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Morningstar | Blackmores Offsets Domestic Slowdown With Asian Growth Spurt

Narrow-moat Blackmores exceeded our expectations for the full year with net profit after tax of AUD 69.2 million on group sales of AUD 746.7 million, up 19.3% and 7.8% year on year, respectively, compared with our forecasts of AUD 65.9 million and AUD 742.2 million. Growth continues to be driven by China and the broader Asian region, as well as its premium Bioceutical product range in the domestic Australian market. EBITDA margin of 14.8%, representing an expansion of around 115 basis points, was a highlight, reflecting improved cost of goods and implementation of a global pricing strategy.

We increase our fair value estimate by 9% to AUD 135 per share from AUD 124, given time value of money considerations and a revised cost of revenue margin outlook, which we now see as trending to 48.6% by 2022 from 50% previously, given the results achieved to date in this result and the forecast impact of backward integration with the acquisition of contract manufacturer Catalent on the cost of goods line. Nonetheless, at current levels, we consider shares in Blackmores to be slightly overvalued.

We remain positive on the Asian opportunity and expect the domestic sales mix to continue moving offshore over the next five years. As a result, we see Australia’s contribution trending towards 53% of group revenue by 2023 from 65% currently. Sales growth of 22% and 20% in China and the other Asia segment, respectively, exceeded our expectations, with operating margins for both regions expanding incrementally, reflecting strength of brand in these markets, the key source of our narrow moat rating for Blackmores. China sales were driven by Blackmores' direct export to the Chinese business, combined with growth of in-China sales and buoyed by online promotional events. As such, with joint-venture plans with Alibaba now signed, and the establishment of the research and education partnerships with Blackmores Institute (such as Tsinghua University) under way, we expect Blackmores' profile among consumers and key opinion leaders to be elevated. Our China sales forecast outlook is unchanged at 18% per year over the next five years. Similarly, we think solid growth in developed markets such as Singapore and Korea, in addition to joint-venture partnering in emerging markets such as Indonesia, albeit off a small base, bodes well for sustained momentum. We remain comfortable with a five-year revenue CAGR of 10% in other Asia.

The Bioceuticals division, representing 16% of group revenue in fiscal 2018, was the highlight domestically, growing 13% year on year. We remain positive on prospects for this division, given the degree of product differentiation and breadth of the product range. Further, we see growing engagement through educational forums as building loyalty among naturopaths and allied healthcare professionals and increasing brand value and pricing power. We have a five-year CAGR forecast of 10%.

Australia and New Zealand revenue, representing 65% of group revenue, declined by 2% compared with the previous corresponding period. This was in line with our expectations and reflects the waning impact of the daigou shopper phenomenon on domestic sales of the Blackmores-branded product in Australia. We estimate that daigou sales accounted for around 16% of total domestic sales of Blackmores-branded products and forecast daigou sales to continue declining, given the growth of Blackmores' in-China sales and the negative impact of tax regime changes introduced back in 2016 in China on goods brought into the country by individuals. In the medium term, we think the drag to divisional sales created by the diminishing daigou sales in the domestic market will result in a five-year CAGR of around 2% for the Australian division overall. In the longer term, however, as the daigou effect becomes less material, we see growth of the underlying Australian business normalizing, with Blackmores-branded product sales trending back to historical growth rates of around 3%. From a margin perspective, we think the Catalent manufacturing capability should be positive and support EBIT margins of around 21% achieved in first-half 2018, with efficiencies gained in transitioning to the new distribution centre at Bungarribee in Western Sydney.

Blackmores’ financial position remains solid, with net debt/EBITDA a healthy 0.45 times as at end June 2018, and net interest cover, as defined by EBIT/net interest expense, of 25.9 times. Net cash flows from operations remain robust with AUD 58 million for the full year, up 27% on the prior corresponding period. The company is carrying long-term debt of AUD 86 million versus loan facilities totalling AUD 220 million. As such, we remain comfortable with the AUD 9 million purchase of the Impromy brand announced on Aug. 28 and the AUD 43 million fully debt-funded acquisition of the Australian Catalent manufacturing facility, expected to close in October 2019. We see net debt/EBITDA remaining low at around 0.25 times in fiscal 2020. The company declared a full-year dividend of AUD 3.05 per share, fully franked, equating to a payout ratio of 75%, which we think is sustainable over the long term.