Rating Target Price: BUY $34.16 Blackmores Limited (ASX:BKL) 12 October 2013 Consumer Health Australia Stock Data Price at 16 Oct 2013: $25.58 Intrinsic Value: $34.16 52 Week High: $33.89 52 Week Low: $24.23 Average Price: $28.82 Market Cap (mn): $429.26 Shares Outstanding(mn): 16.90 Daily Volume (Avg): 9.35 K Source: Yahoo Finance, BKL Data Key Financial Data FY13 End Debt/Equity 77.34% Net Debt/Equity 58.53% Dividend Yield 4.91% PE 17.48% Price/Book 4.47% EV 1 /EBITDA 11.1x Source: BKL Data BKL Share price (AUD) 35.00 33.00 31.00 29.00 27.00 25.00 23.00 An Unexpected Journey This report provides potential investors with an analysis of Blackmores LTD (BKL), a leader in the Vitamins and dietary supplements production industry in Australia with operations in New Zealand, and Asia. While there are significant challenges in Asian operations we can expect progressive earnings growth in all its operating regions by exploiting changing demographics and social trends. Valuation of $34.16 reflects a decreased valuation from 2012. It reflects the increasing competition in the VDS industry and Blackmore s struggles in China as it attempts to establish itself as a late comer to an established competitive market. However, the high intrinsic value affirms the view that it is in good position to leverage on its quality products to ride the growing health conscious Asian market. FY13 marked the eleventh consecutive year of sales with sales rising approximately 25% (incl. BioCeutical brand), despite its market share in Australia decreasing to 16.9% in 2012 from its high of 18.8% in 2009 as competitive pressures continued to increase. All profitable ratios that were examined including gross profit margin, EBIT margin, EBITDA margin and net income margin declined during 2012/13. The highly fragmented nature of the market and increasing competition in the VDS markets in both Australia and abroad will pose to be a challenge. FY14 will see continued revenue growth from Asia relative to that of Australia. Sales growth for Blackmores is expected to increase to 27% in FY14 and decrease steadily to approximately 4% by FY18 as we expect the market to mature and growth be slightly above GDP growth in the long term Key risks to target price include barriers in Asian markets regulations, consumer tastes, culture, and political unrest. Heavy PR efforts have established foreign VDS brands as quality products in Asian markets and Blackmores can exploit these conditions. Strong Australian dollar could be an additional downside risk for Blackmores. This report does not in any way reflect a professional recommendation of BKL shares. It is produced for educational purposes as part of university assessment (reconfigured for hwasungyou.wordpress.com) 1 EV = Market Cap + (Debt + Minority interest + preferred shares) (cash and cash equivalents) 1
Figure 1: Sales and EBITDA margin (AUD 000s) 350,000 300,000 250,000 200,000 150,000 100,000 50,000 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 140% 120% 100% 80% 60% 40% 20% Figure 2: BKL relative performance Blackmores S&P/ASX 200-2009 2011 2013 0.00% 0% Sales EBITDA margin See Appendix 1 for relative performance against its GICS sector Figure 3: Revenue by segment 3.83% 9.26% 9.20% 13.68 % Australia Other Asia Source: Euromonitor 71.57 % Thailand BioCeuticals Figure 4: Blackmore Operations Business Description Blackmores Ltd (ASX:BKL) founded in 1932 and based in Sydney is the leading brand in the Australian consumer health industry. According to Euromonitor International, Blackmores has a 7% market share in consumer health and 17% market share in vitamins and dietary supplements (VDS). Blackmores develop and market products in the VDS sector with a view on natural approaches to health across many Asian countries such as Thailand, Malaysia and Singapore. Asia is increasingly becoming an important market for Blackmores and long term growth in this region is expected to be strong, particularly from mainland China. The BioCeuticals business, through the acquisition of Fit-BioCeuticals in July 2012, allowed Blackmores to ride the growing healthcare practitioners-only market. Industry Overview Australia Growing VDS industry and underlying trends In CY12 the Australian VDS industry grew 9%, bringing it to a total value of $1.8 billion (Euromonitor 2013). The factors driving the growth in this market are Australia s increasing health awareness and trend towards an ageing population. According to Australian Bureau of Statistics it is estimated that over 63% of adult Australians and over 25% of children aged 5-17 are overweight, making Australia the fifth obese nation in the world. The percentage of people aged 65 and over is also increasing in relation to the whole population and is expected to be 25.7% of the total population by 2050. The VDS industry is highly correlated to these wave of changes and the demand for its products will continue to increase as consumers increasingly turn to supplements to bridge the gap in their diet and nutritional needs to maintain a healthy lifestyle. As the leading brand in Australia, Blackmore s is well positioned to take full advantage of this trend. Refer to Appendix 1 for SWOT and Porter s 5 forces analysis. Source: BKL 2
Figure 5 : Estimate of global VDS market size (2012) Country Market size (US$ mn) China 12230.9 South Korea 3770.6 Taiwan 1962.9 Australia 1669.7 Thailand 1159.5 Hong Kong 588.0 Malaysia 517.3.1 Singapore 487.8 New Zealand 201.5 Source: Euromonitor at 16 Oct 2013 exchange rates Figure 6: Market Share of major brands in Australia 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2009-2010 2011-2012 Blackmore Swisse Cenovis Nature's Way Nature's Own Herron Berocca 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Figure 7: Historic VDS sector growth vs. BKL sales growth Source: Euromonitor, IBIS 2008 2009 2010 2011 2012 Blackmores sales growth Australia China Malaysia Singapore South Korea Thailand Asia Growing market: The expansion into the Asian market is increasingly becoming an important revenue source for Blackmore and this trend is expected to continue. Sales grew by 14% and reported profits by 24% for the Asian region compared to the previous year, while over the same period Australian sales grew only by approximately 5.14%. The sales growth is backed by wider distribution channels that are available in this region including highly connected online market, pharmacies, health food stores, specialty stores, hospitals, department stores, home shopping and direct selling. China: The economic growth in China has slowed dramatically from its double digit figures prior to the financial crisis. According to the World Bank the Chinese economy grew by 7.8% in CY12 and has forecasted that it will grow by 7.5% in CY13, much in line with International Monetary Fund s forecast of 7.75% over the same period. Strong single digit growth in the vicinity of 7-8% is expected for years to come. The VDS industry has seen stable growth over the years reaching market size of approximately US$11.31 billion in CY12 and this trend is expected to continue with the growth in Chinese consumers disposable income, health awareness and knowledge and demand for higher quality life. The VDS industry in China is also highly fragmented with the leading brand being Amway at 17% of market share (Euromonitor 2013). Amway leads sales in direct selling and has a portfolio of diverse products tailored to the needs of Chinese consumers. Blackmores could integrate direct revenue stream through online orders into the Chinese online retail industry and tap into the Chinese internet population of approximately 591 million. 3
Competitive Positioning Figure 8: Australian VDS market share by product brand (2012) 48.7% 2.0% Blackmores Cenovis Nature's own Source: Euromonitor 2.3% 16.9% 13.7% 6.4% 5.6% 4.4% Swisse Nature's way Herron Australia: Blackmores is the market and brand leader in Australia s highly fragmented VDS market. The VDS market in Australia is fragmented with a number of dominant suppliers including Blackmores, Nature s Way, Pfizer, Swisse Vitamins and Nature s Own. Such competitive environment combined with the size of the Australian market has limited growth potentials in the Australian market. Blackmores strategy in Australian VDS market has been to retain market share through investment in advertising and channel promotions, increasing its online presence and new sustainable product ranges (Blackmores 2013). Asia: Blackmores is recognised as the most trust brand in Thailand and Malaysia with sales growing by 21.99% in Thailand. The rapid increase in sales across Southeast Asia has been backed by improved health standards across the region, causing demand for immunity products to increase (Euromonitor 2013). Blackmore faces competitive pressures from Amway in Malaysia (19%) and Cerebos in Thailand (38%) although its core products and operations in these regions do not compete directly with its competitors products. Blackmore expanded its global footprint with expansionary efforts into East Asia, in particular China and South Korea. These markets have long established market leaders that have products that meet consumer tastes including traditional Chinese medicine and ginseng. In order to adapt to the market, Blackmores partnered with Eu Yan Sang in Hong Kong to take advantage of local tastes and to commit to its expansion into China. Blackmores Australian based production line is a competitive advantage it has over its competitors as it signals quality. Compliance with TGA standards in addition to the recent launch of Blackmores Institute reinforces quality and helps Asian consumers identify the brand with quality (Blackmores 2013). Company Strategy In order to maintain its competitiveness and market position, Blackmores continued to diversify its product range through innovation and reformulation, launching 120 new products across the group in FY13 (Blackmores 2013). The aggressive product development and improvement seems to be a response to the increasing competition in the VDS market in Australia and its consequent lack of market share growth. To retain its leading position it also successfully diversified itself from traditional retailing activities by reaching out to practitioner segment through its BioCeuticals brand. It is well positioned as the market leader in practitioner only segment to capture this growing market. Corporate value chain analysis R&D Manufacture Distribution Marketing & Sales Services The production, distribution and storage facilities of Blackmores located at Warriewood campus in Sydney. The campus is equipped with up to date technology, such as RTL's voice picking RF and pick to light systems, which enhances the company s materials handling and distribution with more accuracy and thus, facilitates stronger synergies between the supply chain and customer service. With heavy emphasis on innovation and improvement, its products are developed through a combination of scientific research and traditional knowledge. The Blackmores range is produced under the PIC/S (Pharmaceutical Inspection Convention and Pharmaceutical Inspection Co-operation Scheme) standards of manufacturing practice with ensured quality. Furthermore, Blackmores has moved to an ecofriendly production process with emphasis on sustainable and reliable products from research to finished product. 4
Accounting analysis The remuneration system of Blackmores includes both fixed and performance-based incentives that are mainly based on key performance indicators of the company, such as the revenue growth. This creates potential incentives for managers to manipulate the numbers for reasons such as pay-per-performance. Additionally, the preparation of financial statement that complies with the AASB provides managers a certain degree of judgments that enlarge this opportunity. A. Revenue and Other Comprehensive Income Adjustment In order to reflect the true performance of Blackmores from its reported operating activities, we adjust the revenue by excluding the interest revenue from bank deposits, royalties, membership and other income (See appendix for details of adjustment). Furthermore, other comprehensive income are not included in our income statement analysis as we believe that some of the other comprehensive income items may be used to distort the true operating performance of the company. B. Lease Adjustment In Blackmores 2013 annual report, we detected that its financial lease liability was much lower than its operating leases. Since a company reporting a lease as an operating lease may typically show higher profits, higher return measures and a stronger solvency position in early years than an identical company reporting it as a finance lease, an adjustment is made on capitalizing the operating lease obligations of Blackmores to reflect the true performance of the firm. As a result, both non-current assets and non-current interest bearing liabilities will increase accordingly for each year considered for analysis. Consequently, the following accounts were also adjusted: depreciation expense, interest expense and net income (See Appendix 2). C. Other Adjustment We believed that the estimation of all the other items, such as provisions and allowances for doubtful debts are reasonable. Furthermore, no impairment loss is detected in 2013 and the intangible assets of Blackmores are performing well in 2013, no further adjustment is made on these items. Financial analysis A. Time-series analysis Dupont Analysis: Blackmores ROE has shown a decline from 38.62% in 2009 to 28.10% in 2013, with a temporary increase in 2011. Table 1 presents the decomposition of ROE under both the traditional method and the alternative method. The results of the traditional decomposition suggest that the ROE trend, especially the large drop between 2011 and 2013 is due to the movement of the ROA and net profit margin. The alternative decomposition, after applying the three level analysis (Appendix 4), indicates that the change of ROE in the past five years, especially the sizable drop in 2013, was mainly driven by the increase COGS and intangible assets turnover. The increase in COGS is caused by both the squeezed price premium from intensified competition and $2.8 million inventory write-offs in 2013, as reported in the FY13 annual report. Table 1: Return on equity 2009 2010 2011 2012 2013 ROE¹ 38.62% 35.78% 37.37% 33.57% 28.10% Traditional Decomposition Net profit margin 10.50% 10.85% 12.03% 10.64% 7.93% Asset turnover 1.55 1.46 1.51 1.57 1.57 ROA 16.24% 15.79% 18.15% 16.71% 12.49% Leverage 2.38 2.27 2.06 2.01 2.25 Alternative Decomposition Operating net profit margin² 10.94% 11.53% 12.86% 11.42% 9.03% Operating asset turnover 2.34 2.24 2.27 2.27 2.24 Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18% Spread 22.76% 21.07% 22.19% 19.63% 13.54% Net financial leverage 0.57 0.47 0.37 0.39 0.59 ROE 38.62% 35.78% 37.37% 33.57% 28.10% 5
Note: (1) The net income used here is adjusted for revenue and lease adjustment. See Appendix 1 for the detailed adjustment and calculation. (2) See Appendix 4 for the calculation of NOPAT, net assets, spread and net financial leverage. Profitability: As explained in three level analyse in Appendix 4, all of the profitability ratio for Blackmores has declined in 2012 and 2013 after the increase recorded for the period from 2009 to 2011. Comparison of market share allows the conclusion that this was due to the increasing competition in the Australian VDS market. Table 2: Summary of margins 2009 2010 2011 2012 2013 Gross profit margin 56.33% 58.13% 59.53% 56.89% 52.30% EBIT margin 15.39% 16.47% 18.53% 16.11% 12.27% EBITDA margin 26.11% 25.48% 20.55% 18.12% 14.23% Net income margin¹ 10.50% 10.85% 12.03% 10.64% 7.93% Note: (1) The net income we used here is adjusted for revenue and lease adjustment, which is not the NOPAT we used in the Dupont analysis. The difference and how NOPAT is derived from net income (adjusted) and their relevant calculation are discussed in detail in Appendix 4. A1. Investment management Working Capital Management: The deterioration in the operating working capital turnover from 8.9 in 2009 to 6.04 in 2013, indicates that Blackmores capacity to generate operating revenue from its operating working capital invested have declined. The decline, however, has narrowed in 2013, implying an improved efficiency during the year. This trend is attributable to an improved operational management, which is reflected in the increase in accounts receivable turnover, inventory turnover and accounts payable turnover in 2013 after the fall from 2009 to 2012. Overall, the results in Table 3 suggest that Blackmores has improved its working capital management in 2013 as it collected receivables, sold inventories and paid payables at a faster pace than in 2012. Table 3: Analysis of working capital management 2009 2010 2011 2012 2013 Operating working capital to sales ratio 11.24% 12.25% 13.96% 16.15% 16.55% Operating working capital turnover 8.9 8.16 7.16 6.19 6.04 Accounts receivable turnover 6.02 5.74 5.72 5.26 5.55 Inventory turnover 5.21 4.66 4.10 4.05 4.35 Accounts payable turnover 3.05 2.51 2.67 2.52 2.74 Days receivable 60.64 63.55 63.86 69.43 65.74 Days inventory 70.05 78.33 89.07 90.13 83.96 Days payable 119.87 145.44 136.82 144.90 133.31 Note: Refer to Appendix 8 for the reformulation and calculation of operating working capital Long-Term Asset Management: Despite the improved efficiency on the use of PP&E from 2010 to 2013, as seen through the increase in PP&E turnover from 3.17 to 4.66 after the decline in 2010, Blackmores use of long-term asset has been fluctuating during the past five years and have recently deteriorated as a result of decline in net long-term asset turnover in 2013. One possible reason is in the large increase of intangible assets and goodwill in 2013 due to the acquisition of BioCeuticals as reported in the 2013 annual report. Table 4: Property Plant and Equipment turnover 2009 2010 2011 2012 2013 Net long-term asset turnover 3.17 3.09 3.33 3.60 3.55 PP&E turnover 3.23 3.17 3.49 3.86 4.66 Note: (1) Refer to Appendix 8 for the reformulation and calculation of Net long-term assets (2) PP&E is adjusted with the lease adjustment from Appendix 2 6
A2. Financial Leverage and Decision Analysis Figure 9: Liquidity ratios 3.00 2.50 2.00 1.50 1.00 0.50 0.00 2009 2010 2011 2012 2013 Liquidity Despite of the decline in operating cash flow ratio from 0.8 in 2010 to 0.55 in 2013, Blackmores overall short-term liquidity has strengthened with the growth of its current ratio, quick ratio and cash ratio in the past three years. Current ratio Cash ratio Quick ratio Operating cash flow ratio Table 5: Operating cash flow ratio 2009 2010 2011 2012 2013 Current ratio 2.18 2.34 2.36 2.39 2.75 Quick ratio 1.68 1.68 1.65 1.63 1.87 Cash ratio 0.47 0.69 0.35 0.35 0.45 Operating cash flow ratio 0.74 0.8 0.67 0.59 0.55 Note: Operating cash flow is adjusted for the lease adjustment from Appendix 2 Figure 10: Solvency ratios 25.00 20.00 15.00 10.00 5.00 0.00 2009 2010 2011 2012 2013 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Solvency Due to funding of the BioCeuticals acquisition, Blackmores was experiencing higher solvency ratios and lower interest coverage ratio in 2013 as a direct result of increased debt level. Such an increase in solvency risk will not cause an issue for Blackmores as the acquisition performed well during the year and has started to contribute profits to the parent. Interest coverage ratio Debt-to-equity ratio Net-debt-to-equity ratio Table 6: Solvency measures 2009 2010 2011 2012 2013 Liability-to-equity ratio 1.35 1.23 1.03 0.97 1.21 Debt-to-equity ratio 82.65% 75.96% 60.53% 54.72% 77.34% Net-debt-to-equity ratio 57.23% 47.25% 36.67% 38.65% 58.53% Interest coverage ratio 20.60 14.24 14.67 13.88 7.98 A3. Cross-sectional analysis 7
As a multinational healthcare company in VDS industry with operations that are geographically similar to Blackmores, despite in a much smaller scale, we believe that the cross-sectional comparison with Vita Life Sciences (VLS) will provide us with a better understanding of Blackmores strategy and relative performance. In order to make the analysis consistent, the accounting adjustment for VLS has been adopted in Appendix 5. The reason for limiting our analysis to profitability and working capital management analysis and the drawbacks of our cross-sectional analysis are discussed in detail in Appendix 6 and 7, respectively. Profitability: Although VLS reported higher gross profit margin than Blackmores from 2011 to 2012, both of its EBIT and net income margin are lower than Blackmores. Because VLS is a multinational company who entered the Asia market, especially China, earlier than Blackmores, the market it operates is more diversified than the market Blackmores operates. The resulted higher gross profit margin of VLS is consistent with Blackmores strategy of diversification and expansion to Asia markets. The lower EBIT and net income margin, however, implies that the cost management of VLC is not as efficient as Blackmores. Table 7: Profitability comparison Profitability Vita Life Sciences Blackmores 2011 2012 2011 2012 Gross profit margin 64.77% 64.65% 59.53% 56.89% EBIT margin 6.01% 9.42% 18.53% 16.11% Net income margin 4.81% 7.71% 12.03% 10.64% Working capital management: VLS s overall working capital management is less efficient than Blackmores as indicated by the lower NOWC turnover and inventory turnover despite of the strong receivable turnover, which is not believed to be sustainable in the long run. This trend again, indicates Blackmores efficiency in it operational management. Table 8: Working capital management (VLS vs. BKL) Vita Life Sciences Blackmores 2011 2012 2011 2012 Operating working capital to sales ratio 13.89% 17.02% 13.96% 16.15% Operating working capital turnover 7.2 5.87 7.16 6.19 Accounts receivable turnover 3.94 7.34 5.72 5.26 Inventory turnover 2.39 2.29 4.10 4.05 Days receivable (days) 92.6 49.75 63.86 69.43 Days inventory (days) 152.44 159.23 89.07 90.13 Note: Refer to Appendix 5 for detailed calculation of net operating assets and net working capital Valuation A. Assumption and Forecasting We used four different valuation methods in calculating the intrinsic value of Blackmores and here is the summary of the forecasted inputs of relevant models (Refer to Appendix 10 for detailed analysis): Table 9: Summary of forecasts and assumptions in valuation 2014 2015 2016 2016 2017 2018 DCF, Abnormal Earnings and Abnormal Returns Model¹ Sales growth rate 27% 16.77% 10.41% 6.47% 4.02% 2.49% NOPAT/sales 9.5% 9.3% 9.1% 8.9% 8.7% 8.5% Beginning NOWC/sales 14.86% 14.66% 14.46% 14.26% 14.06% 14.06% Beginning NOLT assets/sales 26.55% 26.05% 25.55% 25.05% 24.55% 24.55% Net debt/book value of net capital 42.91% 41.91% 40.91% 39.91% 38.91% 38.91% Cost of debt 4.06% Market risk premium 5.80% Risk free rate 5.16% 8
Common equity beta 0.62 Cost of equity 8.76% Discounted Dividend Model Dividend growth rate 12% 10% 8% 6% 4% 2.5% Note: (1) Since we apply the same assumptions for all three models as we believe that the assumptions derived from DCF is reasonable and consistent for the other two, they should result in the same value and we put them into the same basket. B. Sensitivity & Scenario Analysis DCF: Since the result of DCF and residual income methods rely heavily on the multiple assumptions and forecasts we have made above, it is necessary to run the sensitivity and scenario analysis to the check the effect of those assumptions on the equity value and assign a range of value based on different scenarios. According to the sensitivity analysis of each individual inputs (See details of sensitivity analysis in Appendix 11), we determined that changes in NOPAT/sales ratio, perpetual sales growth rate and cost of equity are the major assumptions that affect the share price the most. As a result, by assigning the worst and best scenarios of these inputs explained in more detail in Appendix 12, we obtained the range of the intrinsic value of Blackmores from our DCF method as follow: Table 10: Summary of scenario analysis - DCF DCF, Abnormal Earnings and Abnormal Returns Method Share price Worst case $22.49 Base case $36.07 Best case $53.36 DDM: By conducting the sensitivity analysis for DDM by changes of the only assumption of constant dividend growth rate from 2014 2018 in Appendix 13, we obtained the range of intrinsic value from DDM method as follow: Table 11: Summary of scenario analysis - DDM DDM Method Share price Worst case $20.71 Base case $26.51 Best case $45.03 C. Triangulation Till this point, we have applied four valuation methods in valuing the intrinsic value of Blackmores and the summary of the results is gathered as follow: Table 12: Summary of scenario analysis all models DCF, Abnormal Earning and Abnormal Return¹ DDM² Worst case $22.49 $20.71 Base case $36.07 $26.51 Best case $53.36 $45.03 Note: (1). Since we assigned the same assumptions and forecasting for discounted abnormal earning and abnormal return method, they conducted the same results as DCF, which improves the consistency of our calculation (Refer to Appendix 14 for the worksheet for DCF, Abnormal Earning and Abnormal Return method. (2)See Appendix 15 for the worksheet for DDM method In order to derive the final range of value for Blackmores from four methods, we run the triangulation by assigning different weights to each methods according to their degree of fitness (refer to Appendix 16&17 for the discussion of each method and the justification of the weighting). The final share price of Blackmores calculated after the triangulation ranges from $22.13 to $51.69. Table 13: Triangulation Weightings DCF, Abnormal Earning and Abnormal Return 80% 9
Figure 11: Triangulation $60.00 DDM 20% Triangulation Worst case Base case Best case Final value $22.13 $34.16 $51.69 $55.00 $50.00 High $45.00 $40.00 $35.00 Fair value $30.00 $25.00 $20.00 DCF, Abnormal Earning and Abnormal Return DDM Triangulated Low Conclusion In conclusion, Blackmores is believed to be an undervalued company which is recommended as a strong buy based on our valuation (fair value of $34.16) and its difference from the current market price of $26.28 per share (closed on the 17 th of May 2013 on ASX). According to our market, industry, accounting and financial analysis, it is believed that Blackmores current strategy of diversification and expansion will provide company the capability to sustain its growth and maintain its leading positions in Australia despite of the intensified competition. Although China appears to be a bright opportunity for Blackmores, further setbacks need to be overcome before the company can fully utilize the market opportunity. Appendices Appendix 1: Strategic Analysis Figure 12: Relative performance against Consumer Staples (BKL GICS classification) Source: Morningstar 10
Figure 13: Blackmores SWOT Analysis Strengths 1. Market leader in natural healthcare with strong presence in VDS 2. 11 years of consecutive sales growth 3. Highly efficient operations in Australia 4. Recognised brand with 80 years of experience and trust in quality 5. Strong market position and brading in Thailand, Malaysia and exanding into growing and lucrative Asian market 6. Long sighted management approach to company growth Opportunities 1. Acquision of FIT-Bioceuticals giving them exposure to the growing healthcare practitioner s only market and giving organic growth prospects in this sector 2. Shfting demographics and health awareness of the general population in Australia and Asia 3. Much wider potential distribution channels in Asia including pharmacies, department stores, health food stores, specialty stores and online 4. Partnership with Eu Yang Sang (HK) could open up knowledge of traditional Chinese medicine to better align product with the market SWOT Weaknesses 1. Revenues are affected by many factors including interest rates, global economic outlook, consumer confidence and the cost of living 2. Decreasing bargaining power against its main distribution channel in Australia (i.e. Coles, Woolworths and Chemis Warehouse) 3. Asian expansion has not been tailored to the specific market, and currently relying on partnerships with local firms 4. Australian business model is not optimal in Asia Threats 1. Highly regualted industry and new regulations could impact sales (e.g. regulatory change in South Korea caused short term prodcut delays in 2012) 2. Competition from low cost producers (e.g. Suisse) and other producers leading to margin erosion 3. Increaing competition in VDS in Australia where Blackmore generates majority of its sales revenue 4. Competition from subsitutes in Asia (e.g. bottled liquid vitamins) 5. Competition between discount chemists and traditional retailers adverse impacting on margins on Blackmore products 11
Figure 14: Porter's five forces analysis for Blackmores Rivalry among Existing Firms HIGH Aggressive competition both inand out of Australia. Swisse Vitamins posing to be one of the biggest competitors to Blackmores (In Australia) Highly fragmented market and competition is fierce with products being easily reformulated by competitors In East Asia: BKL is a small player competing against well established domestic and global brands Bargaining Power of Buyers HIGH Besides, recent launch of online sales, which is the only direct selling channel, BKL has to maintain good relations ship with their three major buyers who generate more than half of their revenue. Supermarket chains have significant power over BKL due to their economies of scale Threat of New Entrants LOW Barrier to enter the markets are restricted by high requirements of CAPEX and different legal barriers. Deteriorating margins mean less lucrative to enter the VDS market at current state In Asian operations the threat of entrants is HIGH as companies expand into Asia to grab a share of the region's growth Blackmores Limited Threat of Substitute Products LOW There is minimal threat from freshfoods as consumers continue to trust measurable concentrated nutrients that are lacking in their diets Chinese medicine is available in Australia, however, remains to be seen whether it will pose to be a threat in the long term. In China it poses to be a significant competitor. Bargaining Power of Suppliers LOW Most of the inputs used by BKL are not highly specialised so bargaining power of suppliers remain weak Its expansion into Asia could also expand its supplier choices Appendix 2: Accounting and Financial Analysis Table 14: Revenue adjustment 2009 2010 2011 2012 2013 Revenue and other income 201,715 217,093 236,592 262,100 327,539 Other income 519 1,286 1,325 533 936 Royalties 882 873 844 681 - Membership - - - 54 - Operating revenue (adjusted) 200,314 214,934 234,423 260,832 326,603 According to Note 3.10.1 of Blackmores 2013 annual report, operating lease payments of the company are recognized as on a straight-line basis over the lease term. By assuming the discount rate as the weighted average interest rate from Blackmores annual report, the distribution of the lease payments and the calculation of present value of operating lease are illustrated as follows: Table 9: Lease adjustment Future lease payment 2013 PV 2013 2012 PV 2012 2011 PV 2011 2010 PV 2010 2009 PV 2009 2008 PV 2008 2014 2311 2221 1426 1360 998 944.4 800 755.3 765 722.2 1,684 1590 2015 1070 988 311.8 284 289.8 259.4 154.5 137.7 166.8 148.6 223.8 199.4 12
2016 1070 950 311.8 270 289.8 245.5 154.5 130.0 166.8 140.3 223.8 188.3 2017 1070 913 311.8 258 289.8 232.3 154.5 122.8 166.8 132.5 223.8 177.8 2018 1070 877 311.8 246 289.8 219.8 154.5 115.9 166.8 125.1 223.8 167.8 2019 218 172 Discount rate 4.06 % 4.85 % 5.68 % 5.92 % 5.92 % 5.92 % Total 6119.71 2418.04 1901.42 1261.65 1268.76 2323,21 Since Blackmores operating leases are related to business premises and motor vehicle fleet with lease terms between three to six years, by assuming the useful life of 6 years and residual life of zero, the estimated depreciation rate and the corresponding depreciation & interest expense from 2010 2013 are calculated as follow: Table 16: Lease adjustment (depreciation and interest expense) 2013 2012 2011 2010 2009 Estimated depreciation rate 17% Interest rate 4.85% 5.68% 5.92% 5.92% 5.92% Depreciation expense 411.07 323.24 214.48 215.69 394.95 Interest expense 117.27 108.00 74.69 75.11 137.53 As a result, both non-current assets and non-current liabilities of Blackmores are affected by the amount of PV of operating lease each year. Lease adjustment will also increase the profit before tax, tax expense and net income by the amount calculated by netting the reported operating lease expense and the depreciation & interest expense calculated above. The changes on financial statements, including the cash flow statements are indicated below: Table 17: Lease adjustment (Changes to the financial statement) 2013 2012 2011 2010 2009 Changes on Balance Sheet ( + increase, - decrease) Non-current assets +6,119.71 +2,418.04 +1,901.41 +1,261.65 +1,268.76 Non-current liabilities +6,119.71 +2,418.04 +1,901.41 +1,261.65 +1,268.76 Changes on Income Statement ( + increase, - decrease) Operating lease expense -2,707-1,664-1,391-1,034-2,289 Interest expense +117.27 +108.00 +74.69 +75.11 +137.53 Depreciation expense +411.07 +323.24 +214.48 +215.69 +394.95 Profit before tax +2,178.66 +1,232.76 +1,101.83 +743.2 +1,756.52 Effective tax rate 26.4% 29.1% 30.6% 30% 28.9% (reported) Tax expense +575.17 +358.73 +337.16 +222.96 +507.63 Net income +1.603.49 +874.03 +764,67 +520.24 +1,248.89 Changes on Cash Flow Statement ( + increase, - decrease) Lease payment -2,707-1,664-1,391-1,034-2,289 Interest payment +117.27 +108.00 +74.69 +75.11 +137.53 tax payment +575.17 +358.73 +337.16 +222.96 +507.63 CFO +2,014.56 +1,197.27 +979.15 +735.93 +1,643.83 CFF -2,014.56-1,197.27-979.15-735.93-1,643.83 Appendix 3: The Red Flag from Blackmores 2009 Balance Sheet Reporting Although we have included FY09 in our financial analysis, it is important to note that there are some inconsistencies in terms of balance sheet reporting of FY09 performance from 2009 and 2010 annual reports. Both assets (current and noncurrent) and liabilities (current and non-current) reported in 2009 annual report are different from those reported in 2010 annual report. The possible reason for the inconsistency could be that Blackmores followed the auditors opinion or 13
suggestions in 2010 and changed relevant items accordingly. Thus, we believed that the data for 2009 reported in 2010 annual report is more appropriate and have applied it for our analysis. Appendix 4: Three level analysis of ROE A. Level 1 Analysis The alternative decomposition indicates that the change of ROE from 2009 to 2013 is caused by both operating ROA and spread, and is partly offset by the changes of net financial leverage starting from 2010. To illustrate, although the spread, which stands for the economic effect of borrowing (operating ROA effective interest rate after tax), has changed accordingly to the movement of ROE, its effect is offset by the net financial leverage as Blackmores overall financial leverage gain to the shareholders has actually improved in 2013 (from 7.59% in 2012 to 7.92% in 2013) while the ROE is experiencing a large drop (from 33.6% to 28.12% in 2013). Therefore, it is the operating ROA that mainly drives the changes of ROE, which leads us to the level 2 analysis. Table 18: Financial leverage gain Alternative Decomposition 2009 2010 2011 2012 2013 Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18% Spread 22.76% 21.07% 22.19% 19.63% 13.54% Net financial leverage 0.57 0.47 0.37 0.39 0.59 Financial leverage gain 13.03% 9.96% 8.14% 7.58% 7.92% B. Level 2 Analysis By decomposing the operating ROA into operating net profit margin and operating asset turnover, the resulting outputs indicate that the change of operating ROA is driven by both the operating net profit margin and operating asset turnover. In order to determine the key drivers of these two factors, we applied the level 3 analysis below to further decompose the operating net profit margin and operating asset turnover. Table 10: Decomposing Operating ROA 2009 2010 2011 2012 2013 Operating net profit margin 10.94% 11.53% 12.86% 11.42% 9.03% Operating asset turnover 2.34 2.24 2.27 2.27 2.24 Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18% C. Level 3 Analysis Operating net profit margin The operating net profit margin can be further broken down by using the common-sized income statement, as in Table below. From the common-sized income statement, we observe COGS as the main source of change of operating net profit margin for the past 5 years, especially to the recent drop of net operating profit. According to the market analysis above, the large increase of COGS to sales ratio from 2011 to 2013 can be partly explained by the squeezed price premium from the intensified competition. Furthermore, $2.8 million of stock write-off in 2013 due to the decreased sales in Australia also contribute to the increase of the COGS (BKL annual report 2013). Additionally, the decrease of SG&A to sales ratio from 2011 to 2013 indicates that company has improved its cost management during the past three years. Table20: Common-size income statement 2009 2010 Values 2011 2012 2013 Sales 200,314 214,934 234,423 260,832 326,603 COGS 87,482 89,996 94,874 112,451 155,800 SG&A 52,957 60,397 82,034 90,395 110,458 Other 7,574 9,786 9,331 10,711 13,882 Effective tax rate (adjusted) 28.9% 30% 30.6% 29.1% 26.4% 14
Tax 8,550 9,995 12,433 11,396 9,291 NOPAT 21,919 24,784 30,148 29,799 29,486 Ratios as a percentage of sales COGS 43.67% 41.87% 40.47% 43.11% 47.70% SG&A 26.44% 28.10% 34.99% 34.66% 33.82% Other 3.78% 4.55% 3.98% 4.11% 4.25% Tax 4.27% 4.65% 5.30% 4.37% 2.84% NOPAT 10.94% 11.53% 12.86% 11.42% 9.03% Operating asset turnover By formulating the inverse common size balance sheet, the operating asset turnover can be broken down into individual asset turnovers as follow. It is important to note that the cash turnover is excluded in the analysis as the breakdown is based on the net operating assets of the company, which does not include cash and other equivalents. According to the inverse common size balance sheet, the recent drop of operating net asset turnover is driven by the decrease of intangible asset turnover and some decrease of inventory turnover. The decrease of intangible asset turnover is caused by the large increase of intangible assets from the acquisition of BioCeuticals while the drop of inventory turnover is probably due to the increased inventory from the decreased sales in Australia. Table 111: Operating asset turnover 2009 2010 Values 2011 2012 2013 Average receivables 33,282 37,421 41,012 49,614 58,827 Average inventory 16,789 19,314 23,152 27,768 35,839 Average fixed assets 62,082 67,741 67,119 67,581 70,067 Average intangible assets 205 563 1,364 2,135 10,095 Average other assets 1,753 1,914 2,018 2,081.5 2,456.5 Average net operating assets 85,623 95,973 103,121 114,655 146,111 Turnover Ratio Receivable turnover 6.02 5.74 5.72 5.26 5.55 Inventory turnover 11.93 11.13 10.13 9.39 9.11 Fixed asset turnover 3.23 3.17 3.49 3.86 4.66 Intangible asset turnover 977.14 381.77 171.86 122.20 32.35 Other asset turnover 114.27 112.30 116.17 125.31 132.95 Operating net asset turnover 2.34 2.24 2.27 2.27 2.24 Appendix 5: Vita Life Sciences Revenue adjustment Similar to the adjustments on Blackmores, the revenues of Vita Life Sciences are adjusted by excluding the other income to reflect the operating revenue as follows: Table 22: Revenue adjustment (VLS) 2011 2012 Revenue and other income 24,477 30,354 Other income 210 163 15
Operating revenue (adjusted) 24,267 30,191 Non-operating item adjustment The share of associate s profit/loss is excluded in the profit calculation as they are assumed as non-operating items. Lease adjustment The same lease adjustment applies to the Vita Life Sciences as well and the followings are the results of the lease adjustment for Vita Life Sciences: Table 23: Lease adjustment - Vita Life Sciences Future lease 2012 PV in 2012 2011 PV in 2011 2010 PV in 2010 payment 2013 203.00 195.08 263.00 250.83 206.00 194.49 2014 24.00 22.16 59.75 54.35 48.50 43.23 2015 24.00 21.30 59.75 51.84 48.50 40.81 2016 24.00 20.47 59.75 49.44 48.50 38.53 2017 24.00 19.67 59.75 47.15 48.50 36.38 Discount rate 4.85% 5.68% 5.92% Total 278.68 453.61 353.44 Note: (1) Since company does not release any information related to finance lease, the interest rate is assumed to be same as Blackmores 2012 2011 Non-current assets (PP&E) +278.68 +453.61 Non-current liabilities (Interest-bearing liabilities) +278.68 +453.61 Operating lease expense (Occupancy expenses) -302-295 Interest expense +25.77 +20.92 Depreciation expense +149.69 +116.64 Profit before tax +126.54 +157.44 Effective tax rate 18.48% 13.55% Tax expense +23.38 +21.36 CFO +252.85 +252.72 Note: (1) The depreciated rate is estimated as 33% because the average life of the leased assets is reported as 1-3 years and is assumed as 3 years. (2) The effective tax rate is calculated by dividing the income tax expense to the profit before tax. Table 24: Adjusted income statement for VLS 2011 2012 Sales ¹ 24,267 30,191 Cost of sales 8,549 10,674 Gross profit 15,718 19,517 Expenses Distribution 2,071 2,570 Marketing 1,804 2,278 Occupancy ² 344 417 Administrative ³ 9,638 11,113 Other 402 296 Profit before interest and taxes 1,458 2,843 16
Finance income 78 113 Finance costs 185 163 Profit before income tax 1,351 2,794 Income tax expense 183 516 Net profit for the year 1,168 2,277 Loss attributable to minority interest - -51 Profit attributable to the parent 1,168 2,328 Note: (1) Adjusted for revenue adjustment (2) Adjusted for lease adjustment (3) Adjusted for lease adjustment Table 25: NOPAT (VLS) 2011 $000s 2012 $000s Net interest expense after tax Interest expense 185 163 - Interest income 78 113 = Net interest expsnese(income) 107 50 *(1-Effective tax rate) 86.45% 81.52% = Net interest Expense after tax 93 41 Net Operating Profit after tax Net operating income (adjusted) 1,168 2,328 + net interest expense after tax 93 41 = net operating profit after tax 1,261 2,369 Net operating Income to common Net income 1,168 2,328 - Preferred dividends - - = Net operating income to common 1,168 2,328 Table 26: Calculation of net operating assets, net working capital and net debt (VLS) 2010 2011 2012 Net Working Capital = Total current operating assets - Total current operating liabilities Accounts Receivable 8,564 3,749 4,481 + inventory 3,440 3,701 5,612 + Other current assets 245 285 469 - Accounts payable - current 4,302 3,917 4,591 - Provisions - current 242 414 542 - Current tax liabilities 20 34 289 - Others - - - = Net working capital 7,685 3,370 5,140 Net Long term Assets = Total long-term assets - Non-interest-bearing long-term liabilities Long term tangible assets 166 127 126 + Long term intangible assets 57 67 73 + other long term assets - - - 17
- Minority interest 478 464 86 - Deferred tax (net) -47-80 -80 - Other long-term Liability 5 20 41 = Net Long-term assets -213-210 152 Total Net Operating Assets = net working capital + net long-term assets net working capital 7,685 3,370 5,140 + net long-term assets -213-210 152 = Total Net Operating assets 7,472 3,160 5,292 Net Capital Short term debt 1,814 - - + Long term debt - - - - Cash and Investments 1,993 5,332 5,964 = Net debt -179-5,332-5,964 + Preferred equity - - - + Shareholders' equity (less OEI) 7,651 8,492 11,256 = Total Net Capital 7,472 3,160 5,292 Appendix 6: Justifying the exclusion of liquidity, solvency and other ratios in crosssectional analysis Vita Life Sciences is a much smaller company compared to Blackmores and has a debt balance of zero (in both short- and the long-term). Its net debt, however, is negative and it is meaningless to apply the solvency and liquidity ratio analysis. Additionally, the negative net long term assets caused by the large amount of minority interest which is higher than the total long-term assets makes it unnecessary to compare the long-term asset management between companies (see below for calculations). Appendix 7: Limitations of the cross-sectional analysis Firstly, due to the limited information we have on Vita Life Sciences, some of the ratios, for example, payable turnovers are not included in our analysis. Secondly, Vita Life Sciences financial year ends on the 31 th of December instead of 30 th of June. This limits the quality of our analysis and opens up the possibility of data bias due to timing differences and seasonality in companies performances. Appendix 8: Adjusted IS, NOPAT, NOA, NWC and Net Debt of Blackmores Table 27: Adjusted income statement (BKL) and calculation of NOPAT 2009 2010 2011 2012 2013 Sales 200,314 214,934 234,423 260,832 326,603 Total revenue¹ 200,314 214,934 234,423 260,832 326,603 Promotional and other rebates 18,581 19,054 22,907 32,478 49,487 Changes in inventories of finished -2,437 5,194 2,047 3,422 5,955 goods Raw materials and consumables used 71,338 65,748 69,920 76,551 100,358 Employee benefits expense 42,212 48,179 52,730 54,910 64,060 Selling and marketing expenses 2,444 4,141 22,102 24,462 34,141 Depreciation and amortization expense² 21,473 19,350 4,743 5,245 6,400 18
Operating lease rental expenses³ - - - - - Professional and consulting expenses 2,753 2,198 3,303 4,011 3,853 Repairs and maintenance expenses 1,795 1,992 2,221 2,591 Freight expenses 3,091 3,006 3,278 4,149 4,973 Bank charges 662 881 621 642 840 Other expenses 7,574 9,786 9,331 10,711 13,882 Total expenses 169,486 179,529 190,982 218,802 286,540 EBIT 30,828 35,405 43,441 42,030 40,063 Interest revenue 265 427 161 172 174 Interest expense 4 1,510 2,517 2,972 3,041 5,043 Net interest expense 1,245 2,090 2,811 2,869 4,869 Profit before tax 29,584 33,315 40,630 39,161 35,194 Income tax expense 8,550 9,995 12,433 11,396 9,291 Net income 21,034 23,321 28,197 27,765 25,903 Effective tax rate (Tax expense/profit before tax) 28.90% 30.00% 30.60% 29.10% 26.40% Note: (1) Adjusted for revenue adjustment (2) Adjusted for lease adjustment (3) Adjusted for lease adjustment (4) Adjusted for lease adjustment 2009 2010 2011 2012 2013 Interest expense 1,510 2,517 2,972 3,041 5,043 - Interest income 265 427 161 172 174 = Net interest expense (income) 1,245 2,090 2,811 2,869 4,869 *(1-Effective tax rate) 71.10% 70.00% 69.40% 70.90% 73.60% = Net interest expense after tax 885 1,463 1,951 2,034 3,584 Net operating income (adjusted) 21,034 23,321 28,197 27,765 25,903 + net interest expense after tax 885 1,463 1,951 2,034 3,584 = Net operating profit after tax 21,919 24,784 30,148 29,799 29,486 Net Income 21,034 23,321 28,197 27,765 25,903 - Preferred dividends - - - - - = Net income to common 21,034 23,321 28,197 27,765 25,903 Table 12: Net Operating Assets (NOA), Net Working Capital (NWC) and Net Debt of Blackmores 2008 2009 2010 2011 2012 2013 Net Working Capital = Total current operating assets - Total current operating liabilities Accounts Receivable 28,216 38,348 36,494 45,530 53,698 63,956 + inventory 17,506 16,072 22,555 23,749 31,786 39,892 + Other current assets 2,111 1,373 2,429 1,574 2,549 2,219 - Accounts payable - current 21,035 25,820 26,575 25,843 34,937 38,369 - Provisions - current 3,351 2,855 3,230 3,653 4,456 5,219 - Current tax liabilities 3,407 2,119 3,992 3,570 2,117 - - Others - - - - 37 848 = Net working capital 20,040 24,999 27,681 37,787 46,486 61,631 19
Net Long term Assets = Total long-term assets - Non-interest-bearing long-term liabilities Long term tangible assets¹ 56,092 68,073 67,410 66,827 68,334 71,801 + Long term intangible assets - 410 716 2,669 2,914 35,508 + other long term assets 10 12 14 19 21 124 - Minority interest - - - - - - - Deferred tax (net) -1,158-1,734-2,321-2,330-3,623-3,683 - Other long-term Liability 600 682 741 792 908 995 = Net Long-term assets 56,660 69,547 69,720 71,053 73,984 110,121 Total Net Operating Assets = net working capital + net long-term assets Net working capital 20,040 24,999 27,681 37,787 46,486 61,631 + Net long-term assets 56,660 69,547 69,720 71,053 73,984 110,121 = Total Net Operating assets 76,700 94,546 97,401 108,840 120,470 171,752 Net Capital Short term debt - 1,109 660 141 363 599 + Long term debt² 40,279 48,625 48,618 41,915 48,091 93,516 - Cash and Investments 13,930 13,751 23,667 12,328 14,264 20,414 = Net debt 26,349 35,983 25,611 29,728 34,190 73,701 + Preferred equity - - - - - - + Shareholders' equity 50,351 58,563 71,790 79,112 86,280 98,051 = Total Net Capital 76,700 94,546 97,401 108,840 120,470 171,752 Note: 1&2. Adjusted for lease adjustment Appendix 9: Detail Analysis and relevant assumptions on valuation models A. Revenue growth rate forecast The revenue growth forecast of Blackmores is undertaken based on both company s own strategic analysis and market analysis of countries where Blackmores operates. Since Blackmores is a multinational company that operates in many countries within the Asia Pacific region, our market analysis focused on three major markets that we believe contributed or will contribute the most for company s overall revenues. Australia Blackmores will continue to lead the market in Australia maintaining its market share of approximately 17% for the foreseeable future. Their revenue in this region is backed by its popularity and high penetration rate amongst consumers with up to 70% of Australian currently using VDS (Blackmores 2013). The increasing health awareness in the Australian society also means the VDS industry will continue to grow. Blackmores expects the VDS sector to grow at 9% p.a. at the retail level for the next 3 years. However, increased competition, especially from Swisse Vitamins, is posing to be a potential challenges for Blackmores. Its revenue growth rate has decreased dramatically from 8.7% in 2012 to 3.94% in 2013. Taking these factors into account, Blackmores ability to realise the market overall growth will be hindered by the increasing competition and market maturity. Its expansion in Australia is likely to slow as viable locations become increasingly scarce in Australia. As a result, we expect that Blackmores revenue growth rate in Australia in the next 5 years will remain constant at 2013 levels. Table 29: Australian revenue growth rate by Blackmores 2012 2013 Revenue growth rate 8.7% 3.94% Thailand Considering that the revenues generated from Thailand has been stable and factoring in the increase of approximately 20% from 2011 to 2013, Blackmores is expected to enjoy continued steady revenue growth for the next 5 years. 20