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16-Nov 2015 Monday 10:54 PM (3084 days ago)

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To identify a value growth company, we can first look into the company’s business. Although OSIM International (OSIM) has diversified and is growing its business into luxury tea as well as health and nutrition products industry under TWG Tea (TWG) and GNC respectively, its main business is in luxury lifestyle products such as high quality massage chairs and various other kinds of massagers.

OSIM’s shares have plunged 45.6 percent over the past year to $1.475 as of 7 Sep 2015 from a 52 week high of $2.71, after poor sales in Asian markets and contraction in its margins have resulted in disappointing quarterly results.

The Business

OSIM currently leads the industry with a total of 827 retail outlets inclusive of 220 GNC/Richlife outlets and 47 TWG outlets, with 254 OSIM outlets in 45 cities across China.

Other notable industry participants are OGAWA and OTO, both of which are also competing for market share in China.

While companies in this industry have patented design and technology, limiting the threat of new entrants, imitation products have always been a problem.

However, there is hardly any notable substitute product or services, except for massage therapists which are not as convenient and would cost several times more over the long run.

OSIM would likely be able to maintain the profit margin for its products as low cost manufacturers are abundant in China. OSIM’s strategy of marketing its products to the growing middle and upper class have been successful thus far, as household income have been increasing across major markets such as Singapore and China, maintaining its luxury massage chair’s premium pricing.

In a recent release of The China Mass Affluent White Paper 2015 by CreditEase Wealth Management and Forbes China, China’s mass affluent population, those with investible assets of between Rmb0.6 million and Rmb6 million, numbered 13.88 million, up from 11.97 million in 2013, and is expected to increase to 15.28 million by the end of 2015.

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16-Nov 2015 Monday 10:55 PM (3084 days ago)

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In a recent release of The China Mass Affluent White Paper 2015 by CreditEase Wealth Management and Forbes China, China’s mass affluent population, those with investible assets of between Rmb0.6 million and Rmb6 million, numbered 13.88 million, up from 11.97 million in 2013, and is expected to increase to 15.28 million by the end of 2015.

The Management

OSIM’s chairman and chief executive officer, Ron Sim, holds 66 percent of the company’s shares, indicating a close alignment of shareholders’ and management’s interests.

The company also adopts a remuneration policy for its staff comprising a fixed component and a variable component that is linked to the company and individual performance.

While we would not be able to determine the exact percentage components, OSIM paid its top 8 directors $7.8 million in FY14, approximately 7.6 percent of its net profit for the year which we believe to be a reasonable amount.

Based on the latest four annual reports prior to delisting from Bursa Malaysia, OSIM’s Malaysian competitor, Ogawa, paid its top 9 directors a total remuneration package which made up least 26.7 percent of its net profits.

In identifying a growth company, ideally we would prefer a company with a compound annualized growth rate (CAGR) of 15 percent to 50 percent over the last three to five years.

While OSIM registered a less than desirable CAGR top line growth of 6.3 percent over the last five years, its overall results met our expectations with a 15.3 percent compounded annual growth in net profits and a 12.7 percent compounded annual growth in earnings per share from $0.0738 in FY10 to $0.1341 in FY14.

OSIM has a high current ratio of 4 as of 1H15 with $302.2 million in fixed deposits and $102.3 million in cash. Though a high current ratio allows the company to capitalize on investment opportunities, OSIM’s abnormally high current ratio might stem partly from the founder’s personal preference for higher liquidity after his near brush with bankruptcy during the 1985 recession.

Nonetheless, a company which is able to achieve such a growth rate despite having a high current ratio with increasing dividend payout ratios from 27.1 percent in FY10 to 44.7 percent in FY14, is worth our consideration.

High Net Cash

Over the years, OSIM has been increasing its stake in TWG to 69.9 percent. With TWG being the key growth driver, we can expect another increase in equity interest in TWG within the 12 to 18 months as OSIM’s strong war chest is more than sufficient for such a move.

OSIM has also recently acquired 21 percent of Hong Kong-based cosmetics company Laboratoires Du Palais Royal Limited, and 8.41 percent in Trek 2000 International. This could indicate a signal that the group has some collaboration plans in the pipeline.

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16-Nov 2015 Monday 10:57 PM (3084 days ago)

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The Valuation

We expect the number of TWG outlets to increase at a steady pace to 55 by end 2015 and to 70 by end 2016. TWG is expected to lead OSIM’s growth over the next 2 years.

For 2014, we estimate that TWG Tea accounted for 10 percent to 12 percent of revenue. We expect the portion to increase to 14 percent in FY16 and to 19 percent in FY17 as new stores commence operations and corporate sales pick up. We expect strong performance from TWG to be seen in OSIM moving forward

Despite the disappointing 1H15 results, we expect OSIM to pick up the pace in 2H15 following the launch of new versions of its popular massage chair. We expect FY15 EPS to maintain at FY14’s EPS at $0.135, plausible earnings recovery in FY16 with a bigger boost in FY17.

OSIM has shown impressive results over the last 5 years, by reinvesting an average of 61.1 percent of its net profits while growing its equity by 38.6 percent.

As growth rate is derived by the return on equity multiplied by the earnings retention rate, this translates into an overall annual growth rate of 23.6 percent over the last 5 years.

Currently, OSIM’s shares are trading at a PE of 14.2x based on earnings from the latest 4 quarters. The shares were trading between a PE band of 20.7x and 12.1x over the last 3 years, with an average PE of 16.2x.

Despite the impressive results over the last 5 years, we maintain a cautiously optimistic view amid the uncertain global economic situation. Should OSIM trade near the average PE range, based on the closing price of $1.475 as of 7 Sep 2015, its upside would be approximately 14.1 percent.

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