OSIM has always been able to deliver more than 20% in return on equity before the investment in 2005 as well as from 2009 onwards after the write-down on Brookstone. Using the Du Pont financial ratio, ROE is the multiplication of net profit margin x asset turnover x equity multiplier. With this in mind, I shall delve further into the business model of OSIM.
Figure 2 10 Years Profit Margin Figure
For most of the 10 years period, OSIM has been able to maintain a net profit margin of 10% other than in 2007-2009. For 2006, it is as a result of finance expense as well as Brookstone losses, else its net profit margin will be around 10% too. How has OSIM been able to maintain a 10% profit margin despite its high advertising expenses as well as aggressive expansion?
Branding. This has been the key word to OSIM's success to date as mentioned here:
"I had to shift from being a trader to being a builder. I thought the best way was really to create your own brand, create your own products, designs,concepts and services because if you can't differentiate, over time, you will lose control. As a Singapore company, we have a very small domestic market. So how can you grow if you do not build on your brand? Since 1989, when we embarked on brand building, we have grown 20 to 30 per cent."
Source : http://www.scribd.com/doc/80778051/OSIM-Research-Info
Figure 3 - Price Comparison
Brand has not only been the key factor that has allowed OSIM to secure a very strong market share such that when we talk about massage chair the name of OSIM naturally comes to our mind. It has also allowed OSIM to price its product above its competitor without losing significant market share as the price comparison chart shown above. Of course, to be able to continue holding on to this mind share requires significant advertising expenditure which will naturally eat into the profit margin.
Between 2007 to 2009, net profit margin even after excluding Brookstone drops tremendously as a result of recession to 5% and below. This drop in net profit margin is accompanied by a drop in revenue which hints that either gross profit margin is affected or fixed cost accounts for a huge percentage of revenue.
Figure 4 - Gross Margin
From figure 4, we can infer how OSIM has been able to grow its net profit so fast during the past 2 years. COGS as a percentage of total revenue drops rapidly from 37% during 2007-2009 to 34.6% in 2010 and 31% in 2011. It is more than likely that OSIM has priced their goods higher than that they have managed to reduce their COGS as this is a period of economic recovery and strong growth. However, this is still unable to explain their 50% profit growth in 2009 where revenue only increases by 5%.
Figure 5 - Financial Statement for 2007
Figure 6 - Financial Statement for 2009
Figure 7 - Financial Statement for 2011
From figure 6, we can also easily understand how profit expanded by 50% in 2009 without an increase in gross profit margin. Ignoring "Changes in Inventories of Finished Goods" as well as "Finished goods purchased" since they stand for Cost of Goods Sold, its pretty obvious that the rest of the cost hardly changes. Something surprising is that despite all the revenue fluctuation from 2006 to 2011, employee benefits expense, other operating expenses (this was much higher in 2006 as OSIM had undergone a restructuring exercise in 2007) and depreciation expenses hardly changes throughout the 6 years. Therefore, we can conclude that OSIM has a high fixed cost business that cannot be easily sized down even during recession. This fixed cost as whole is around $250m to $300m annually which comes to around 50% of the total revenue.
What the above 2 paragraphs serve to show is that should a recession comes, OSIM will be hit badly as a result of higher fixed cost % (due to drop in revenue) as well as shrinking of gross margin coming from pricing down of goods. This is not totally unexpected as OSIM's product is not really a luxury good and it is something that is not necessary especially during a recession. As such, OSIM can be viewed as a cyclical stock though its core business did not create losses during 2007-2009. Another point to note is that as OSIM is a franchisee of GNC, it has to pay 5% royalty fee on its total revenue which can easily be a matter of profit or losses.
Figure 8 - Summarised 5 years Balance Sheet
For asset turnover ratio wise, it has ranged from 1.5 time to 2x (total asset is current asset + the non-curren asset reflected right above the current asset). However, I feel that the 2 x asset turnover ratio from 2008-2010 is not a very good ratio to use though there is nothing wrong theoretically. As seen above, the huge write-off of $90m off the shareholders equity (more than 50% of the equity in 2007) sort of falsely inflated the asset turnover ratio for the next 3 years. If you are thinking in terms of ROIC, there seemed to be no mistake as the leftover equity is the capital that they are really using to fund their core business. However, OSIM has previously been using those 166m equity to fund most of OSIM's expansion before that, which I feel should be accounted for when calculating the actual ROE of the business from 2008-2010. For 2011, expansion has been using funds generated during the past year, as such using 168 million as the equity is acceptable.
As for equity multiplier, the figure has been at around 2x -3x even after the write off of Brookstone. With such high equity multiplier, question must then be asked regarding the strength of the balance sheet as well as the type of liabilities that it holds. Since 2009 onwards, OSIM has learned from its LBO mistakes and has quickly paid all its term loan as we seen from Figure 8 where term loan has been fully paid by 2009. However, in 2011, OSIM has once again issued a $120 million convertible bond at an interest rate of 2.75%. Next, we shall look at the current liabilities.
Figure 9 - Current Liabilities
Figure 10 - Current Asset
Looking at Figure 9, interest loan only takes up 10% of the total current liabilities which means OSIM has a relatively strong balance sheet currently. This is taking into account that it has not spent much of the $120 million from issuing of convertible bond as seen in the fixed deposit. Should they decide to spend it in a huge acquisition, OSIM will then have a weak balance sheet.
As for the other 90% current liabilities, these are supposed to be treated as interest-free loan that OSIM has earned through its own ability. Owning a 30% stake in the OSIM-Daito subsidiary as well as a 20 years relationship with key contractor Oriental Export & Import Co has allowed OSIM to have a low working capital requirement. Owning $100 million in payables, OSIM only has a receivables of $50 million, which means OSIM enjoys a $50 million free short-term working capital. This is a definitely a key advantage of OSIM as it has definitely helped to mitigate its huge debt in the past. Therefore, before 2011 OSIM has a healthy equity multiplier which rightly boosted its ROE. However, taking on a $120m convertible bond, the ROA might now be a better ratio to use over ROE when analysing OSIM.
In conclusion, OSIM's key competitive advantage lies in its brand, premium pricing, relationship with suppliers as well as its negative working capital. However, it is subjected to recessionary pressure which will not only erode gross margin but also increases its fixed cost per unit sold. Another key risk will be that OSIM returns to its Brookstone path through aggressive acquisition and expansion through debt as seen from its issuing of $120m convertible bond. At the current price, I will not dare to touch it not only because that I might be catching it at the peak earning but that its expansion might drag it down should recession comes. As in 2008, this is a stock worth catching perhaps after the balance sheet is cleared and net profit falls drastically.
No comments :
Post a Comment