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Morningstar | Blackmores’ Soft March Quarter Was Expected, AUD 105 per Share FVE Retained

Blackmores third-quarter profit of AUD 10 million was down 43% on the previous corresponding period. Revenue fell 4% but the real hit was from higher marketing and promotional spend, which crunched profit margins. While earnings fell precipitously, it was mostly expected. At the interim result in February, management flagged China headwinds and guided towards weaker second-half earnings. It’s likely we’ve seen the nadir and expect improvement in the fourth quarter. Nonetheless, we trim our fiscal 2019 net profit after tax forecast 3% to AUD 59.5 million. Longer-term forecasts remain largely unchanged and we remain comfortable with our AUD 105 per share fair value estimate. At the current price, we consider the stock marginally undervalued.

Management has embarked on an efficiency drive, targeting AUD 60 million in benefits. Of this, AUD 20 million is targeted to go to pretax profit, with the balance reinvested to grow the brand and improve staff capabilities. The latter seems sensible given this is a small company growing sales quickly, and facing shrewd competition. We understand most of the cost savings will come from redundancies and simplifying the business. Acquisition of the Catalent pill-making facility should also help margins, as greater vertical integration should unlock some synergies from greater control of the supply chain. However, competitive pressure will continue, potentially eroding some of the profit margin gains. Higher raw material costs are also a threat to margins in the near term, but as this is an industrywide problem, we expect higher costs to be passed through to customers.

Revenue in the Australia and New Zealand business fell 26% with headwinds in indirect sales to China. Management estimates underlying domestic ANZ sales grew at low-single-digit rates. Inventory levels at China-focused sellers had built up, requiring increased marketing and promotional activity to clear. We understand this has mostly played out, though there will be some residual impact in the fourth quarter. Revenue growth was also hurt by the nonrepeat of a costly promotion at a major customer last year. We think it’s sensible to limit heavy discounting to drive volumes through discount chemists, as this cannibalises more profitable channels and erodes brand strength.

Direct Chinese sales improved 19%, partly offsetting weaker indirect sales. Management estimates total sales to Chinese customers fell 6%. Blackmores has had a few issues in China recently, including softer demand, strong competition from Swisse and others, and cross border regulatory changes. But the opportunity remains attractive and we’re confident management can improve performance. Current plans involve re-engaging interest of Daigous with a wider range of products and potentially partnering with local retailers and distributors. A new team has been put in place to focus on China sales.

Other Asia performed well with revenue increasing 32%, led by Indonesia, Taiwan, Malaysia, and Hong Kong. Indonesia, where the firm operates via a 50:50 joint venture with a local player, is now profitable. With a large population, Indonesia could be a handy addition to earnings in the longer term. Management also discussed India as a market it is keenly interested in building a presence in.