What’s new

• Neutral outlook. We met Hai-O’s management recently and came back feeling neutral about the Group’s future prospects. Management remains conservative about current year outlook and pinning hopes that earnings will be better for 2HFY20. The Group believes contribution from Multi Level Marketing (MLM) segment will be slightly better banking on introduction of few new products, mainly focusing on small-ticket items as well as implementation of cost optimisation strategy.

Comment

• Better 2QFY20. To recap, the Group’s revenue and earnings during FY19 were tepid, down 28.9% yoy and 36.6% yoy respectively due to lower contribution from MLM division coupled with higher marketing and branding costs. On its recent financial results (1QFY20), Hai-O reported a net profit of RM7.7m, declining 22.7% qoq and 29.6% yoy. Similarly, the Group recorded lower quarterly revenue of RM66.1m, -5.5% qoq and -17.5% yoy. The disappointing results were due to lower sales generated from MLM division coupled with reduction in A&P subsidy incomes. Moving forward, we envisage 2QFY20 result to perform better than 1QFY20 following end of major festive season (which is normally lead to slow-down in business activities pursuant to fasting month and Hari Raya festival) coupled with launch of new products.

• More new products under MLM to boost recurring income – MLM division has been experienced a challenging results during FY19 due to domestic and global uncertainties such as re-introduction of sales and services tax (SST), tepid consumer sentiment as a result of rising cost of living. Numbers of membership has been depleted to c.100k as of to date (as compared to FY19: c.150k). Still, the Group is able to maintain its active membership of about 30%-40%. Despite expecting a marginal drop in recruitment of new members, the Group will continue to reward its current members with variety of rewards and incentives such as trip to overseas, cash rebates, monthly bonus and others. Notably, this business segment is mainly driven by its Food & Beverages and Health supplements & Nutrition food (c.80%). The Group is sanguine on introducing more small ticket items to boost its recurring income and hence the overall earnings going forwards.

• Exports of bird nest product to strengthen Wholesale division – Currently, Wholesale division supplies to more than 100 wholesalers and 2,000 retailers such as Chinese medical halls, restaurants, supermarkets and pharmacies in Malaysia which include Chinese medicated tonic and other health and wellness products. The Group’s current strategy is to focus on non-alcoholic products such as food and beverage products (i.e. Medetop coconut oil, herbal beverages, canned food and ready-to-drink bird’s nest) instead of alcoholic products (i.e. cooking wine, health tonic, tea and wine). In the previous financial results, the Group successfully obtained approval from the Chinese government to export bird nest products there. The bird nest products are produced locally. Management believes the expansion plans in China will help to bolster the Group’s business expansion.
   
• Extensive sales campaign ahead for Retail division – Retail division, which mainly focuses on Traditional Chinese Medical (TCM) and Chinese physician consultation services, will continue to launch extensive sale promotions in order to expand their house brands products. Currently, the retail division has 57 outlets, including 7 franchises. Going forward, the Group expects to add one or two additional outlets in East Coast Malaysia, with the hope to have large presence in all of the states in Malaysia. Currently, the Group has two international standards manufacturing facilities which assemble for manufacturing of Halal and non-Halal products.
   
• Minimal overseas contributions. Most of the revenue of the Group thus far are derived from local. The Group also has business ventures in other countries such as Indonesia and Brunei. However, the Group expects minor contributions from overseas MLM markets as the market shares are relatively small due to less established network and team leaders.

Earnings Outlook/Revision

• We lift our earnings forecasts for FY20F and FY21F by 4.8% and 3.6% to RM43.7m and RM49.1m respectively, to account for higher sales assumptions for all segments.

• Risks include: 1) Higher-than-expected operating expenses (i.e. higher marketing and branding expenses), 2) Lower than-expected domestic spending due to higher cost of living and 3) Depreciation of MYR against USD.

Valuation & Recommendation

• Upgraded to HOLD from SELL with a higher target price of RM2.30 (previous target price of RM2.20) following our earnings upgraded. We believe market has discounted the prevailing earnings hiccup and share price is well supported by decent dividend yield of slightly over 4%. Our revised target price is based on P/E multiple of 15.8x FY20F EPS which is at its 3-year historical mean P/E.

Source: JF Apex Securities Research - 12 Nov 2019