This article first appeared in The Edge Financial Daily, on July 1, 2016.

Hai-O Enterprise Bhd
June 30 (RM2.79)
Maintain market perform with a higher target price (TP) of RM2.85: Hai-O Enterprise Bhd’s financial year 2016 (FY16) net profit of RM36.4 million beat our expectations by 6%. Its FY16 dividend per share (DPS) of 15 sen was above forecast due to the stronger-than-expected earnings. FY17 estimated net profit is upgraded by 7% on higher multilevel marketing (MLM) contribution, while FY18 forecast earnings are introduced (9.8% growth). Earnings growth momentum is expected to be supported by the company’s MLM division.

We maintain “market perform”, with a TP lifted to RM2.85 post-earnings upgrade and higher valuation to reflect the strong results and healthy earnings growth.

Its FY16 net profit of RM36.4 million (+22.2% year-on-year [y-o-y]) was slightly above expectations by matching 106% of our full-year forecast. Consensus comparison is not available as the stock is not widely tracked. The stronger-than-expected performance from its MLM division might have contributed to the positive deviation. As expected, a final DPS of 11 sen was proposed, bringing its FY16 total DPS to 15 sen (FY15: 15 sen), which is above our initial forecast due to the higher-than-expected profit.

Y-o-y, FY16 revenue grew 24.3% to RM298.1 million, driven by strong contribution from its MLM division (+46.6% to RM198.7 million), thanks to its successful strategy transformation to focus on smaller consumer products that attracted more young entrepreneurs to join in as distributors. The higher sales led segmental operating profit to jump 25.8% to RM35.5 million. As a result, the group’s net profit surged 22.2% to RM36.4 million.

Quarter-on-quarter, fourth quarter of FY16 (4QFY16) revenue grew 10% to RM88.6 million, again driven by Hai-O’s MLM division (+23% to RM64.2 million) as the positive momentum was sustained on the back of the successful transformation strategy, which more than offset lower contribution from wholesale (-17.9%) and retail (-6.8%). Operating profit contribution by its MLM division grew in tandem with the sales growth by 18.4% to RM12 million. However, net profit only increased by 14.5% to RM11.2 million as the effective tax rate was higher at 26.9% in 4QFY16 (3QFY16: 25%).

MLM is expected to anchor growth. We are encouraged by the commendable results as the group has managed to showcase its flexibility and market awareness in adopting the appropriate strategy to protect its business from the threat of negative economy headwinds and subdued consumer sentiments. As such, we are hopeful that the earnings growth momentum moving forward will continue to be supported by its MLM division on the back of overwhelming growth (more than 30%) in its distributor force, thanks to the transformed business model, which requires a smaller capital outlay.

We are lifting FY17 forecast earnings and upgrading expected FY17 net profit by 6.7% after we factored in higher earnings contribution from its MLM division. We also take this opportunity to introduce FY18 forecast earnings, implying a net profit growth of 9.8%.

We maintain “market perform” with a higher TP of RM2.85 (from RM2.55). Correspondingly with the earnings upgrade, our TP is lifted to RM2.85, based on higher FY17 forecast price-earnings ratio of 13.3 times (from 12.9 times), which implies +0.5 standard deviation over the five-year mean. We think that the higher valuation is justified by its strong performance, considering that it was achieved on the back of weak consumer sentiment due to its successful transformation strategy, which has borne meaningful fruit. We expect the momentum to be sustained as earnings growth is forecast to be at 14% and 9.8% in the next two years. — Kenanga Research, June 30