Best World International - DBS Research 2018-05-15: Growth Slows Amid China Transition

BEST WORLD INTERNATIONAL LTD SGX: CGN

Best World International - Growth Slows Amid China Transition

Best World International's 1Q18 earnings weak as per earlier guidance, but cautious tone on FY18F growth prospects a negative surprise.
Demand growth in China eased y-o-y, while Taiwan re-entered contraction mode.
FY18F/19F earnings cut by 18%/15% as we lower growth projections to account for transitionary effects in China and dismal performance in Taiwan.
Downgrade to FULLY VALUED with lower Target Price of S$1.29.

Downgrade to Fully Valued with lower Target Price of S$1.29; FY18F earnings cut by 18% as Taiwan disappoints and growth eases in China.
Best World’s 1Q18 revenue and earnings declined sharply by 43% y-o-y and 41% to S$25.4m and S$5.7m, respectively. While a weaker 1Q18 was largely anticipated given higher forward sales recognised in 4Q17, management’s more cautious tone on FY18F growth prospects - particularly for the China Wholesale business (Best World’s key growth engine) - came as a surprise. This suggests that the company may likely fall short of consensus’ expectations of c.20% bottom-line growth in FY18F.
Amid Best World’s transition towards the new China Wholesale model, which will only begin to contribute from 2H18 onwards, 2Q18 performance is likely to remain weak. The short-lived recovery in Taiwan, which fell c.61% q-o-q to a three-year low of S$12.1m, further weighs on near-term expectations.
After cutting FY18F/19F earnings by 18%/15% and assuming a lower valuation target multiple of 15x (larger discount to peers’ 21x) to reflect the earnings decline, we arrive at a lower Target Price of S$1.29. Downgrade to FULLY VALUED.

Given lower earnings expectations and higher geographical concentration risk on the group’s fast-growing exposure to the China market, we have assumed a 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 could help share price to rerate.

Downgrade to FULLY VALUED with lower Target Price of S$1.29, based on lower valuation multiple of 15x FY18F PE (vs global peers’ c.21x) after cutting our earnings projections by 18% for FY18F to account for slower growth in China and weakness in Taiwan.
The stock offers a decent prospective 2.7% yield.

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.

Following the recognition of higher upfront sales in 4Q17 as Best World prepared for its transition from an Export model to the new “China Wholesale” model – Best World’s equivalent of the Direct Selling model for China - the group reported sharp declines in 1Q18 revenue and net profit of 43.4% and 40.6% to S$25.4m and S$5.7m, respectively.
To recap, Best World sold c.5-6 months’ worth of inventory via exports into China in 4Q17 (vs 3 months historically) as it prepared against possible importation delays from the planned transfer of import licences from its third-party agent to Best World’s subsidiary in Zhejiang. The higher upfront sales resulted in record revenues and profits in 4Q17, but at the expense of lower export revenues and profitability in 1Q18.
While the weaker 1Q18 was largely anticipated, the adoption of a more cautious tone on FY18F growth prospects - particularly for the China Wholesale business - came as a surprise, which suggests that the company may likely fall short of consensus’ expectations of c.20% bottom-line expansion in FY18F.

While the c.23% growth displayed in combined 4Q17 and 1Q18 export revenues compared to a year ago – a better representation of the group’s operational performance in our opinion - reflects robust underlying demand in China, we note that growth has eased vs average of c.91% for FY17.
Meanwhile, Taiwan disappointed as it re-enters contraction mode. Despite the good showing in 4Q17, which was likely boosted by promotional activities, Taiwan sales re-entered a contraction mode and fell to a three-year low of S$12.1m (- 35% y-o-y, -61% q-o-q) in 1Q18.
While Best World’s membership pool continued to grow sequentially to a record 500,259 members as at end-1Q18, we remain concerned over the lower retention rate of members in Taiwan – a worrying trend which could continue to impact performance over the next few quarters.

Applying a similar methodology to the pretax line, we observe that Best World’s profit before tax for the last six months (4Q17-1Q18) has fallen c.11% y-o-y to S$27.3m (vs S$30.5m in the same period last year).
Given the short-lived recovery in Taiwan and challenging near-term outlook, we have cut our revenue growth projections from +8% y-o-y and assumed 5% revenue decline for FY18F instead.
For China, amid the transition to the new China Wholesale model, we choose to be more conservative for now as
1. export sales are likely to head lower in 2Q18, and
2. contributions from China Wholesale only likely to kick in from 2H18.

After imputing the lower revenue growth assumptions, our FY18F/19F earnings are cut by 18%/15%, respectively. We also apply a lower valuation multiple of 15x (at a larger discount to larger peers’ c.21x) vs 17x previously to reflect the lower FY18F earnings, resulting in a lower Target Price of S$1.29. Downgrade to Fully Valued.

Carmen TAY DBS Vickers | https://www.dbsvickers.com/ 2018-05-15

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