2007 | 2008 | ||||||
Price: | 1.33 | EPS | |||||
Shares Out. (in M): | 0 | P/E | |||||
Market Cap (in $M): | 457 | P/FCF | |||||
Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
TEV ($): | 0 | TEV/EBIT |
2001A |
2002A |
2003A |
2004A |
2005A |
2006A |
2007E |
2008E |
2009E | |
Revenue (Hong Kong $) | 93,500 | 138,100 | 188,055 | 262,335 | 346,586 | 466,601 | 615,913 | 800,687 | 1,040,894 |
CGS | -63,822 | -95,360 | -126,876 | -174,045 | |||||
Gross Profit | 124,233 | 166,975 | 219,710 | 292,556 | |||||
Other Operating Inc. | 312 | 1,347 | 3,141 | 8,815 | |||||
Distribution | -35,602 | -57,143 | -92,904 | -138,931 | |||||
Administrative | -8,738 | -12,665 | -14,052 | -16,923 | |||||
Other Operating Exp. | -407 | -870 | -5,743 | -10,333 | |||||
Operating Income | 40,600 | 58,400 | 79,798 | 97,644 | 110,152 | 135,184 | 155,210 | 208,179 | 291,450 |
Finance Cost | -362 | -536 | -444 | -810 | -1,000 | -1,000 | |||
Pretax Profit | 79,798 | 97,282 | 109,616 | 134,740 | 154,400 | 207,179 | 290,450 | ||
Taxes | -13,667 | -9,097 | |||||||
Profit After Taxes | 66,131 | 88,185 | 109,616 | 134,740 | 154,400 | 207,179 | 290,450 | ||
Diluted Shares | 342,360 | 342,360 | 343,991 | 343,991 | 345,000 | 359,000 | 359,000 | ||
EPS (HK$) | 0.19 | 0.26 | 0.32 | 0.39 | 0.45 | 0.58 | 0.81 | ||
EPS (Singapore $) | 0.04 | 0.05 | 0.06 | 0.08 | 0.09 | 0.11 | 0.16 | ||
Operating Stats | |||||||||
Operating Margin | 43.4% | 42.3% | 42.4% | 37.2% | 31.8% | 29.0% | 25.2% | 26.0% | 28.0% |
Revenue Growth | 47.7% | 36.2% | 39.5% | 32.1% | 34.6% | 32.0% | 30.0% | 30.0% | |
Operating Income Growth | 43.8% | 36.6% | 22.4% | 12.8% | 22.7% | 14.8% | 34.1% | 40.0% | |
ROE (Ex. Cash) | 251% | 168% | 133% | 109% | |||||
Valuation | |||||||||
Share Price (Singapore $) | 1.33 | 1.33 | |||||||
Cash | (0.06) | (0.06) | |||||||
Adjusted Price | 1.27 | 1.27 | |||||||
P/E | 11.4 | 8.2 |
Q1 07 |
Q2 07 |
Q3 07E |
Q4 07E |
Q1 08E |
Q2 08E |
Q3 08E |
Q4 08E | |
Revenue (Millions HK$) | 114.7 | 118.7 | 182.1 | 196.0 | 149.1 | 154.3 | 236.8 | 254.9 |
Net Income | 35.4 | 34.6 | 41.9 | 41.2 | 37.3 | 37.8 | 63.9 | 71.4 |
Earnings Growth YOY | 0.7% | 4.8% | 5.3% | 9.3% | 52.6% | 73.3% | ||
Net Income Margin | 31% | 29% | 23% | 21% | 25% | 25% | 27% | 28% |
Subject | New Writeup |
Entry | 10/01/2007 09:13 PM |
Member | thoreau941 |
Description: Summary
Beauty China (Bloomberg ticker BCH SP) possesses one of the top 10 cosmetics brands in China. The company currently trades at 11.4x 2008 earnings and 8.2x 2009 earnings (excluding excess cash on the balance sheet) and has a long-term growth rate of 25-35% per year. We believe this company is worth S$ 2.26-2.84, significantly more than the current price of S$ 1.33. (Prices are in Singapore dollars.)
The company is benefiting from enormous secular tailwinds. Economic history has shown that as countries develop and become more wealthy, people begin to spend a larger and larger portion of their incomes on cosmetics. This is currently taking place in China. The Chinese cosmetics industry is growing rapidly (estimated at 10-20%), and Beauty China will be a prime beneficiary.
Beauty China possesses very attractive financial characteristics. Over the last 5 years, revenue and operating income have grown 38% and 27% on average annually (CAGR). Operating margins are approximately 30%, and ROE is over 100% (will come down).
The primary reason the stock is cheap is because operating profit growth will slow over the next 2-4 quarters due to startup costs as the company ramps up production at its new cosmetics production plant in Zhuhai. During the first half of 2007, revenue grew at 33% and operating income grew at 30%, in line with historical levels. Over the coming several quarters, revenue growth should continue to be around 30%. As the company starts up the new factory, operating income growth will slow. However, once the factory is up and running, Beauty China will experience several quarters of above trend operating income growth as the company recaptures lost margin and experiences margin expansion from the factory. In other words, operating income growth over the coming quarters may look something like 1%, 5%, 5%, 9%, 53%, 73%, instead of 30%, 30%, 30%, . . . . Over the next 2-3 years in totality, operating income should grow 25-35% annualized, but the growth just will not be in a straight line because of costs from bringing the new factory online.
This slowdown in profit growth is completely known and has been discussed by management for the last 7 months. We believe the temporary slowdown in earnings growth presents an opportunity to buy a long term 25-35% grower at 11.4x earnings in an extremely attractive business.
In addition to this writeup, the reports put out by Merrill Lynch and the company’s investor presentation (available at http://www.beautychinaholdings.com/IR_slides.asp) are useful sources of information. The stock trades approximately $600,000 (USD) per day on the Singapore exchange and so is liquid enough for institutional investors to buy.
Background
Over the last several years, we have been watching the tremendous economic growth taking place in China and India and wondering how to participate. As long-term value investors, our hope has been to invest now in great businesses with long runways of growth ahead that we hope to own for a long time. If we can find businesses in China of the same quality as Starbuck’s, Moody’s, or See’s Candy in the US, we should be able to compound money at high rates of return for a long period of time.
Unfortunately, finding companies like these has been easier said than done. Most of the Chinese businesses that we are pitched have narrow economic moats, questionable business models, or are in commodity industries. And the Chinese companies with significant competitive moats tend to already be trading at nosebleed valuations. Beauty China is one of the few Chinese companies we have looked at in an attractive business that trades at a cheap valuation. Cosmetics companies with strong brands are truly great businesses. They typically have ability to raise prices from year to year, grow over the long-term, have high margins, generate strong cash flow, possess high return on capital, and are stable businesses as long as brand identity is maintained.
The Business
Beauty China sells two main brands of cosmetics. Colour Zone is the company’s flagship brand responsible for approximately 90% of sales. The company is developing a second brand called Charming Lady which is currently in its startup phase.
The Chinese cosmetics market can be divided into 3 tiers. At the very high end are brands like Lancome. High end brands sell products which are nearly identical in quality and price point to the products those companies sell in the West and Japan. The mass market (middle level) is made up of branded products made by both Chinese companies and international cosmetics giants. Price points in this market typically range from 40-150 RMB ($5-20). Below the mass market, the cosmetics market is mainly made up of unbranded, low price products. Product quality at the low end can be highly inconsistent.
The mass market is currently affordable for a fraction of people in China. Accurate data is hard to obtain, but published estimates suggest that perhaps 150 million of China’s 1.3 billion people can afford mass market cosmetics. As the country becomes increasingly wealthy more and more people are beginning to be able to afford cosmetics. Currently, annual per capita spending on cosmetics averages $4 compared to $60 in the West. However, annual per capita cosmetics spending in the most developed Chinese cities (where wages and incomes are higher) is already up to $20. Based on this data, one might anticipate that the cosmetics market will have a long road of growth ahead. The market is currently estimated to be growing at 10-20% annually.
Beauty China’s products address the mass market segment. Colour Zone products participate in the middle-to-low price points of the mass market, and Charming Lady (in development) addresses the high end of the mass market. Colour Zone’s target demographic is young women ages 18-28. Charming Lady is targeted to a slightly older age group with more conservative color choices and the ability to add on a high margin skin care segment similar to Avon and Olay. Competing products in the middle market include local Chinese brands and Western brands such as Maybelline, Avon, Revlon, Cover Girl, etc.
Beauty China was started in 1996 by Wong Hon Wai (Chairman). In the beginning, the company had only 50 products. Access to capital was limited at the time so the company developed a low capital, low-risk
Catalyst: 1. Successful startup of Zhuhai plant and recapture of ma | |
Subject | Distributors |
Entry | 10/02/2007 02:50 PM |
Member | david101 |
Thoreau, Can you provide some more color on the distributors? Who are the distributors? Are they wholesalers or retail chains? Who are the bigeest distributors and what type of relationship does BCH have with them? I understand the benefits of having third party distributors but it would be helpful to understand the risks, as well. David | |
Subject | Reply to Scrooge |
Entry | 10/02/2007 09:15 PM |
Member | pman908 |
Thanks for the questions. 1. Why do you think they have been successful so far selling to the middle and low income market? Is there something about their product, how they advertise or about how they sell to their customers that make them stand out? I think BCH has been successful because they have a strong brand and a reputation for having quality products. Overall, I do not think they have a “secret sauce” that the competition does not have. (This is similar to the US where I do not think Revlon and Cover Girl have a secret sauce that Avon and Maybelline do not have.) However, I think Beauty China is very good at the key elements of the business. They are strong at marketing (picking up the Twins as brand ambassadors was especially savvy), strong at quality control, and possess a well managed distribution network. 2. What do you think is their payback period for the plant in Zhuhai? I think the payback period will be 3-5 years, depending on how fast they can get the capacity ramped up. Capacity ramp comes from two things, first is the production of their own products (in methods testing now with business license expected in the near term) and the second is the outsourced OEM production. I would anticipate that the production of their own supply (which will be coming on all year and be completely in house by the end of the year) will fill approximately 40% of production. The company hopes to build up OEM business over the same time period and into the future. Given the stellar condition of the factory and the associated GMP certificates already obtained, I would anticipate the company would reach its breakeven capacity in the next year. 3. What are the terms of their sales? Do they give 60 day credit? And do the suppliers give them credit when they purchase raw materials? When BCH buys raw materials, the raw materials and finished inventory are mostly carried on the balance sheets of the distributors and outsourced manufacturers. (This is why inventory is only 1/8 of COGS.) BCH typically gives 90 days credit to their distributors and receives 60 days credit from their suppliers. | |
Subject | Reply to David |
Entry | 10/02/2007 09:17 PM |
Member | pman908 |
1. Can you provide some more color on the distributors? Who are the distributors? Are they wholesalers or retail chains? Who are the biggest distributors and what type of relationship does BCH have with them? Most of the distributors are individuals/companies in China that set up shops in department stores. Some distributors may work in specific regions with fewer counters, and others may have further reaching networks and relationships. In China, department stores allocate a lot of space to vendors to set up counters at which they sell product. Unlike the Macy’s model we are used to in the States, it is very much a store within a store model, with a landlord owning the building, and the individual departments (cosmetic, fashion, fragrance, etc.) all being run by outside companies paying a percentage lease. Given the good brand acceptance of Color Zone, and the easy “add-on” option of Charming Lady which can be added to existing leasehold improvements, these distributors can turn a fantastic return with little investment. Beauty China does sell through some retailers (such as Sa Sa) as well. Generally, BCH will pay for the counters and signage. (This is done to ensure branding uniformity.) BCH will sell to distributors at 50% of the retail price. So a 50 RMB item is sold to the distributor at 25 RMB. As BCH has a 63% gross margin, this items is made for roughly 8-9 RMB. Distributors generally cannot return product. | |
Subject | Clarification |
Entry | 10/02/2007 11:49 PM |
Member | thoreau941 |
Due to an inability to log in earlier this evening, I asked a friend (pman908) to post my answers to today’s questions in an effort to get them up in a timely manner. Hope they help. | |
Subject | Answer to Scrooge |
Entry | 10/04/2007 07:51 PM |
Member | thoreau941 |
Yes, you are right. BCH has less inventory, but their cash conversion cycle is not much better because BCH has larger accounts receivable balances and lower accounts payable. BCH does run with less PPE than the competition and overall is less asset intensive. | |
Subject | Taxes |
Entry | 10/10/2007 09:51 AM |
Member | ilpadrino98 |
The company sells in China, but runs its business through Macau, although listed in Singapore, but domiciled in the Caymans. Will they ever have to pay taxes? | |
Subject | Reply to Taxes |
Entry | 10/10/2007 10:06 AM |
Member | thoreau941 |
The business of procuring and marking up the raw materials for production of the product is run through Macao, this business will likely be tax free for the foreseeable future. The marginal profit generated at the factory, when it become operational, will most likely be taxable at the new standardized Chinese tax rate, however we anticipate that much of this profit can be booked through the Macao entity thus limiting taxable income as much as possible. Keep in mind that they make much of the margin on the procurement business. | |
Subject | quality of management |
Entry | 10/10/2007 10:10 AM |
Member | ilpadrino98 |
Do you have a view on the management team? | |
Subject | Mamagement Quality |
Entry | 10/10/2007 01:28 PM |
Member | thoreau941 |
We have not spent time with the chairman, however we have spent time with the CFO and the director of production at the factory and found them to be knowledgeable and conscientious. In addition some of the analysts who cover the company have come away with positive comments regarding his abilities. | |
Subject | update? |
Entry | 01/14/2009 01:57 PM |
Member | mpk391 |
still following this one? Seemed to me the fundamentals have been holding up fine thx | |
Subject | RE: update? |
Entry | 01/15/2009 04:42 PM |
Member | thoreau941 |
Yes--fundamentals are holding up well. The company saw almost no effect from the slowdown in China's economy through Q3. My expectation is that there will be some pressure on growth and/or margins as things worsen in China going forward, but I think the company should remain profitable and may even be able to grow profits through downturn. BCH has also been picking up foreign orders for its new factory so that should help some. The company has about 20% of the mkt cap in net cash so the risk is low. | |
Subject | market share |
Entry | 01/16/2009 05:47 PM |
Member | mpk391 |
One more question: where is BCH now in terms of market share, which way is that trending and why? According to one article (see link) BCH had 1% around Jan 2005, and back then the concern was that gradual lowering of import tariffs would mean more foreign competition for BCH, yet they apparently grew to 4-5% share by Oct 2007 per your writeup. I'm just wondering who has been losing share. Supposedly foreign brands were already 68% of the market in Jan 2005 (20% by volume). I'm guessing that if tariffs have come down and the government has tightened regulations on safety and quality, that argues for an even higher share today - but it's just a guess. So could BCH have gained at the expense of other domestic guys? And whatever the trend, is it likely to continue? Finally, does the history of other markets offer any clues here? i.e. did foreigners try hard to get into countries like Japan, Korea, Singapore, etc. when their living standards began to really take off? if so, how did that play out, etc.
http://www.sharedxpertise.org/file/2371/outsourcing-works-for-beauty-china.html |