Osim International Ltd (Time to buy?)

A stock that has been on my radar for years (read here) is currently trading near its 52 weeks low. The stock price of OSIM International Ltd on 25 June 2015 is 1.6350, which is inches above the 52 weeks low of 1.62.

“If the stock goes down we want to buy more.” “Look at companies selling at new lows.” Walter Schloss

Before I elaborate further, I must highlight that I have always had reservation about OSIM.

I have always like companies which produce low tech, easy and disposable products, similar to how Peter and Warren would have liked Gillette (repetitive nature of the product that is relatively immune from technological obsolescence and recessions). The impression I have of OSIM products, is the opposite of that. Known for its range of innovative massage chairs, OSIM has produced some of the most iconic (and pricey) products such as uDivine (approx. $4,988), uInfinity (approx. $6,988), uAngel and uDiv (even TWG tea seems a bit on the expensive side). Therefore on numerous occasions, I have ignored news on OSIM.

Nevertheless, it was the best stock performer in Singapore since the global financial crisis (which was why it caught my attention then). It was a high growth stock. However, how times have changed. (If you read the posts in Value Buddies, you can find investors screaming for the blood of Ron Sim, Founder and chief executive of OSIM).

The drop in the share prices was most dramatic back in Oct 2014 (read here and here).

OSIM reported a 28 per cent drop in net profit to S$16.4 million for its third quarter ended Sept 30, 2014. (read here)

As mentioned in the report:

• The profit drop was due to a mix of legal costs and startup costs for subsidiary TWG Tea, as well as a weaker consumer spending environment in Asia.
• Macquarie Research analyst Sam Chan cited the following four factors: There are near-term headwinds in China; it is too early to be bullish on TWG; sales growth excluding TWG is slowing; and management has a poor record of meeting their guidance targets.

OSIM is a leading purveyor of well-being and healthy lifestyle products such as its namesake massage chairs and TWG Teas. The company can be broken down into 3 components:

1. OSIM (Innovative massage chairs)
2. ONI Global (Nutritional products, vitamins, minerals, herbal and other specialty supplements and sports nutrition, diet and energy products. ONI Global is the sole franchisee for GNC)
3. TWG Tea (Luxury tea brand and was established in Singapore in 2007)

A brief look on the past years’ financial results reveals some worrying trends.

• Profit after tax has stagnated in 2014.
• Non current liabilities has ballooned.

• Net earnings growth, return on asset, return on equity and current ratio have progressively gotten worse.

The recent quarter results are not any better. Read here and here, and see below:

Indeed, there is an issue with earnings growth in OSIM. The lack of innovative products, poor macro-outlook in China, increasing wages/rents and investment / start-up costs in TWG outlets all seem to hinder earnings growth.

A snap shot of the current financial fundamentals of OSIM reveals mix results.

• It does not have extremely high PE.
• Has a PEG that is less than 1 (generally less than 1 is good).
• Has a EV/EBITDA of 7.78. (As a rule of thumb, any EV/EBITDA below 10 is the sign of a good value)
• Has a respectable return on equity of 18.79% (close to 20%).
• Total cash is still more than total debt (by approx. 285 mil).
• Total Debt / Equity is not that high.

However,

• Price / Book ratio is 2.74 (definitely more than 1).
• Quarterly earning growth is a disappointing -53.1% (hence the fall from grace, no longer enjoy a growth stock status).
• Current ratio is 4.01. (Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.)

OSIM has also been recently been in the news for:

• Its investment in Trek 2000 (read here and here).  Following the purchase, OSIM will own an 8.75% stake in Trek 2000, up from 1.14% previously. A quick look at the financial fundamentals of Trek 2000 reveals a blotchy free cash flow, a P/E of 39.21 and a EV/EBITDA of 22.29. I do not consider Trek 2000 as a financially strong company. Moreover, it engages in the research, design, development, and dealing of computer hardware, software, electronic components, and other related products. Not an easy business to be in as it requires constant innovation (and is not something within my circle of competence).
• Its massive share buyback scheme (read here) On the other hand, one of its shareholder, The Capital Group has been actively selling its shares (read here). Seems to me like deja vu, as it is similar to Super Group (the selling part by The Capital Group).

So is the current share price a bargain?

We already knew that the PEG is 0.46. Let’s do a calculation on its intrinsic value.

Intrinsic Value

First let’s look at the estimated 5 years earning growth. We are going to use a time-frame of 5 years from now for this purpose (don’t have the 10 years figures). Given the EPS and PE ratio, the intrinsic value can easily be calculated for any company. Using the below formula.  (Actually I just got the results after keying in the figures in this website)

F = P(1+R)^N where:

• F = the future EPS
• P = the starting (present) EPS (0.11)
• R = compound growth rate (29.26). However, let’s discount it by 20%, and will be using 23.41.
• N = number of years in the future (5)

Estimated future EPS: 0.31

I will be estimating the future PE of OSIM to be 16.55. (Chart from Morningstar below) Average of P/Es from 2009 to 2014.

Future Stock Price

P=EPSxPE

• P = future stock price
• EPS = future EPS
• PE = future PE

Hence future stock price of OSIM is 0.31 x 16.55 = 5.1305

Intrinsic Value

P=F/(1+R)N

• P = present (intrinsic) value
• F = future stock price (5.1305)
• R = MARR (15% or 0.15)
• N = Number of years (5)

Hence intrinsic value of OSIM is 2.55.

The stock price of OSIM on 25 June 2015 is 1.6350. Hence, there is a margin of safety, and the percentage difference between the intrinsic value and current stock price is approx. 36%!

In summary:

The recent poor quarters results and the drop in earning growth in the recent year has negatively impacted OSIM’s share prices. However, one should take a longer historical view of OSIM past performance and not let a few quarters or a year of bad results cloud one’s judgement. The low PEG and intrinsic value seems to suggest that the recent share price is a bargain. It financial fundamentals although not perfect (eg. high current ratio, negative growth), does have its good points, notably strong cash level (after deducting debt) and good ROE.

“One has to know more about a company if one buys earnings.” Walter Schloss

Having said that the recent lack of earnings growth in OSIM’s results seem to stem from a few factors, namely the poor macro-economics outlook in China (group had closed 32 non-performing OSIM outlets in China last year), lack of innovative products (absence of a major flagship chair launch this year), increasing rents/wages and high set-up costs of TWG.

“Your premium brand had better be delivering something special, or it’s not going to get the business.” Warren Buffett

Moreover, there seems to be a lack of evidence for recurring income since OSIM’s products are neither low tech, easy nor disposable. A fab that is fading fast? It is not in a low hurdle business (and that applies to OSIM massage chair, GNC products & TWG tea), and management has to grapple with the issues of constantly pushing out innovative products and fierce competition (with many other brands eg. OTO and Ogawa offering cheaper alternatives). Its recent potential blockbuster product, the new uMagic massage chair which runs on improved massage technology does not seem to differentiate itself much from its predecessors. Note:  It is launched in April 2015. The China launch of uMagic is stipulated to be in June 2015.

 

The recent investment is Trek 2000 does not appear convincing. Trek 2000 provides solutions for the Internet of Things (IoT), with an emphasis on cloud, wearable and medical technologies. OSIM could be interested in connecting its wellness devices such as blood-pressure monitors and weighing scales to the cloud, just as it did its massage chairs. Although there might be synergy between the 2 business, it is currently too early to tell. Moreover the financial fundamentals of Trek 2000 is far from pristine.

At the moment I am hesitant in buying the shares. This is due to the poor outlook / narratives and the nature of its products / business (just too exciting and unpredictable for me). I don’t just buy shares because its price dropped, because it may drop further if there is simply no growth.

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Warren Buffett