 2014, primarily attributable to the decrease of 6% in Eastern Europe and decrease of 0.7 in South America and China.

This company has the lowest gross margin among peers, which is around 73-75%, probably because it has had its products made in USA where there are usually higher products costs and unfavorable influence of currency. Therefore, when this company’s SG&A increased as percentage of sales in 2015/16/17, its operating margin went down close to 1% and cash flow down below 1% with a volume incentive costs (direct selling) as percentage of sales of 35%.  And all those working together with falling sales, its operating income actually went down by 26%, 28%, and 90% (annualized) in 2015, 2016 and 2017 respectively. The improved sales, which driven by increasing demand from Asia and eastern Europe, helped leverage margin and brought positive growth in cash flow in 2018.

Stock price

This stock currently has an enterprise price/EBI ratio of 63 ($9/share)and enterprise price/sales ratio of 0.5, which we think, is relatively undervalued considering while its weak performance in US market there are increasing opportunities in developing market.