Why Blackmores (ASX: BKL) is a Buy

This article was originally published at MF & Co. Asset Management.

Blackmores (ASX BKL) is a supplements company with exposure to the massive Chinese supplements market, which is growing rapidly. The Blackmores share price experienced a meteoric rise in the past two years and a subsequent pullback, is the BKL share price still a buy?

Operating in 17 countries, Blackmores leverages e-commerce presence including a key leadership advisory role in China Association for Quality Inspection (CAQI) to significantly boost profits in the Chinese market. After launching in the Chinese market, BKL is facing problems including fake food, political tension, advertising scandals and growing competition costs.

About Blackmores Limited (ASX BKL)

Blackmores (ASX BKL) is Australia’s leading natural health company offering vitamins, minerals, herbal and nutritional supplements within the company’s product range. Founded in the 1930s, Blackmores was awarded as the ‘most trusted brands’ in 2017.

With a market capitalisation of $2.45 billion, the company has consumers in over seventeen countries, fourteen of which are in Asia.

Major competitors include Swisse Wellness Pty Ltd, and Sanofi-Aventis Australia Pty Limited who own brands such as Healthcare, Nature’s Own, Cenovis, and Ostelin.

Blackmores Is The Biggest Market Player in Australia

 According to IBIS World data, Blackmores is the biggest market player in the vitamin and supplement manufacturing industry in Australia.

Blackmores (41.2%) and Swisse (29.7%) account for over 70% of total market share, followed by Sanofi-Aventis with a smaller market share.

Blackmores share price (ASX BKL) market share

With more than 250 types of products in its range, Blackmores dominates the market as a key market player.

Products are stocked and sold at a wide range leading retailers, including pharmacies (Chemist Warehouseand Priceline), health food stores, and major supermarkets (Coles and Woolworths). More than half of BKL’s total revenue is contributed to the Australian segment.

Business Is Booming Thanks to China’s Consumption

According to Blackmores, direct sales to China for fiscal 2017 rose 71 per cent to $132 million. This translated to a meteoric rise in the Blackmores share price from $90 to over $170 per share.  The company is the only major Australian vitamin companies that remain independent, following Swisse, Vitaco and Nature’s Care buyouts. Corporate deals in the sector continue to help keep valuations rise to meteoric levels.

Due to a widening consumer focus on health, as well as rising household incomes, health and wellness continue to see steady double-digit growth in China.

All over China people are trading up to health and wellness packaged food and beverages, with some trading up to premium imported products such as organic milk.

The health and wellness market in China and is expected to continue to climb to an astonishing $70 billion market by 2020. There is also a need for health products since China has witnessed the problem of obesity-related diseases.

In just one generation, the per cent of overweight and obese children has skyrocketed in China from 5 to 20 percent. The over the counter drug market in China is worth $18 billion dollars and is expected to grow at a rate of $8 billion a year until 2020.

Blackmores strong brand in China will mean that the Blackmores share price will be heavily correlated and leveraged to a rise in this market.

Hurdles In Place For Blackmores – Fake Food, Political Tension and Advertising Scandal

 In May 2018, police in southern China seized more than $6.3 million worth of counterfeit products, including large hauls of popular Australian-branded wines, vitamins, foods, and cosmetics.

As in accordance with a 2016 United States Chamber of Commerce report, China is the world leader in producing and exporting counterfeit goods. PwC estimated 40% of food companies find food fraud difficult to detect with current methods, and 39% believed their products were easy to counterfeit.

Companies like Blackmores could face serious losses and have their reputation damaged by the risk of counterfeit and should be aware and proactive. With that in mind, E-commerce giant Taobao, a subsidiary of Alibaba Group, has begun the fight against counterfeits. Taobao said they shut down 240,000 online shops suspected to be selling counterfeits in 2017. Alibaba is also starting to test block chain technology in the fight against fake food within Australia and New Zealand.

With additional red tape and paperwork required, Australian exporters have been experiencing delays getting shipments cleared since late last year and this could correlate with the tense China-Australia foreign relationship. Historically, China imposed tighter controls on Philippines banana exports in 2012 due to a territorial dispute over the South China Sea.

In 2017, Blackmores was publicly shamed on China’s annual Consumer Rights Day for violating the Chinese government’s strict “truth in advertising” laws. The vitamin company was fined approximately $69,000 for claiming that it was Australia’s top nutritional supplement brand, and that its vitamins could treat cardiovascular disease and assist with the treatment of arthritis.

Furthermore, the Chinese market is becoming a tougher market in which to compete, as different players step up their efforts to gain a bigger share of the market.

Blackmores Results Realigning After Capacity Limit and Re-negotiations

 BKL sales increased 21% in the first half-year of FY 18, however, sales in the third quarter were lower than expected due to capacity-constraint.

Following demand, Blackmores has acquired a tablet and soft-gel capsule making plant in Melbourne, and sales during the last quarter of FY 18 are expected to rise.

EPS has increased dramatically from 1.49 in 2014 to 2.69 in 2015 and to 5.76 in 2016. Additionally, Blackmores has enjoyed more than 1.5 times’ growth because of its expansion into emerging markets such as China. EPS declined drastically to 3.4 in 2017 because of reduced sales and increased costs.The decline in EPS was also evident in the Blkacmores share price

Blackmores share price (ASX BKL) EPS

Blackmores has a profit margin of 10.97%, which is higher than competitors Sirtex (ASX SRX) and Mayne Pharma (ASX MYX). These two companies both have a negative profit margin, implying a difficult time in 2017, but Blackmores has remained strong.

Blackmores’ ROE (11.57%) is higher than SRX and MYX. At the current Blackmores share price at the time of writing, the P/E ratio is 37.94 while the industry level is 29.52, which indicates that Blackmores may be overpriced. However, the higher BKL share price and subsequent PE can be justified by the extreme growth that the company is experiencing.

At the current BKL share price and time of writing, Blackmores has a P/B ratio of 13.6, which is higher than SRX (12.59) and MYX (1.21) as well as the industry level (13.46), which means that investors are paying a high premium for Blackmores’ stocks.

Even though Sirtex and Mayne Pharma are not direct competitors of Blackmores, from a fundamental standpoint, there is more upside and less risk in discretionary products such as supplements compared to the research and development heavy healthcare industry.

Blackmores Continues To Thrive In A Competitive Landscape

Blackmores has been around for many years, and is currently playing in a more competitive market than ever before. Downstream, the company is facing competition from Aumake, a Daigou or retail store that aims to build a vitamin range to rival Blackmores.

Industry wide, competitors like Nutrition Care look to own a slice of Blackmores’ market share. Foreign companies such as China’s PE CDH Investment is also pushing Go Healthy, one of New Zealand’s biggest vitamins brands, to be more competitive in the vitamins market.

Although BKL has been sound financially and has a strong foothold in Australia and New Zealand, expanding into emerging markets is not without costs that could put pressure on the Blackmores share price.

With more competitors coming into the industry both at home and abroad, the company has to be fully aware of how to tackle fake food and potential political risks, as well understand quickly what are the most popular vitamins to continue to thrive in a competitive landscape.

However, as a market leader with a strong brand leveraged to China’s supplements industry which is experiencing double-digit growth, we expect strong upside for the BKL share price for years to come.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

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