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McPherson’s Eyes Off China

Small Caps | Sep 28 2016

This story features MCPHERSON'S LIMITED, and other companies. For more info SHARE ANALYSIS: MCP

McPherson's has redoubled its focus on health & beauty brands and has China in its sights. Moelis initiates coverage of the stock.

-Health & beauty brands identified for campaign to Australian and Chinese consumers
-Moelis speculates household consumables may be divested
-Success in China could lead to stock re-rating


By Eva Brocklehurst

McPherson's Ltd ((MCP)) has undergone a significant transformation over recent years and Moelis observes the company's strategy is now about its key divisions in health & beauty and household appliances.

The broker likes the yield and growth story and initiates coverage with a Buy rating and $1.35 target, on an estimated 31% total return. FY17 is considered to be the first full year post the transformation and there is a renewed focus on lowering the company's exposure to the grocery channel.

Moelis bases its view on EBITDA margins (earnings before interest tax depreciation and amortisation) expanding to 10% in FY17, because of gross profit margin expansion in the health & beauty division and the effect of measures taken to offset the negative impact of a fall in the Australian dollar.

Moreover, a new CEO could mean divestments are on the agenda, as there is a clear strategy to grow the company's own health & beauty brands. McPherson's has identified seven A'kin units and five Dr LeWinn's “hero” units which appeal to both the Australian and Chinese consumer and launched a WeChat campaign to introduce the products.

Moelis does not factor in sales from new international markets but notes the new CEO, Laurie McAllister, was managing director of Sanofi Australia & New Zealand and has extensive experience in the consumer health care segment.

The broker suspects the company may divest its household consumables division which would lead to improved quality in earnings. With a focus on health & beauty and overseas expansion, particularly China, the broker considers BWX ((BWX)), which has the Sukin brand, and NZX-listed Trilogy International are the most comparable companies.

The broker believes McPherson's should trade on a discount to these companies given its home appliances and consumables divisions and the early stage of its expansion overseas. If the natural skin care market continues to grow and the brands gain traction overseas the stock could re-rate to more of a market multiple, in the broker's view.

A fully franked 9c per share dividend is forecast for FY17, which represent a 65% pay-out ratio and 63% of estimated free cash flow. The broker estimates health & beauty revenue will decline in FY17 by 23% because of around $25m in from Swisspers, Moosehead and Maseur brands being moved to the household consumables division. The latter division should therefore benefit from this to the same degree.

Health & beauty will also be negatively impacted by McPherson's not retaining the distribution contract for Dolce & Gabbana fragrances post October 31 2016 because of the Procer & Gamble/Coty merger. In home appliances, the broker estimate revenue will decline by 5.5% because of the impact of the closure of Masters, which is estimated to provide around 10% of revenue. McPherson's currently has a tender with The Good Guys for a range of built-in ovens, increasing the division's range of products and number of retailers.

McPherson's has closed its impulse merchandising business following the decisions by a major Australian grocery retailer to cease its impulse merchandising program. This has led to one-off costs but will release $2m in working capital and should marginally improve overall earnings in FY17, Moelis believes.

Prior to 2012 McPherson's was largely involved in the grocery channel and in its printing business. The printing has been de-merged since than and the exposure to grocery decreased. The company divested the remaining 49% of its housewares division in March this year.

The proportion of purchases in US dollars has fallen to 65% from 85% in FY14 and management expects this to continue to decline. Management has also now taken the view that where customers do not accept price increases and margins are inadequate, it will exit the contracts. This has been the case with some private label and the impulse merchandising division.

In terms of China, Moelis notes Dr LeWinn's and A'kin are not as well known as Sukin or Trilogy and, therefore, the company's strategy is to partner with Daigou sellers, rather than going direct to the consumer. Daigou businesses are shopping agents that purchase items for residents in mainland China which are unavailable or hard to obtain otherwise.

By using Daigou, McPherson's does not need to adhere to the recent Chinese regulation that requires foreign manufactured products to be registered by May 2017. Nevertheless, if the company decides to sell direct to the Chinese consumer via a flagship store it will need to register its products and this may be the case if the uptake of its brands in China is successful. McPherson's has expansion plans for New Zealand and Singapore as well and has appointed distributors in South Korea and the UK.

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