Blackmores: Interim result 2019

Blackmores has been one of the market's 'China stocks' for years; yet in the latest half direct sales to China fell 11%. Investors panicked, prompting a 25% fall in the stock. 

Although direct Chinese sales fell, when you include 'Chinese-influenced' sales through Australian retailers - where enterprising individuals buy supplements in Australia to ship back to China - sales to Chinese consumers actually rose 8%. That's still a long way from the double digits investors are used to.

Management said the main driver behind the diverging Chinese sales result was Australian retailers 'more directly targeting the China export trade'. In other words, your local pharmacy is doing a better job of marketing to Chinese entrepreneurs, who are preferentially buying from them at the expense of direct purchases within China itself. 

We're not buying it

We think chief executive Richard Henfrey touched on a bigger reason for China's decline during an analyst call: 'I think there is an issue in China, which is just that it's a very crowded market space. There's a lot of brands piling in cross-border. So it's really important that we're visible, loud and proud in all of those areas.' 

China is a big market, no debate there, but big markets have a way of attracting hungry competitors. Blackmores increased its marketing spending in the region this half, but with limited brand recognition and thousands of competitors trying to do the same, the campaigns don't seem to be gaining traction. 

To make matters worse, vitamins are considered a luxury item in many parts of China, where disposable incomes are lower, unlike their everyday grocery status in Australia. And if you want to pinch pennies, what's the first thing you cut from your shopping list? Luxury items. China recorded its lowest GDP growth in 25 years this past year and that's likely to have caused shoppers to cut back on supplements generally. 

Selling and marketing expenses rose 31% during the half due largely to investment in China and other Asian countries, which caused Blackmores' operating margin to fall from 17% to 16%. Net profit was flat at $34m, despite an 11% increase in total revenue to $319m.

Australian sales strong

Despite Blackmores' China troubles, the company achieved record revenue in several other Asian markets, such as Korea, where sales rose 67%, and Indonesia, where sales grew 72% thanks to the country's largest pharmacy chain adding Blackmores to its shelves.

Australian sales were also strong: revenue increased 19% to $144m, with management attributing the rise to increased investment in promotional activity, as well as retailers targeting exports, as mentioned above. The company's BioCeuticals practitioner-only brand had a good year, with sales up 7%, and - keen to join another shaky bandwagon - management even mentioned the commencement of a study into whether medical cannabis can be used as a cancer treatment.

Turning to the balance sheet, net debt rose from $50m in June 2018 to $71m due to an increase in working capital and the November purchase of the Impromy weight loss program. Net debt has risen three years in a row and we'd prefer to see it going the other way given the volatility of sales. However, Blackmores still has a relatively clean balance sheet and operating profits exceed interest expense a good 23 times over, so we don't expect debt to be a problem unless sales drop materially.

Though management didn't provide specific numbers, it said 'we do not expect the second half profit performance to be ahead of the first half'. Blackmores trades on a price-earnings ratio of 23, though with management's ominous guidance and the slowdown in China, we wouldn't be surprised if profits decline in the full-year result. 

The stock is down 45% since we recommended selling a bit over a year ago in Blackmores and the marketing arms race. We're lowering our price guide but, with a strong brand, decent Australian sales growth and economies of scale, we're sticking with HOLD.