OSIM - CIMB Research 2016-01-29: Still too early to massage into an Add

OSIM INTERNATIONAL LTD O23.SI

OSIM International - Still too early to massage into an Add

After a disastrous 3Q, expectations were low. 4Q15’s 66% yoy decline in net profit was therefore deemed in line, and would have exceeded if not for one-offs.
No change to gross margins at more than 70%. But
1. negative operating leverage,
2. TWG rollout expenses and
3. one-offs dragged down OP margins.

Management hinted at new products this year, but sales may not materialise just as uMagic disappointed in 3Q15.
OSIM is net cash and generates positive FCF. No threat to DPS of 6 Scts (6% yield). Our target price of S$1.00 (13x CY17 P/E) is pegged to -1 s.d. levels. Upgrade to Hold.

Operationally, not much has changed since 3Q:
1. overall end-demand is still soft,
2. OSIM is still in a period of store rationalisation and
3. South Asia remains the bigger drag.
4Q’s 66% yoy decline in net profit (S$9.3m) was therefore not a surprise as we already expected weak results. However, 4Q15 also included one-offs from legal expenses (S$3.4m) and the deconsolidation of ONI Australia (S$5.6m). In this context, 4Q was better than expected.
FY15 net profit was 98% of our forecast.

FY15 carried the bulk of TWG’s legal expenses (S$10.1m). Both cases are still pending judgment, and management guided that 2016 should see lower legal expenses.
ONI Australia is also undergoing voluntary administration and the group took a S$5.6m writeoff.
Not including these, FY15 OP margins (14%) were still lower vs. FY14 (19%), mostly due to
1. negative operating leverage and
2. TWG start-up costs.
We expect margins to stay at these lower levels.

History shows that its business model of creating demand with new product launches and celebrity-helmed A&P does not work in economic downturns.
Sales in 2007/08 declined by 12-16% yoy as it pruned 5-9% of OSIM stores.
Store closures in 2015 (-5% yoy) mirror the previous downturn.
Hence, given the current bleak environment, we do not expect a big uptick in sales even as OSIM has new product launches in the pipeline.

While 4Q15 group sales declined 5% yoy, it is a vast improvement on the 12% decline over 9M15. In particular, North Asia’s 4Q sales (+3% yoy) finally turned a corner after three consecutive quarters of yoy declines. Further, management expects to save S$3.5m p.a. after deconsolidating its loss-making ONI Australia.
While OSIM is caught in a weak macro retail environment, it is still profitable and generates positive FCF.

The stock has retraced c.42% since our downgrade in 3Q15 and trades at 13x CY16 P/E, in line with its -1 s.d. levels of 13x (past 5 years). OSIM has net cash of S$211m (30% of market cap) and offers a yield of c.6%.
Management guides that it intends to maintain its 6 Scts DPS.
We think these levels should provide share price support, while greater earnings visibility could be a catalyst. For these reasons, we upgrade to Hold even as we lower our target price following EPS cuts on lower sales and OP margins.

Kenneth NG CFA CIMB Securities | Jonathan SEOW CIMB Securities | http://research.itradecimb.com/ 2016-01-29

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