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Blackmores Endures Setback, Long-Term Health Intact

Australia | Nov 02 2016

This story features BLACKMORES LIMITED. For more info SHARE ANALYSIS: BKL

Health product manufacturer Blackmores had a very weak September quarter and does not expect to match its FY16 performance in FY17.

-Affected by de-stocking at retailers and exporters changing acquisition channels
-Leveraged to long-term demand for Australian health products in China
-Potential challenges remain in selling via cross border e-commerce


By Eva Brocklehurst

Health product manufacturer Blackmores ((BKL)) sustained a weak September quarter, with sales down 8.1% and net profit down 46.6%. The latter was the element that disappointed many brokers as it signalled significant operational de-leveraging. Sales momentum is becoming more positive and a better second quarter is expected but the company does not expect to match the FY16 performance, suggesting profit will be lower in FY17.

The Australian business endured a tough quarter, Morgans acknowledges, because of the slowing in the wholesale market, impacted by de-stocking at retailers and some exporters changing the channels through which they acquire products. The notable crunch to EBITDA (earnings before interest, tax, depreciation and amortisation) and net profit is a result of the company's high fixed cost base, the broker observes. The EBITDA margin fell sharply, to 13.3% versus 21.5%.

Importantly, management said that de-stocking is now easing and its major customers are placing orders while the company is taking costs out of the business. Morgans downgrades FY17 and FY18 net profit by 29% and 20% respectively.

Over the medium term, the broker considers the stock well positioned given its strong brand, market leadership and rapidly expanding international operations, as well as leverage to the increased awareness of health, an aging population and the rise of the wealthy Chinese middle class. Recent corporate activity in the sector by the Chinese demonstrates the strong future demand potential in this market, in the broker's view.

CLSA is in no doubt the regulatory headwinds in China will continue and reduces its earnings per share estimates significantly. The broker, not one of the eight monitored daily on the FNArena database has a Sell rating and $85 target for the stock. CLSA asserts a change in exporter procurement strategies through late FY16 contributed to a significant build up in domestic inventory and now de-stocking has caused a sharp contraction in first quarter profit which will weigh heavily on FY17 sales.

The broker expects Blackmores to still face material challenges in selling products via cross-border e-commerce after China's period of grace ends in May 2017. Blackmores has no products registered and, while management noted strong growth in direct sales in China, CLSA envisages material risks to this channel should the company fail to gain product registration. Exporters that take on inventory risk are also likely to be more cautious.

Opaque distribution channels and mixed feedback from channel checks on system inventory mean Ord Minnett is inclined to edge its recommendation down to Accumulate from Buy, cutting the target to $120 from $150.

The broker prefers to await a sustained sales recovery in the industry before becoming more positive but still envisages Blackmores as a very well-run business for the longer term, leveraged to an attractive and growing category. The longer-term thematic of Chinese consumer demand for Australian products remains intact, as long as the exchange rate does not appreciate significantly.

Goldman Sachs was surprised by the extent of the deterioration in the quarter and negative operating leverage and also draws attention to the opacity of the selling channels, which means that quantifying the amount of excess inventory is challenging. From its channel checks with re-sellers as well as industry data, the broker concludes that inventory levels are improving, but still remain too high.

Goldman envisages limited opportunity for a sustained turnaround in revenue at this juncture as there is regulatory uncertainty related to obtaining product registration for the free trade zone, ongoing price discounting and a muted consumer response to recently launched products. Goldman Sachs, not one of the eight monitored daily on the database, believes it too early to become more constructive and retains a Neutral rating and $95 target.

Credit Suisse is another broker that considers the long-term growth prospects are undiminished. Blackmores has also had some success in setting up its own, nascent export division and selling direct to China. This is now a $17m business representing about 10% of group sales. Investors have been nervous over price discounting but recently the broker has observed fewer promotions and price discounting in both Australian retailers and also Chinese e-commerce platforms.

Credit Suisse's long-term investment view remains underpinned by a $200m revenue opportunity in Chinese retail stores. This is a US$9-10bn channel in the Chinese vitamins/supplements category and Blackmores has a fairly negligible presence because of onerous registration requirements.

China's new 'orange hat' registration process should allow the company to register a far larger range of Chinese-compliant products through this channel. The opportunity accounts for around $25/share in Credit Suisse's valuation.

Blackmores has indicated it is still waiting for further clarification from the Chinese administration on the new 'orange hat' registration process. The broker observes, while the draft legislation is quite detailed and yet to be finalised, Blackmores is continuing to take active steps to build its Chinese presence. More recently it has been adding to its sales/marketing force and opening new sales offices.

There are two Buy ratings and one Hold on the database. The consensus target is $118.33, suggesting 4.7% upside to the last share price. Targets range from $110 (Morgans) to $125 (Credit Suisse).

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