SINGAPORE (Dec 3): Best World International, which sells a little-known brand of skincare through a multi-level marketing (MLM) scheme, saw its share price rocket from just $1.21 on Aug 21 to $2.27 on Nov 22. That’s because its business model is very attractive to investors owing to the low inventory, low capital expenditure, low debt and high growth.
The global direct selling market posted US$190 billion ($261.1 billion) in retail sales in 2017, recording a three-year compound annual growth rate (CAGR) of 8%. It is expected to maintain this growth mainly through the performance in emerging markets, particularly China.
MLM is a sub-set of direct selling. Direct selling involves person-to-person selling and mainly consists of two key business models — single-level marketing and MLM. They are differentiated through the revenue streams they provide to participants, that is, distributors and parties contracted by the companies to sell their products.
Single-level marketing strictly involves compensation paid out in the form of commission to participants, which is based on the amount of sales they are directly able to generate. MLM includes single-level marketing, as well as the ability of participants to recruit other participants to sell the products.
Direct selling is a cheaper alternative to other forms of marketing such as broadcast advertising because it significantly reduces marketing costs. Direct selling, especially MLM, provides customers with individual experiences, which can greatly increase awareness and sales of a particular product.
MLM is often misunderstood as being synonymous with pyramid schemes. Pyramid schemes usually do not have a proper underlying product and sustain themselves through the initial investments or “membership fees” from new recruits. Pyramid schemes are outlawed, but MLM schemes are legal in most parts of the world. It is illegal in China, but direct selling has been legal in the country since 2005. In Singapore, MLM schemes and activities are regulated by the Multi-Level Marketing and Pyramid Selling (Prohibition) Act.
Companies that deploy the direct selling strategy usually sell household consumer products and often have extremely high margins. Unlike other companies, they do not spend a large portion of capital on advertising and marketing and also cut out middlemen. Investors ought to focus on the quality and usefulness of the companies’ product, as that is what mostly drives the sustainability of the business.
Will Beauty Community recover from recent poor share price performance?
Beauty Community is a leading cosmetic and skincare products player in Thailand, and also has a presence in many Asian countries. The Stock Exchange of Thailand-listed company has two main operating segments, which also happen to be its distribution channels. The retail segment, focused on direct selling, makes up two-thirds of the company’s operating income while the non-retail segment, which consists of franchises, overseas distribution and e-commerce, contributes the rest. Beauty Community has three main brands, which largely target the high school and junior working-age population.
For 3QFY2018, the company registered a 28.3% q-o-q growth in net profit and a 28.9% q-o-q growth in revenue. It also expanded the number of its stores in Thailand by almost 4% from the previous year. Beauty Community currently has a net profit margin of over 30% mainly due to its cost-efficient business model. The company also has no interest-bearing debt, and has paid consistent and increasing dividends since its listing in December 2012.
Beauty Community’s competitive edge stems from its relatively cheap premium skincare and cosmetic products. They are easily accessible as the company has more than 300 stores nationwide. The market for cosmetics in Thailand is expected to grow at a CAGR of around 9.1% for the next three years, according to Statista, a global statistics portal. Given the rosy outlook, Beauty Community is poised to capture greater growth as it has a relatively strong market share compared with competitors such as local player Oriental Princess and international names such as The Body Shop and Yves Rocher.
However, Beauty Community’s share price plunged more than 50% between April and November following a scandal in the Thai cosmetics industry that led to tighter overall FDA controls and the curbing of the sale of illegal cosmetics in the country. Although Beauty Community was not involved, its share price was affected.
With consumers now shunning little-known names, the company has the opportunity to manufacture higher-quality cosmetics which, in turn, can boost its overseas expansion plans. With its most recent quarterly performance, Beauty Community is on track to reach its revenue target of THB4.3 billion ($179 billion) by end-FY2018.
Our discounted cash flow (DCF) valuation indicates a fair price of THB12.79 for the stock, while its fair price based on the margin of safety analysis indicates a price of THB3.31. Beauty Community is currently trading at THB9.75.
Best World’s best yet to come?
Best World sells premium skincare, personal care and nutritional products. In 1HFY2018, more than 75% of its revenue was derived from direct selling, which is done through its subsidiaries. During the period, the company posted a 163% q-o-q increase in revenue and 129% q-o-q increase in net profits, driven largely by growth in demand for its products in East Asia and China. Its performance in 1H was subpar as it was transitioning from an export model to a franchise model in China.
Best World has maintained a gross profit margin of over 70% in the past five years. Its current net profit margin of 24.7% is significantly higher than that of competitors such as Nu Skin Enterprises (-1.7%) and Avon Products (6.9%). Best World has cut its gearing ratio from 11% in 2014 to 3% in 1HFY2018. Furthermore, it has strengthened its net cash position by almost 2.5 times and cut its interest-bearing borrowings by half in the past four years. The company maintained a dividend payout ratio of around 40% in the past five years. All these figures indicate a strong performance, liquidity and returns to the shareholders.
The company introduces on average three to four new products a year. In 2016, it paid $10 million for a site in Tuas on which it is building a manufacturing facility. The factory will be operational by end-2019. It will enable the company to shorten the lead time for product rollout by about six months, and give it more control over the quality of the final products. It will also reduce the need to hold more inventory.
The acquisition was made in anticipation of higher demand from global markets, especially China. Best World also plans for deeper penetration into its current markets in Southeast Asia, such as Indonesia for its halal-certified skincare products.
Within China, Best World aims to capture 5% of the skincare product market, which is valued at about RMB10 billion ($1.97 billion). Euromonitor’s forecast of a CAGR of 8% in the demand for skincare products in China and 12% for premium skincare products in the world in the next five years bodes well for this strategy.
Best World’s highly scalable business model should also enable it to grow without incurring much capital expenditure. The key risk is mainly regulatory changes to MLM models. In addition, there is the risk that Chinese consumers may opt for better-known European and Korean brands rather than Best World’s products, even as demand in Taiwan falls off.
Our discounted cash flow valuation indicates a fair price of $2.72 for Best World while its fair price based on the quality of its assets, using a margin of safety analysis, indicates a price of $2.31. Best World is currently trading at $2.27. In the event the China strategy fails or performs below expectations, the ensuing cash flow indicates a valuation of $1.23 per share.
