Has Hai-O’s MLM division bottomed out?

Hai-O Enterprise Bhd
(Dec 21, RM2.60)


Maintain “underperform” at RM2.87 with reduced fair value of RM1.35 (from RM1.71): Aside from being affected by the amendment to the Direct Selling Act (DSA), Hai-O’s MLM division was affected by weaker sales in September, partly because of Ramadan and Hari Raya Aidilfitri resulting in lower member productivity.

Over 90% of its members are Malays. However, we understand that sales were abnormally low, even for a Ramadan month, and a lot worse than previous fasting months, which we believe was partially due to the continuation of the downward momentum seen in previous months.

We understand the MLM division will be on a better footing after Hai-O’s internal restructuring, undertaken in April as a result of the amendment to the DSA.

The management believes that 2Q11 represented the bottom for its MLM division and it expects sales to grow from here on through various new strategies, such as new
incentives for the members, new products, and emphasis on training.

Previously, Hai-O’s incentives included yearly trips to various countries in Europe once a member reached a certain sales target. It is now introducing holiday trips closer to home, Hong Kong and Australia, for example, with a lower sales target so more members can achieve it.

Hai-O’s Indonesian venture is still loss-making, although management does expect it to break even by April 2011 (end-FY11). We understand that it is now focusing on

smaller towns, such as Pekan Baru and Surabaya, where it currently has one stockist each. Hai-O’s initial target market was Jakarta, but the capital did not receive its products well as the market was already saturated with similar products, that is water filters. We understand the total core distribution force (CDF) in Indonesia is about 300 members, but only a small number are active.

The risks include:

(i) termination of supply agreements from its suppliers in China;
(ii) stronger than expected strengthening of the US dollar; and
(iii) weaker than expected increase in consumer spending.

After the changes in our revenue/member assumptions, and after imputing its energy division losses of RM2 million, our FY11/13 earnings were reduced by 19.8% to 22.5% per year.

After our earnings changes, our fair value is reduced to RM1.35 (from RM1.71 previously) based on unchanged 10 times CY11 earnings per share.

Maintain “underperform”. — RHB Research, Dec 21