Saturday, May 22, 2010

The Great: Hai-O Enterprise Bhd




Brief Business Background
Hai-O or seagull in Mandarin founded in 1975 with an initial capital of RM168K. Today it is worth about RM780millions (as of the time of writing). Hai-O as most of us know today is a Traditional Chinese Medicine (TCM) wholesaler and retailer – or most of us thought so. Actually, Hai-O Ent also involved in Multi-Level Marketing (MLM) via its subsidiary Hai-O Marketing. In fact, as of FY09, 80% of its revenue and 78.5% of its pretax earnings is contributed by its MLM division. And despite Chinese sounding name, some 90% of its direct marketers are Bumiputras.
Hai-O Marketing isn’t selling TCM to the Bumiputras but in fact an entirely different types of products. Its champions are Bio-Aura water filter, Premium Beautiful foundation lingerie as well as its new LaPraise and Bio-Ever personal care products. I’ll not go too into details about each of these products but if you were to know more you can contact one of their distributors.
Well, when we talk about MLM business it is not just about the products – of course it involves the product – but not just that. It needs its marketing business plan to work for their distributors as well. This is how they grow. MLM works for both sides leveraging on distributors for time and effort and the distributors leverage on producer (Hai-O for this matter) on its finances and products. Unlike the olden days, people are now starting to understand this idea and accepting it.
I am not selling any MLM products to you but this is just my belief. Yes, over the years there are many MLMs popping out in Malaysia and mostly are scam. Some I’ve never even heard of. But let me ask you this, are you sure your bank is not putting a scam on you? I can talk lengthy about this but I just wanted to let you know that basically any business is susceptible to scam. To avoid being cheated, please do your homework. The great Warren Buffett is a good example; he doesn’t buy businesses that he doesn’t understand.
Historical Business Performance
I would say, Hai-O Ent fell into a blue ocean by accident. If you go all the way back to 1997, things do not go really well for Hai-O. Its was plagued by internal power struggle from 1997 to 2000. Top Chinese salespersons left during the height of economy crisis in 1998. However, Managing Director Tan Kai Hee took order to revamp its MLM business. Malays salespersons who mostly stayed, turned out to be a blessing in disguised for Hai-O. YES, a vast unexplored market in this country and the rest are histories…….
Sales and earnings wise, Hai-O Ent has grown at the average rate of 32.8% annually while pre-tax earnings grows at 64.7% mainly driven by its MLM divison. I’m not sure how true this statistic is, but I was told MLM in this country has been growing 40% annually. If it is true, Hai-O is definitely riding on this growth.




Gross profit ratio is consistent around 30%-35% (Higher than Amway which is around 25%-31%). Net profit ratio has improved to about 17.6% - likely due to restructing process. Some may want to this to Zhulian. Zhulian has way higher margin because they manufactured their products in-house. There is a BUT…I’ll write about that next time.
Hai-O sales force seem to be more productive versus the likes of Zhulian – they compete in the same market. A rough figures shows that Hai-O members produce RM3400/member while Zhulian made RM788/member. Probably due to its higher cost of entry to join Hai-O distributors force which is around RM28K each. With this, Hai-O able to recruit more serious members. You won’t pay that much of money unless you are serious right?
Its Balance Sheet looks pretty healthy as well for the past 5 years. With my extreme liquid test where liquid assets = current assets – inventories – receivables, it look like the table below 0.86 – 1.35. For business like Hai-O, the receivables portion might not seem necessary but I just wanted to show you how strong they are.




Yea,with this much of cash, they must have retain lots of their profits lo. Err…yes and no. Hai-O has a dividend policy of returning 50% of their profits as dividend. So, this shows that they are really good at generating cash. With current price weakness, you’ll get dividend yield at about 3%-3.3%.(correction on dividend yield)
Inventories turnover takes about 1-3 months while receivables turnover takes less than 2 months for the past 5 years. Not bad at all. Hai-O doesn’t seem to like keeping debts for too long so their credit repayment period takes less than 2 months. That’s good.
ROE is improving over the years and in FY09 its ROE stands at 34.2% slightly lower than FY08 at 34.9%.
Prospect
Management wise, they have made few bad investments actually in the past. But they seem to have learn from it. Unlike others, they don’t jump into expansion plan quickly. They do look more careful nowadays. Indonesia is their first foreign market and are slowly looking into China. Current shareholders and potential buyers should scrutinise closely about their plan in China. Yes, China’s market is enormous so as the competition. Many have gone there and fail. Indonesia will be a new source of growth for Hai-O. Like China, Indonesia’s market is its private consumption. Its population is 10 times the size of Malaysia. If it turns out well, it is gonna be HUGE.
How much should you pay for Hai-O?
The big question is, is 30% growth sustainable. Well, I doubt UNLESS their Indonesia business turns out well. To stay conservative, I’ll exclude the operations in Indonesia and focus solely on Malaysia. For Malaysia, my valuation will be based on forecast over the next 5 years as Malaysian market is saturating.
  • Cost of Revenue: Cost of revenue stays around 67% for the past 5 years so I’ll stick to this. Hai-O are beginning to manufacture more products themselves and that should improve margins. But I’ll stick with 67%.
  • SGA Expenses: 20% of revenue.
  • Depretiation: Maybe about RM2.5millions.
  • Changes in Working Capital: This has actually correlates with its revenue over the years.
  • Capex: After their Indonesia expansion, it should stays back to about RM2.5millions.
  • Income Tax: 25%
  • Revenue: This is the tough part. Historically, you’ll see that it has grown at about 32.8% annually. Well, this number is a bit too high for me to do a valuation. Just wanted to stay conservative to get the best price. I wasn’t sure which economy data correlates with MLM businesses. Anyway,I’ll use the average GDP growth of 12% over the next 5 years and 3% for terminal value after. Maybe I could come out with a better way someday.
What do I get from here? Since revenue growth is estimated base on average GDP growth, I might over estimate it. So, I’ll use a higher discount factor of 12% (considering I’ve yet to include operations in Indonesia 12% is actually 40% of risk in my risk profile). With 20% margin of error, Hai-O Enterprise is valued at RM5.30 - 5.60.
For a business with such huge potential growth, I would BUY it below RM5.30.




This is based on my personal thoughts, opinions and my risk tolerance. It should not be considered as an investment advise. Please consult your financial advisor or do some research of your own before making any decision. You might have your own thoughts. I would love to here from you. You can always place your comments here and or email me privately at luzeeker@gmail.com


2 comments:

Darknight said...

Just found out this blog, Hai-O is sliding, what do you think? Is it the time to accumulate this stock?

LuZeeker said...

I am still working on the valuation. If don't mind my "cheong hei" thoughts, I have just posted on Hai-O