Hai-O Enterprise Bhd
(March 26, RM2.58)
Maintain underperform with a reduced target price of RM2.10: Nine months for financial year 2019 (9MFY19) core net profit (CNP) of RM37.4 million (-36%) came in below our and consensus expectations at 68% and 62% of full-year estimates, dragged down by lower-than-expected multi-level marking (MLM) sales.

 
No dividend was declared for the quarter as expected. HAI-O Enterpise Bhd (Hai-O)typically pays its dividends in the second quarter (2Q) and 4Q. Year on year (y-o-y) 9M19 CNP plunged 36% dragged by: (i) lower overall revenue (- 26%) from lower MLM division (-35%), netted off by stronger Chinese New Year (CNY) sales from retail division (+11%), (ii) contraction in earnings before interest and taxes (Ebit) margin by 2.4 percentage points (ppt) to 18.9% from 21.3% in 9MFY18 from unfavourable merchandise mix skewed towards small ticket items as well as heavy discounting activities to attract distributors, and (iii) higher effective tax rate of 24.8% (9M18: 23.1%). It was unable to match last year’s grand sales due to weaker MLM sales attributed to cautious distributors’ spending, and tepid purchasing power that led to stagnant distributors’ growth.

The 3QFY19 CNP decreased by 6% mainly due to lower revenue (-7%) from weaker MLM sales (-11%) and the wholesale segment (-5%), but netted off by stronger CNY sales from retail division (+16%) which typically falls in 4Q. Furthermore, Ebit margin contracted by 0.2 ppt to 19.3% from 19.5% in 2QFY19 with merchandise mix skewed towards small-ticket items, while the effective tax rate was slightly higher at 24.4% (versus 24.1% in 2Q19).

We expect to see additional cost pressure coming from the new sales and service tax (SST) implementation as well as from the weakening ringgit against renminbi and further pressure from minimal distributors’ growth (currently at 140 thousand , plunging from the highest level in FY18 at 160 thousand distributors).

 Note that, Hai-O absorbed the SST of 6%, while maintaining its sales price, pending further talks with suppliers. Hai-O expects its Indonesian MLM market to break even this year, but is withholding its Vietnam expansion plans due to the weak market condition. The group’s wholesale division will continue promoting premium Chinese medicated tonics and non-alcoholic products while expanding its neighbourhood medical halls network in particular. The half-yearly members’ sales campaign had been carried out for the retail division during the CNY festive season.

We cut both our 2019 financial year earnings (FY19E) and 2020 financial year earnings (FY20E) CNP by 9% each on the expectation of lower MLM average sales.

As such, we also cut our target price to RM2.10, from RM2.20, based on revised 12x FY20E earnings per share (EPS) (roll over from 12 times FY19E (EPS)) at its -0.5 standard deviation (SD) of 5-year forward historical mean.

Reiterate “underperform”

Risks to our call include: (i) higher-than-expected sales, and (ii) lower-than-expected cost of sales — Kenanga Research, March 26