Despite introducing new marketing strategies for its MLM business to sustain sales, we expect additional cost pressure coming from the new SST, especially on imported products, as HAIO has to fully absorb the cost with further pressure from minimal distributors’ growth. Thus, we cut both our FY19E and FY20E NP by 15%. As such, we lower our TP to RM2.20 from RM2.60. Downgrade to UP from MP.

2H19 to be sustained by the New Marketing Strategies. With the limited growth in physical distributors’ recruitment strategy, HAIO continued promoting its new Bizumer Digital App, which now accounted for 50% of total MLM sales, and to recruit new distributors. Additionally, HAIO plans to penetrate into the kids and infants market with a new brand (undisclosed) and expanding its Indonesian market (currently, <10k distributors) by organizing the Jakarta Business Summit. Furthermore, HAIO will be launching several new products in 2H19, including the line extension for its popular brands of Infinence (Women fashion) and Conzuma (Beauty Products) as well as upgrading its shake & shape products for the slimming & nutritional markets. On the other hand, HAIO has completed an incentive trip campaign (for the Sept 2018-Dec 2018 period) to Kunming, China with targeted 700 qualifiers at estimated cost of RM3-4m, and has initiated another campaign (Jan 2019-Mar 2019 period) featuring Bonanza Spring Draw (total prizes up to RM170k). We believe these marketing strategies will be able to sustain HAIO sales for the current financial year, albeit with limited growth in the number of distributors (currently at 140k, plunging from highest in FY18 at 160k distributors).

Other segments vulnerable to currency risk. Both wholesale and retail segments (c.20% of revenue) are vulnerable to currency risk (weakening MYR against RMB) which in turn is limiting its earnings growth. Nevertheless, HAIO’s focus on high margin in-house brands (c.40% for retail sales) has been able to sustain the profitability, and the group expects to maintain the momentum with the support of 140,000 card members in its retail segment. Additionally, HAIO has added one more exclusive dealership under its retail segment for Traditional Chinese Medicines (TCMs) line-ups to sustain the sales momentum.

Outlook. We expect to see additional cost pressure coming from the new SST implementation as well as from weakening MYR against RMB and further pressure from minimal distributors’ growth. Note that, HAIO absorbed the SST of 6%, while maintaining its sales price, pending further talks with suppliers. HAIO expects its Indonesian MLM market to break even this year, but is withholding its Vietnam expansion due to weak market condition. The group wholesale division will continue promoting premium Chinese medicated tonics and non-alcoholic products while expanding its neighbourhood medical halls network in particular. The half yearly members’ sales campaign will be carried out for the Retail division during the CNY festive season.

Cut both FY19-20E NPs by 15% each. We cut both our FY19E and FY20E net profits by 15% each on expectations of minimal distributors’ growth, and factoring higher cost pressure from imported products. Note that, HAIO absorbed the SST of 6%, while maintaining selling prices.

As such, we cut our target price to RM2.20, from RM2.60, based on an unchanged 12x FY19E EPS at its 5-year forward historical mean. Downgrade to UNDERPERFORM from MARKET PERFORM. Risks to our call include: (i) higher-than-expected sales, and (ii) lowerthan-expected cost of sales.

Source: Kenanga Research - 14 Jan 2019