Best World International - DBS Research 2017-08-08: All Eyes On China

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BEST WORLD INTERNATIONAL LTD CGN.SI

Best World International - All Eyes On China

• China to remain key growth driver as Taiwan pauses for breath.
• Untapped opportunities for Best World outside of China include halal skincare market in Indonesia and M&A in Japan.
• FY17F/18F earnings raised by 7%/10% to reflect strong momentum and margins in China, but partly mitigated by temporary weakness in Taiwan.
• Reiterate BUY with higher TP of S$1.82.

Direct seller riding on highly scalable model to deliver 27% PATMI CAGR over FY16-FY18F. 

• Compared to traditional retailers, Best World’s advantage lies in its highly scalable model (with lower fixed costs). 
• Supported by greater scale economies, we project PATMI to rise quickly from S$34.6m in FY16 to S$55.7m by FY18F as the group further extends its reach.

What’s New 

Yet another record quarter for China export sales. 

• Earnings surged by 63.2% y-o-y (or 23.1% q-o-q) to S$12m as broad trends observed in 1Q17 continued in 2Q17 - export sales in China continued to gain momentum, rising to a record S$25.3m (+134.8% y-o-y) in 2Q17, which more than offset lower sales in Taiwan (-34.1% y-o-y to S$23.1m).
• But, overall sales growth appeared relatively lackluster against the strong bottom-line performance, gaining just 7.2% y-o-y from S$51.6m in 2Q16 to S$55.2m in 2Q17. This was mostly due to differences in revenue recognition under the direct selling vs export model as ASPs under direct sales are typically 2-3x of that under exports. Adjusting for this, we estimate that top-line growth was closer to 30- 40%.
• As the company typically reports a stronger second half, 1H17 earnings was slightly above at 51.5% of our FY17F estimates.

Modest growth in membership pool. 

• The number of members rose 1.8% q-o-q to 468,479 as at end 2Q17. The group also introduced a new metric this quarter – active distributors, or members who have received commission for at least six months over the last 12 months. These distributors made up approximately 11% of the total membership pool.
• While we are unable to make comparisons at this point, tracking this metric going forward should provide greater insight into the progress of Best World’s recruitment efforts and ultimately, earnings potential.

Taiwan sales still weak, but may fare better in second half.

• Best World is now ranked 9th largest direct selling company in Taiwan, according to direct selling publication Power Networking Monthly, from under 30 just a few years ago. Thus, having amassed a pretty decent scale in Taiwan over a fairly short period of time, momentum in its second-largest market has started to ease.
• However, with sales improving to S$23.1m (+23.7% q-o-q) in 2Q17, we remain cautiously optimistic of a slightly better showing for Taiwan in the seasonally stronger second half vs 1H17 given efforts to
  1. further tap into Northern Taiwan, and
  2. enhance distributor efficiency through improved online and mobile platforms.

China to remain key growth driver ahead as Taiwan takes a backseat. 

• Contributions from China has grown at breakneck pace over the last few years. 
• Supported by healthy end demand and good traction in its recruitment and marketing efforts, export sales in Best World’s largest market should continue to remain on an upward trajectory, mitigating softer sales in Taiwan.

Dividend policy raised. 

• Best World proposed an interim dividend of 1.5 Scts for 1H17, which is below the 2 Scts paid in 1H16 but has raised its dividend policy from 30% to 40% payout for FY17-FY19

Where We Differ: 

• Given higher geographical concentration risk on the group’s fast-growing exposure to the China market, we have assumed a slightly higher discount to global peers’ c. 21x FY18F PE for Best World, compared to consensus.

Potential catalysts: Earnings delivery, successful expansion into new markets, and M&A.

• Attainment of a direct selling licence in China, a market over 50x larger than Taiwan, should underpin years of firm growth. Having amassed a pretty decent scale in Taiwan over a fairly short period of time, and coming off an extended period of high growth, momentum in Best World’s second-largest market has thus started to ease. 
• However, we look beyond the weaker Taiwan headline sales in 1H17 to focus on China instead, which we estimate contributes c.60-65% of the group’s current earnings and still holds immense long-term potential.

China’s cosmetics sector is forecast to grow at 12.9% CAGR into 2019. 

• With much of the groundwork already laid in China, the Ministry of Commerce of the People’s Republic of China (MOFCOM)’s indirect endorsement through the recent award of a rare direct selling licence provides Best World with the credibility and platform needed to gain scale in the world’s most populous nation and second-largest direct selling market. 
• Stronger participation rates at Best World’s post-licence recruitment events also confirm this.

Valuation

• Reiterate BUY with higher TP of S$1.82, based on 18x FY18F PE. 
• As Best World enters a period of strong growth, we opine that the stock should trade at 18x FY18F earnings (based on historical average discount to global peers’ 21x). At current share price of Best World International, the stock also offers a prospective 2% yield.

Key Risks to Our View

• Key risks include lack of control over individual distributor’s selling process, discretionary spending levels, and impact of unanticipated changes in local regulations and restrictions.

Carmen TAY DBS Vickers | Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-08-08

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.82 Up 1.650