Best World International - DBS Research 2017-08-16: Lowering Growth Expectations

BEST WORLD INTERNATIONAL LTD CGN.SI

Best World International - Lowering Growth Expectations

China embarks on 3-month campaign against illegal pyramid schemes.
Concerns over Chinese clampdown extends to legitimate direct selling companies.
Best World has yet to convert to direct selling model in China, but recent events could still hurt member growth.

Downgrade to HOLD with lower TP of S$1.45, as we lower growth projections for China.

Best World’s share price fell 12% on Tuesday following China’s campaign against illegal pyramid schemes. Prompted by this event, we have cut sales growth projections for Best World’s China operations from 80%/35% to 45%/15% for FY17F/18F. Potential spillover from this event could weigh on consumer sentiment and hurt member growth.
Downgrade to HOLD with lower TP of S$1.45 after lowering the group’s earnings projections for FY17F/18F by 9%/16% and based on 17x FY17 PE (vs 18x previously).

Given growing exposure to and uncertainty in Best World’s key China market, we have assumed an even higher discount to global peers’ c. 21x FY18F PE for Best World, compared to consensus.

Earnings delivery, successful expansion into new markets, and M&A China business could see some near-term pressure following SAIC’s recent move.
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 over the longer-term.
However, we see near-term pressure on growth as spillover effects from SAIC’s campaign against illegal pyramid schemes could affect consumer sentiment and cause the pace of membership and sales growth to slow.

Given possible spillover impact from the campaign against pyramid selling in China, we cut Best World’s earnings for FY17F/18F by 9%/16% and arrive at a lower TP of S$1.45 (based on 17x FY18F earnings vs global peers’ 21x).
Meanwhile, a prospective 2.2% yield is currently on offer.

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.

Best World shares closed 12% lower on Tuesday to S$1.355 after share prices of larger peers - Herbalife, Nu Skin and USANA - tumbled on Monday after China’s State Administration for Industry & Commerce (SAIC) announced a three-month campaign against illegal pyramid schemes. This came weeks after reports surfaced of a university student allegedly committing suicide after falling victim to a certain pyramid selling scheme’s advertisement posted on a popular recruitment website in China.
The campaign is mainly targeted at
1. preventing future misuse of recruitment portals, and
2. clampdown on illegal pyramid sales models.
Direct selling companies were not mentioned in the announcement.

In a note issued by Best World today, the company shared key differences between licensed direct selling and illegal pyramid schemes (presented below), which are often centered around the issue of sustainability. Best World also highlighted that while the company currently holds a direct selling licence, it has yet to make the conversion, and is currently using the export model in China – where sales of its flagship products are sold through Dr’s Secret brand outlets and workshops (i.e. beauty parlours).
Hallmarks of a pyramid scheme include: (Source: Company)
1. Companies which profit from act of recruitment and not sale of products or services;
2. Low quality products sold at a high price;
3. Products purchased are not for consumption but as a requirement to participate in the scheme;
4. Products are sold without a reasonable product return guarantee; and
5. High startup/entry fee to participate in the scheme.
To summarise, the company believes that SAIC’s announcement has little-to-no impact on its China business, and it also disclosed that current preparations for the progressive conversion to direct selling in China are in line with the SAIC’s guidelines.

While SAIC’s announcement suggests that the investigation is focused on illegal (and thus unlicensed) pyramid sellers and not licensed direct selling companies, we think there could be a negative possible spillover effect on licensed direct selling players.
For Best World, we agree that the impact on existing operations will likely be limited given that it has yet to convert to the direct selling model in China. However, the negative publicity and ongoing investigation on pyramid sales – which is often confused with direct selling - could weigh on consumer sentiment and the effectiveness of Best World’s upcoming recruitment drives.

Given the above, we think the pace of membership and sales growth could slow in the near-term, and have thus turned more cautious on 2H17 and FY18F outlook. After cutting near-term sales growth forecasts for China from 80%/35% to 45%/15% for FY17F/18F, our earnings projections are lowered by 9%/16%, respectively.
Downgrade to HOLD after we arrive at a lower TP of S$1.45 (based on 17x FY18F earnings).

Carmen TAY DBS Vickers | Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-08-16

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