We came back feeling comforted and encouraged by the growing trend of MLM business amidst weak consumer sentiment after attending separate meetings with the two MLM companies under our coverage, namely AMWAY and HAIO. We gathered that several factors are driving and sustaining the interest in MLM, including the accommodative product strategy and new launches, rewarding incentive systems and the modernization of networking. However, we think that the heavy incentive programs might be relatively more rewarding to distributors than shareholders, at least in the near term. As such, our view on the MLM sector is neutral with a slightly positive bias. We maintain our cautious stance on AMWAY (UP; TP: RM8.04) in view of the negative earnings outlook and potential peak saturation in its large distributor base. HAIO (MP; TP:RM3.25) is our preferred pick of the sector as we like its healthy earnings growth outlook backed by strong growth in distributor base coupled with an attractive dividend yield of >5%.

More joining the fray. While AMWAY’s large distributor base was little changed at 239k in FY15 (-1.2% from 242k in FY14), HAIO has managed to grow its distributor base by 57% in FY16 to 83k from 53k in FY15. We gather that the rising interest in MLM was driven by factors including: (i) lower capital requirement with more focus on small-ticket items, (ii) the aid of digitalization and social media in networking, (iii) the uninspiring economy and job market that encourage take-up in undemanding part-time jobs to mitigate the impact of higher living expenses and lower income, and (iv) increasingly attractive incentive trips to motivate distributors. Meanwhile, the MLM companies with established names were able to attract new distributors thanks to their proven track record and rewarding incentive system.

Incentive might be addictive. Despite the rosy picture in terms of distributor growth, we are not overly excited on the prospect of MLM sector. We are concerned over the spike-up in expenses arising from the higher incentives or commission, on top of the luxury incentive trips that will inevitably put pressure on earnings margin. Besides, the strong initiative in giving rewards and incentives might provide overwhelming motivation to distributors, but on the flipside is also becoming a costly obligation for MLM companies to bear. Thus, it might be a double-edged sword as the distributor growth or productivity might fall if the attractive rewarding systems failed to be improved or sustained.

From company perspective, we are reiterating UNDERPERFORM rating on AMWAY post-briefing with unchanged TP of RM8.04, based on 19x PER FY17E. To recap, 1H16 net profit plunged 48.5% despite a healthy 12.7% growth in revenue mainly due to the heavy investment in incentive and marketing programs. Management is guiding for a challenging 2H16 in view of the weak consumer sentiments, higher product costs and the continuous commitment in incentivizing distributors. Thus, we are forecasting its net profit to record second consecutive decline in FY16 and dividend yield is expected to diminish in line with the weaker profit. In view of the earnings risk and saturation in large distributor base, we maintain our cautious stance on AMWAY.

As for HAIO, we keep our rating of MARKET PERFORM unchanged after upgrading our TP to RM3.25 (from RM2.85). New TP is based on 15.2x (from 13.3x) PER FY17E which represents 20% discount from AMWAY’s valuation and implied +1 SD over 5-year mean. We reckon that the valuation gap should narrow in view of the exciting growth in the Group’s MLM division, which recorded FY16 revenue and operating profit growth of 46.6% and 25.8%, respectively, after the huge uptick in distributor base as a result of a successful transformation in business strategy. We understand that the positive momentum has been sustained into FY17 with the Group allocating capex of RM10m (FY16: RM3.9m) to set up more branches to meet demand. Meanwhile, for the other operating division (wholesale and retail), the Group is anticipating a soft outlook in view of the negative economy headwinds. As such, we maintain our neutral view on the company but HAIO remains our preferred pick of the sector for its healthy earnings growth supported by MLM division and attractive dividend yield of >5% on the back of a generous pay-out ratio and relatively modest PER valuations as compared to AMWAY.

Source: Kenanga Research - 19 Aug 2016