Best World International - DBS Research 2018-08-08: Limited Visibility On China

BEST WORLD INTERNATIONAL LTD SGX:CGN

Best World International - Limited Visibility On China

Best World International’s 2Q18 earnings of S$9.1m (-24% y-o-y) below expectations.
Growth prospects could be a challenge as revenue trends over last nine months point to weakening demand from China.
Adoption of Franchise vs Direct Selling model for China impedes the tracking of sales against underlying consumption, which could weigh on investor sentiment.
Maintain FULLY VALUED with lower Target Price of S$1.15; we are suspending coverage on the stock.

While a weaker 2Q18 has been largely anticipated as per management’s guidance, Best World’s revenue of S$35m and net profit of S$9.1m was still below expectations. After adjusting for transitionary effects, revenue trends over the last three quarters point to weakening demand from China – which suggests that the company may fall short of consensus’ expectations of c.24% bottom-line growth in FY18F.

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The adoption of a Franchise vs Direct Selling model for China also complicates the analysis, as it limits investors’ ability to reconcile between sales figures and underlying consumption in China. We believe that this needs to be addressed over time – failing which, could weigh heavily on investor sentiment. We cut FY18F-19F earnings by 11% p.a., mainly on lower sales growth assumptions for China and Taiwan.
Against a valuation target multiple of 15x, implies a lower Target Price of S$1.15. Maintain Fully Valued.
We are also suspending coverage on the stock given limited visibility on underlying consumption trends in China under the new Franchise model.

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.

Maintain Fully Valued with lower Target Price of S$1.15, based on lower valuation multiple of 15x FY18F PE (at a discount to global peers’ c.21x) after cutting our earnings projections by further 11% for FY18F to account for possible weakness in China and Taiwan.
Meanwhile, the stock offers a 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.

While a weaker 2Q18 has been largely anticipated as per management’s guidance, Best World’s revenue of S$35m and earnings of S$9.1m still came in below expectations.
Representing sharp declines of 36.6% and 23.7% y-o-y, respectively, this marks the second consecutive quarter of earnings weakness, which has largely been attributed to negative transitionary effects arising from its conversion from an Export to Franchise revenue model (Best World’s equivalent of the Direct Selling model for China).
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 and 2Q18.
1H18 profits only formed 31% and 25% of our and consensus’ FY18F forecasts, respectively which is significantly below its historical 1H contribution of c.39% (FY16-17).

Best World introduced its new Franchise segment in 2Q18, will formally replace the Export segment from 3Q18 onwards.
While management reiterated expectations of growth in FY18F, revenue trends over the last nine months seem to suggest otherwise - combined 4Q17 to 2Q18 (a better representation of Best World’s underlying operating performance in our opinion) revenues from China exhibited a 22.8% y-o-y decline. Profit before tax numbers displayed a similar trend, -22.1% to S$38.1m over a 9M period.

While Best World’s adoption of a Franchise (vs Direct Selling) model for China may make sense from a tax/earnings perspective, it does not address fundamental concerns over the recognition of upfront sales – as was the case with its Export model:
We believe that this needs to be addressed over time – failing which could weigh heavily on investor sentiment.

While the company remains confident of growth in FY18F vs FY17, we choose to be more conservative on revenue growth given the weaker demand trends exhibited in 1H18. After imputing lower revenue growth for China and Taiwan, our FY18F/19F earnings are cut by 11% p.a.. Against a valuation multiple of 15x FY18F PE implies a lower Target Price of S$1.15. Maintain Fully Valued.
Given challenges in reconciling between upfront sales figures and underlying consumer demand in China, which have yet to be addressed under the new Franchise model, we will suspend coverage for now.

Carmen TAY DBS Group Research Research | https://www.dbsvickers.com/ 2018-08-08

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