Stock Name: HAIO
Company Name: HAI-O ENTERPRISE BHD
Research House: RHB

Hai-O Enterprise Bhd
(July 29, RM3.66)
Downgrade to underperform (from market perform) at RM3.70 with reduced fair value of RM3.63 (from RM4.06): We believe that due to the revised Direct Selling Act (DSA), Hai-O's membership drive will be affected, as well as its retention of existing members.

We have adjusted our forecast to include a net membership contraction of 1,200 per month, which consequently reduces our FY2011 ending April 30, 2011, to FY2013 core distribution force (CDF) assumption by 5.1% to 10%.

One of the reasons for contraction is that the revised DSA has tightened the regulations in the MLM industry to stop MLM members from front-loading stocks, as this could subsequently lead to its members not being able to sell the excess shares.

It also deters MLM leaders or members who were previously front-loading to continue their recruitment activities as they are now unable to make quick profits as they did previously.

While the more stringent ruling will lead to a temporary slowdown in recruitment, we believe that it could also lead to negative growth of MLM members, given that some of the members who were previously making quick profits may drop out of the company.

We are thus cutting our revenue per member growth assumption to negative 10% (from negative 5% previously), for FY2011 because we believe that member productivity will decline as they are no longer able to front-load their stocks. For FY2012 to FY2013, however, we are maintaining our revenue/member growth at 1% for each year.

Although the MLM division outlook is bleak, the negative impact is cushioned somewhat by the fact that all the other divisions are on track, especially its energy division, which has drawn interest from various parties with regard to its heat transference technology.

Private placement is still a no-go and the recently announced cancellation of its proposed private placement is positive news in our view.

The private placement would have diluted earnings-per-share (EPS) by 6.9% and reduced FY2011 projected dividends to 15.6 sen, from 17.1 sen currently.

The risks to the stock include termination of supply agreements from its suppliers in China, stronger-than-expected strengthening of the US dollar; and weaker-than-expected increase in consumer spending.

We are reducing our FY2011 to FY2013 earnings forecast by 8% to 11.8% after incorporating the contraction in membership numbers and a reduction in revenue/member as previously highlighted.

The temporary setback to the MLM business will affect earnings significantly in the near term. However, we believe that Hai-O will be able to pull through and come back stronger in the longer term, with members of higher quality and productivity.

Nonetheless, we are downgrading our call to underperform, as we have reduced fair value to RM3.63 from RM4.06, based on unchanged 10 times CY2011 EPS. ' RHB Research Institute, July 29


This article appeared in The Edge Financial Daily, July 30, 2010.