Some Weaknesses Appearing

Hai-O reported a 1Q19 net profit of RM11m (-38% yoy, -32% qoq), which came in below our and consensus expectations. The MLM segment recorded a significant decline in revenue which was attributable to the slower business activities among the distributors after the general election. This was also exacerbated by weaknesses in the Wholesale and Retail segment. As we turn more cautious on the outlook for the MLM segment, we cut our earnings estimates and downgrade Hai-O to a HOLD with a revised TP of RM4.00.

1Q19 Earnings Miss Estimates

Hai-O’s 1Q19 net profit declined by 38% yoy and 32% qoq, which was mainly dragged by the MLM division, of which posted a 45% yoy decline in operating profit. The MLM division was affected by a slowdown in distributors’ activities during the fasting month and Hari Raya festivities, coupled with lower member recruitment rate after the general election (GE). In addition, MLM margins also saw erosion following the 6% rebate given during the month prior to the zero-rating of the GST coupled with higher marketing costs incurred for new fashion products launched. The quarter further was exacerbated by weaknesses in both the Wholesale and Retail segment due to higher costs yoy in the Wholesale segment and contracting margins in the Retail segment. There was also some minor impact from the MFRS 9 and MFRS 15 adoption which was relatively minimal at c.2% at the PAT level.

Cautious Outlook on the MLM Division Due to Possible Attrition

We foresee some downside risks to the expansion in the MLM distributor base. Management has indicated that new member interest has slowed down recently, as compared to the high double digit growth shown in the past few years. We gather that to date, the number of active members stand at 140,000, which is slightly lower compared to end-FY18 (150,000). Furthermore, we believe that there could be margin pressures moving forward in line with increasing marketing costs incurred for Hai-O’s foray into the fashion segment under the newly introduced “Infinence” brand.

Downgrade to HOLD With Revised TP of RM4.00

In view of the significant earnings miss and cloudy outlook in the MLM segment, we cut our distributor growth assumptions to a 3-year CAGR of 4% from FY19-21E (from 9% previously), resulting in a downward revision of 26- 27% in FY19-21E earnings forecasts. We downgrade Hai-O to a HOLD with a revised TP of RM4.00 (from RM5.39), based on an unchanged PER target of 17x on CY19E EPS. Downside/upside risks to our call: i) loss/expansion in MLM distributor base; ii) weakness in the wholesale and retail divisions; iii) weaker/better-than-expected take-up rate of the new products.

Source: Affin Hwang Research - 27 Sept 2018