Period  2Q14/ 1H14

Actual vs. Expectations Zhulian’s 1H14 net profit (NP) of RM25.4m (-62% YoY) came in below our forecast and consensus at 30.0% and 20.1% of the full-year estimates, respectively.

 While revenue was broadly in-line as we had previously anticipated that its business will only start picking up pace in 2H14, the main culprits for this quarter’s earnings miss were lower-than-expected operating margins and higher-than-expected effective tax rate.

Dividends  As expected, a first interim single-tier dividend of 3.0 sen was declared.

Key Result Highlights QoQ, 2Q14 revenue was down by 0.8% due to weaker sales in the local market, offset by the improved demand from the Thailand market. This is in-line with other consumer stocks, which is facing cautious consumer spending in the current quarter amid a high inflationary cost environment. Notably, EBIT margin has dropped by 14.0ppt to 4.9%, mainly due to higher expenses incurred in marketing plans and higher startup costs in Myanmar operations. We believe that the company incurred higher marketing expenses locally in the current quarter, due to their aggressive marketing campaigns and seminars in order to regain confidence from their consumers. As a result, 2Q14 NP plunged by 51.8% QoQ.

 YoY, 1H14 NP plummeted 62.4% to RM25.4m, mainly due to: (i) a sharp fall in revenue (-38.7% YoY) due to weaker sales in both local and export market demands, (ii) higher operating expenses (EBIT margin -6.7ppt) due to the reasons mentioned above, (ii) lower associate contribution (-60.2% YoY) as a result of weaker sales from Thailand, and (iv) a higher effective tax rate of 20.7% vs. 12.9% in 1H13.

Outlook  Looking ahead, we expect the Thailand market to improve gradually especially if the economy starts to recover after the Thailand election on 20 July 2014. However, there is a risk that the domestic market demand may be falling sharper than previously anticipated. Management indicated that the local market is facing stiff competition in a rather saturated market.

 Margins are lower than expected in FY14 due to higher marketing expenses and start-up costs in Myanmar. However, we think that this is inevitable to recoup sales over the long run.

 The company’s fundamental remains intact with a strong balance sheet of RM98.2m net cash.

Change to Forecasts We have trimmed our FY14 NP forecast by 9.3% to RM76.8m after factoring in higher marketing expenses and higher effective tax rate for FY14.

 Meanwhile, we decided to keep our FY15 NP profit forecast at RM96.9m (+26.0% YoY) as we believe that a lot of the earnings risks and cost expenditures are one-off.    

Rating Maintain MARKET PERFORM

We opined that Zhulian’s share price has bottomed as a lot of negatives have been priced in. FY14-15E net dividend yield of 3.5%-4.4% should limit further downside risks of the stock. While Thailand’s general elections are around the corner, Zhulian’s re-rating will come when the political climate in Thailand settles down post election and when there is clarity on Thailand’s rural area policies, which includes rice subsidies. If all goes well in the next few months, we may look to review our recommendation.

Valuation  We are maintaining our Target Price at RM3.08 based on an unchanged targeted FY15 PER of 14.6x over its EPS of 21.1 sen. This implies +0.5SD over its 3-year mean average, which is in-line with all the other MLM peers.

Risks to Our Call  A prolonged political crisis in Thailand

 A slowdown of consumer spending in domestic market.

 Higher-than-expected operating expenses.

Source: Kenanga