Blackmores: Interim result 2018

Blackmores' stock is down 20% since we recommended selling in November (see Blackmores and the marketing arms race). Most of that decline occurred last Thursday, when the company announced shortages of key ingredients, such as whey protein and fish oil, as well as increasing competition in China.  

The vitamin and supplement maker had a difficult six months to December in the Australian market: sales fell 2% to $121m, though Asian sales helped boost overall revenue to $287m, up 9%

The main culprit was a decline in Chinese-influenced sales through Australian retailers. The army of Chinese entrepreneurs who were buying every bottle they could get their hands on and shipping it back to China – where it could be sold for double or triple the price – have pulled back from the Australian market due to more easily sourced material in China (which we'll get to in a moment).

‘Independent scan data affirms that domestic sales are steady despite the subdued overall consumer retail market,' said management.

Asian growth continues

The company is pushing aggressively into China, Malaysia, Thailand, Taiwan, Hong Kong and Singapore. Blackmores' direct sales to China grew 27% to $74m, accounting for a quarter of total revenue. Unfortunately, margins declined in the region due to increased investment and promotional activity to remain competitive. Other Asian sales were up 18%, with Korea returning to sales growth and a new range of products being registered in Vietnam.

As a proportion of total revenue, overseas sales have increased from 20% to around 40% over the past five years. Asian consumers now account for almost half the company's total sales if you include the indirect sales to China mentioned earlier.

We don't see any specific dark clouds on the horizon, but risks are building as sales are increasingly sourced from developing countries, which tend to be more sensitive to economic swings. Vitamins are an everyday grocery item in Australia, but they are still considered a luxury item in many parts of Asia, where disposable incomes are lower. If those economies hit a rough patch, supplements will be one of the first things off the shopping list.

BioCeuticals

The company's BioCeuticals practitioner-only brand also had a good year, with sales up 16% despite the company experiencing supply challenges. Unfortunately, higher marketing costs meant that earnings before interest and tax (EBIT) was up only 3%.

Turning to the balance sheet, net debt rose from $45m to $66m, which was attributed to the purchase of shares as part of Blackmores' three-year long-term executive incentive plan and the funding of the dividend payment (gulp). Nonetheless, Blackmores has a relatively clean balance sheet and operating profits exceed interest expense a good 20 times over, so we don't expect the debt to be a problem unless sales drop materially.

Net profit rose 20% to $34m due to the strong sales growth outstripping the cost of raw materials and a decline in interest expenses. Management said ‘supply issues affecting the group and the soft Australian retail market will impact us in the second half, though we remain confident we will continue to deliver good profit growth for the full year'.

Blackmores trades on a forward price-earnings ratio of 27 based on consensus estimates for 2018 earnings. The slowdown in Australian sales and rising debt is a concern, but the company still has plenty of growth potential, a strong brand and economies of scale. With the stock having fallen below our recommended Sell price of $150, we're upgrading to HOLD.