Hai-O Enterprise Bhd
(March 26, RM4.81)
Maintain outperform with an unchanged target price (TP) of RM6: Nine months of financial year 2018 (9MFY18) net profit of RM58.6 million (+42% year-on-year [y-o-y]) came in within both of our and consensus expectations at 70% of full-year forecasts. The group declared an interim dividend per share of nine sen for 9MFY18 (9MFY17: five sen), which is within our expectations as normally around 70% of dividends are paid out in the fourth quarter (4Q).

 
We expect 4QFY18 to register higher sales with the start of the 26th-year grand sales overseas trip promotion to Switzerland and Paris (January to May 2018) as well as the maiden contribution from the highly anticipated shoes and leather goods designed in consultation with Datuk Jimmy Choo.

Y-o-y, 9MFY18 net profit surged 42% underpinned by: i) higher revenue (+23%) driven by the multilevel marketing (MLM) division (+28%) and wholesale division (+17%) attributable to higher sales volume from newly launched big-ticket items in its MLM fashion and beauty care range of products as well as higher wholesale sales from its health tonic and Chinese tea; ii) earnings before interest and tax (Ebit) jumping 38% with expanded Ebit margin by 2.3 percentage points to 21.3% from 19% in 9MFY17, boosted by the MLM division (+24%), which contributed 70% of the 9MFY18 group Ebit, and supported by its wholesale division (+168%) through sales of high-margin products (namely premium Chinese medicated tonic); and iii) a lower effective tax rate of 23.1% (9MFY17: 24.9%).

Quarter-on-quarter, 3QFY18 net profit declined by 10% mainly due to the lower revenue (-17%) from the earlier termination of the 25th-year grand sales overseas trip promotion, which ended in 2QFY18, as well as a higher effective tax rate of 23.2% (2QFY18: 22.3%).

We expect MLM earnings to gain further momentum with shoes and leather goods designed in consultation with Choo, which are set to boost high-margin products composition as well as being supported by Hai-O Enterprise Bhd’s 26th-year anniversary grand sales promotion in 2018 and higher contribution from the newly launched fashion and beauty care range of products under the “Infinence” brand. Moving forward, the MLM division will continue to expand its lifestyle segment of which margins are better compared with food and beverages products. On the other hand, wholesale and retail segments are expected to maintain their high Ebit margin with the sales of high-margin in-house brands (namely premium Chinese medicated tonic).

Maintain “outperform” with an unchanged TP of RM6 based on 17 times FY19 estimates earnings per share implying +1SD of its five-year forward historical mean. We believe our target price-earnings ratio of 17 times is justifiable considering Hai-O’s average 32% net profit growth per annum over the next two years.

We like Hai-O for its double-digit growth in distributor base (currently at around 160,000), net profit growth averaging 31% per annum over the next two years boosted by a double-digit margin, and strong earnings support from high-margin products under its MLM and leading Chinese medicine retail shops (under other business). Risks to our call include lower-than-expected sales, and higher-than-expected operating expenses. — Kenanga Research, March 26