Best World International (BEST SP) - Maybank Kim Eng 2017-08-21: Trust In BEST’s Track Record

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BEST WORLD INTERNATIONAL LTD CGN.SI

Best World International (BEST SP) - Trust In BEST’s Track Record

Minimal impact from China’s crackdown 

• Since Bloomberg published an article on 15 Aug 2016 relating to China’s crackdown on pyramid schemes, Best World’s share price has fallen by c.20%.
• We spoke to management and it clarified that the event has no or minimal impact on its business as it is not a pyramid scheme. We trust management based on its consistent track record. We have conducted a scenario analysis for investors who are worried about the China operations, which indicates that a China sales decline of 10-50% could reduce our FY18E EPS by 4-21% and our TP by 14-38% (SGD1.17-1.61).
• Maintain BUY and TP of SGD1.88, pegged to an unchanged 19x FY18E EPS (PEG of 0.7x using FY16-19E EPS CAGR of 27%). We ascribed a c.30% discount to the PEG of 1.0x for regulatory risks. BUY on weakness.

Scenario analysis indicates minimal downside risk 

• To understand the potential downside risks of Best World’s China operations on the earnings and share price, we performed a scenario analysis. 
• We find that the worst-case scenario assuming a 50% decline in China sales from our FY18 forecast will reduce our earnings by 21% and our TP by 38% to SGD1.17. The steeper decline in TP is from pegging to a lower valuation multiple of 15x from 19x FY18E EPS to account for a potentially lower growth profile. Our worst-case scenario TP of SGD1.17 indicates only 3% downside from BEST’s last closing price of SGD1.20.

Export vs direct selling business model 

• Best World currently operates under the export business model in China and aims to convert into a direct selling model starting at end-2017. We note that any delay in conversion will not impact the operations as it is only a change in accounting policy with limited earnings impact. The benefits of Best World's China direct selling licence are mainly:
  1. better profile to attract more customers; and
  2. to prevent issues with the local authorities.

BEST’s share price has underperformed peers 

• Since the Bloomberg news article on 15 Aug 2016, the share prices of all three US-listed direct selling companies featured in the article have declined notably: Herbalife (-6%), Nu Skin (-8%) and Usana (-4%).
• However, Best World International’s share price decline of 19% is higher. This could be due to higher dependency of Best World International on China where c.50% of sales are from China vs Herbalife (19%), Nu Skin (36%) and Usana (4%).

Q&A with management 

1. What is the impact from the Chinese government’s crackdown on pyramid schemes on your China operations? 

• We do not expect any impact as our business is not a pyramid scheme. We highlighted in our response to the Bloomberg article the distinctions between a pyramid scheme and direct selling. Moreover, we are still operating under an export model and have notified the local authorities of all of our activities. (See Best World International's Announcement on 15-Aug-2017)
• More importantly, the crackdown should not impact licensed direct sellers who are running their business in a proper manner. The campaign aims to crack down on the illegal investment-related schemes and recruitment websites.

2. Will you consider delaying the conversion of your current export business model into direct selling model? What are the key differences between both models? 

• We will not delay the conversion process. The key difference between the two models is accounting recognition of revenue and commissions. However, there will be minimal earnings impact. 
• For the business operations, there will also be minimal impact. The reason why we spent so much time and resources to secure the direct selling licence in China is to raise our profile and to prevent regulatory issues as we are a direct-selling company outside of China. 
• Our key success factor in China is our product strength.

3. What are your plans to regain investors’ confidence, after the major correction in your share price? 

• For starters, the company, founders and directors have bought back shares in the open market since the share price correction. Also, we will be writing to the World Federation of Direct Selling Association to request it to issue a clarification that China’s crackdown is aimed at pyramid schemes, and not the licensed direct sellers. 
• More importantly, we will continue to deliver a consistent set of results, particularly for our China operations.

Swing Factors

Upside

• Robust growth in China after the approval of direct selling licence.
• Successful expansion in Taiwan, Indonesia and Philippines.
• Expansion into new markets, such as the Middle East.

Downside

• Regulatory changes detrimental to direct selling in its markets, similar to Indonesia’s restriction on healthcare imports in 2009.
• Reputational risks caused by fraud or fake-product scandals for other direct-selling players or BEST’s members.
• Failure to scale up in China would result in up to 10% downside to the share price valuation.

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-08-21

Maybank Kim Eng SGX Stock Analyst Report BUY Maintain BUY 1.880 Same 1.880