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Healthier Growth Required From Blackmores

Australia | Apr 27 2018

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

Several issues, mostly one-off, plagued Blackmores in the March quarter and some brokers query whether the growth profile justifies the elevated valuation.

-Discounts and rebates affected margins in the March quarter
-Catalent acquisition should mitigate supply risk and expand margins
-Can the company refrain from discounting to drive sales?


By Eva Brocklehurst

March quarter net profit rose 18% but Blackmores ((BKL)) disappointed broker expectations and a strong fourth quarter is now required to meet forecasts. Several one-off issues affected the company's business in the period, although management has signalled that sales growth did accelerate towards the end of the quarter.

Blackmores highlights supply chain disruption and Chinese customer renegotiations as the one-off issues affecting business in China in the quarter, while discounts and increased rebates stymied the margins the company commanded.

Sales were solid in the Australian division, albeit essentially flat on the comparable quarter. The company said it had achieved gains in market share but trading was affected by supply challenges. Sales in China, up 7% quarter on quarter, were below the company's expectations because of the aforesaid disruptions. In other areas of Asia revenue rose strongly.

Blackmores has stepped up its marketing activity, particularly in China. Demand for the company's products and brand position remains very strong and Ord Minnett considers this justifies an Accumulate rating, along with a clear path to margin expansion.

Earnings and sales margin should improve, management asserts, as rebates diminish as a percentage of sales. Yet, for Credit Suisse to become more positive about the stock, growth in China needs to accelerate behind a broad-based marketing strategy.

Results at the earnings level were weaker than Morgans expected, and this is seasonally the stronger trading period for the company. The broker reduces net profit estimates over FY18 and FY19 by -3.9% and -7.7% respectively.

Since the first half result the share price has been weak and Morgans believes the growth profile does not justify the elevated valuation multiples that the stock was trading on at the start of the year. Quarterly results were also underwhelming compared with growth rates reported by the company's China-leveraged peers, in the broker's view.

CLSA downgrades the stock to Outperform from Buy and its target to $137.50 from $169.00. The broker had expected margins would expand from lower rebates and strong sales in China during the quarter but this did not eventuate.

Catalent Australia

The company has announced the acquisition of Catalent Australia for $43.2m, a tablet and soft-gel capsule manufacturing facility in Victoria. This should mitigate supply risk and lead to expanding margins as the company integrates the business. The transaction will be completed by October 2019 as third-party contracts are wound down.

The factory will internalise up to 50% of Blackmores' manufacturing volume. The site is currently producing 15% of its volume and should add around $7m in operating earnings in FY21 when it ramps up to 50%.

Hence, Credit Suisse upgrades FY20 estimates, the fiscal year when the accretive transaction will take effect, and suggests the acquisition is a good tactical move as a company will benefit from flexibility, innovation and shorter lead times.

Blackmores intends to reconfigure the site to suit its needs, stating that the size of its business now justifies an investment in the supply chain, and will look to reinvest some of its efficiency gains back into building its brand.

Morgans suggests the acquisition should provide greater control over production and the broader supply chain, aiding the company's position in Asia and the registration of its products.

Ord Minnett envisages strategic benefits from the acquisition, including licenses and production flexibility. The broker considers the operating risk profile the business has also improved.

While CLSA acknowledges the potential for margins to expand through FY20, and Catalent should help, concerns centre on whether the company can produce more effective marketing and formulate the right strategy in China to take advantage of the long-term opportunity.

Moreover, the broker queries whether the company can refrain from discounting in order to drive sales. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, decreases FY19-20 estimates for operating earnings by -11.4-16.6%.

The database shows one Buy (Ord Minnett) and two Hold ratings for Blackmores. The consensus target is $130, suggesting 6.7% upside to the last share price. Targets range from $115 (Morgans) to $145 (Ord Minnett).

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