Sector financial performance:

This company, which primarily manufactures nutritional supplements & personal care 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 growth in sales of this company’s nutritional supplements and personal acre have been volatile mainly depending on how appealing its incentive/commission to its members (sales). Huge increase in sales in 2015 was mainly resulted from more favourable incentive (trip to USA), which attracted large number of members/sales to sell its products. When such incentive has gone in 2016 and 2017, its sales shrink and went down as its members/sales left. In addition, its sales went down significantly (30%) in 2017 was mainly due to regulation condition as a result of its company’s Hong Kong- based sales force.

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

Organic net sales decreased 1% primarily attributable to a decrease of 1% in Hong Kong (sales to china residences, accounts for 89% of total sales)

For fiscal 2017 compared with 2016

Organic net sales decreased 31% primarily attributable to a decrease of 34% in Hong Kong (sales to china residences, accounts for 89% of total sales)

Organic net sales decreased 28% in the first six months of fiscal 2017 compared with the same period of time of fiscal 2016, primarily attributable to a decrease of 27% in Hong Kong (sales to china, accounts for 89% of total sales)

Organic net sales increased 9% in fiscal 2016 compared with 2015, primarily attributable to the increase of 6.7% in Hong Kong (China).

Organic net sales increased 113% in fiscal 2015 compared with 2014, primarily attributable to the increase of 108% in Hong Kong (China).

This company has been able to improve its gross margins before 2017 while it sources its products from third party. Its gross margin went down a little in 2018 to about 80%. As it reduced its spending on commission since 2015, its commission as percentage as sales went down to 41%, which boosted its operating margin to go up above 25% in 2017. As the sales decreased in 2017/18, its operating margin down to about 19% and incentive percentage as sales up to about 45%.

Stock price

This stock currently has an enterprise price/EBI ratio of 10 ($21/share), which we think, is relatively overvalued considering the uncertainty of the policy and as well the uncertainty of its obtainment of license for doing direct selling business in China.