I retain a Neutral” rating on Hong Kong-listed global family nutrition and wellness company Health and Happiness International Holdings Limited (OTC:BTSDF) (OTC:BTSDY) [1112:HK], or H&H.
This is an update of my prior article on H&H published on April 24, 2020. H&H’s share price has increased by +17% from HK$28.30 as of April 23, 2020 to HK$33.20 as of September 28, 2020, since my last update. H&H trades at 13.3 times consensus forward FY 2021 P/E, and it offers a consensus forward FY 2021 dividend yield of 3.8%.
H&H reinitiates interim dividend payout for the first time since FY 2014, as the company’s operating cash flow grew and its net leverage ratio decreased in 1H 2020. I see this as a positive sign that H&H is confident in the company’s future performance and growth prospects. Nevertheless, I will not upgrade the rating on the stock to Bullish, until I see re-rating catalysts such as the recovery of the daigou business in Australia & New Zealand, and the increased penetration of baby specialty stores in China being realized.
Readers have the option of trading in H&H shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the tickers BTSDF and BTSDY or on the Hong Kong Stock Exchange with the ticker 1112:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.
For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution given that the Hong Kong Stock Exchange is one of the major stock exchanges that are internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $3 million, and market capitalization is above $2.7 billion, which is comparable to the majority of stocks traded on the US stock exchanges.
Institutional investors that own H&H shares listed in Hong Kong include Templeton Asset Management, The Vanguard Group, Dimensional Fund Advisors, and Amundi Asset Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers or Fidelity, or international brokers with Asian coverage, like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.
Reinitiates Interim Dividend For 1H 2020
H&H announced the company’s 1H 2020 financial results on August 25, 2020, and a key highlight was the re-initiation of the company’s interim dividend.
H&H used to pay dividends on an semi-annual basis between FY 2011 and FY 2014, prior to suspending dividend payouts for the FY 2015-FY 2017 period. The company resumed dividend payments in FY 2018, but it only paid dividends once a year for both FY 2018 and FY 2019. It is noteworthy that H&H has reinitiated interim dividend payouts in FY 2020.
H&H declared an interim dividend of HK$0.63 per share for 1H 2020, which is equivalent to a dividend payout ratio of 50%. Market consensus expects H&H to increase its full-year dividends per share from HK$0.85 in FY 2019 to HK$1.06 and HK$1.25 for FY 2020 and FY 2021, respectively.
At the company’s 1H 2020 earnings call on August 25, 2020, H&H explained that it decided to pay an interim dividend, because it has “been able to maintain a high-cash conversion and reduce our net debt leverage” by delivering “profitable growth” in the first half of the year. H&H’s pre-tax operating cash flow grew by +25.4% YoY from RMB960 million in 1H 2019 to RMB1,204 million in 1H 2020, while its net debt-to-EBITDA or net leverage ratio declined from 1.65 times to 1.38 times over the same period.
H&H’s 1H 2020 financial performance was decent despite Covid-19 headwinds. The company’s revenue increased by +1.4% YoY from RMB5,095 million in 1H 2019 to RMB5,167 million in 1H 2020, and its adjusted net profit grew by +8.1% YoY to RMB658 million in the first half of the year. Adjusted net profit excludes net foreign exchange gains & losses, net fair value gains & losses on financial instruments, and one-off amortized loss of interest rate swap for previous term loan. On a like-for-like basis adjusting for the impact of mergers & acquisitions and foreign exchange changes, H&H’s top line and bottom line would have increased by an even higher +2.6% and +8.9% YoY, respectively.
Improved Profitability In the Spotlight
As highlighted above, H&H’s adjusted net profit increased by +8.1% YoY in 1H 2020, in contrast with a mere +1.4% YoY growth in revenue over the same period. H&H benefited from improved profitability as a result of good operating cost control and lower interest costs, as the company’s adjusted net profit margin expanded from 12.0% in 1H 2019 to 12.7% in 1H 2020.
H&H’s administrative expenses-to-revenue ratio declined from 5.9% in 1H 2019 to 5.5% in 1H 2020, and the company’s selling & distribution expenses-to-revenue ratio of 38.7% in 1H 2020 was also lower than its selling & distribution expenses-to-revenue ratio of 40.0% for FY 2019.
The company disclosed at its 1H 2020 results briefing on August 25, 2020 that its selling & distribution expenses-to-revenue ratio decreased because of improvements in operating efficiency, an increase in sales contribution of higher-margin online sales, and a decrease in off-line promotion activities due to Covid-19. Looking ahead, H&H guided for a selling & distribution expenses-to-revenue ratio of 40% or below for full-year FY 2020.
H&H’s interest expenses fell by -30.8% YoY to RMB125.3 million in 1H 2020, which the company attributed to “the improved capital structure post the successful refinancing of these two debt instruments in the second half of 2019” as per its 1H 2020 results announcement. I mentioned earlier that H&H’s net debt-to-EBITDA ratio has declined significantly on a YoY basis in 1H 2020.
Positive Earnings Growth Expected To Be Maintained In 2H 2020
Sell-side analysts see H&H’s revenue and adjusted net profit increasing by +6% YoY and +11% YoY to RMB11,615 million and RMB1,190 million, respectively in FY 2020. This compares favorably with the company’s +1.4% YoY revenue increase and +8.1% adjusted net profit growth in 1H 2020.
With respect to sales trends, H&H noted at the company’s recent 1H 2020 earnings call that its business performance in July and August are “pretty much in line with the trends we have spoken about for the first half of this year.” This suggests that there is less likely to be any negative surprises for H&H with regards to top line growth in 2H 2020. The China market and the probiotic supplements product segment have been out-performers for H&H in 1H 2020, and such positive growth momentum is expected to be sustained in 2H 2020.
H&H’s Revenue By Product Segment And Geography In 1H 2020
Source: H&H’s 1H 2020 Results Announcement
In terms of profitability, H&H has guided that the company will “maintain a stable overall EBITDA margin” for FY 2020. This is aligned with sell-side analysts forecasts which point to a 20.1% EBITDA margin for H&H this year as compared to a EBITDA margin of 20.5% last year. As mentioned above, H&H will target to maintain its selling & distribution expenses-to-revenue ratio at 40% or lower this year as well.
Daigou Business For The Adult Nutrition Segment Faces Covid-19 Headwinds
H&H’s adult nutrition business was the weaker of the company’s two core businesses (the other being baby nutrition business), as its segment revenue fell by -10.6% YoY from RMB1,834 million in 1H 2019 to RMB1,640 million in 1H 2020. The outlook for H&H’s adult nutrition business in 2H 2020 is mixed.
On one hand, the “daigou” business, referring to the practice of Chinese buying products in overseas markets (in this case Australia and New Zealand for H&H) and re-selling them in China, has been negatively impacted by international travel restrictions put in place due to Covid-19. Even prior to the coronavirus pandemic, H&H’s “daigou” business was already suffering because of a new e-commerce law in China introduced in 2019, which forced smaller “daigou” traders out of business due to the huge compliance costs involved.
The weakness in the Australian & New Zealand adult nutrition business is evidenced by the fact that inventory turnover days for the adult nutrition is very high at 298 days in 1H 2020. H&H has set a target to reduce inventory turnover days for the adult nutrition to 250 days going forward, and a positive factor is the shelf life of adult nutrition products on average is approximately three years. Going forward, H&H will focus on driving online sales and capturing domestic demand to improve the performance of the Australian & New Zealand adult nutrition business.
On the other hand, the VHMS (Vitamins, Herbs, Minerals & Supplements) and the China market have been bright spots for H&H’s adult nutrition business in 1H 2020, thanks to increased health consciousness brought about by Covid-19. Sales for H&H’s immunity-related VHMS products surged by +48.5% YoY in 1H 2020, and the company’s adult nutrition business in China saw a +27.9% YoY revenue increase over the same period.
Revenue Decline For Infant Milk Formula Products In The Baby Nutrition Segment
All the product segments for H&H’s adult nutrition business achieved YoY positive revenue growth in 1H 2020, with the exception of the company’s infant milk formula products. Revenue for H&H’s infant milk formula product segment declined by -2.6% YoY to RMB2,338 million in 1H 2020. The company attributed this product segment’s weak performance to a slower-than-expected recovery in offline traffic and inventory destocking in 2Q 2020.
Putting near-term headwinds aside, stiff competition in the Chinese infant milk formula remains a key concern for H&H’s adult nutrition business. At the company’s 1H 2020 results briefing, H&H acknowledged that “the (Chinese infant milk formula market) has always been very competitive” but stressed that “the premium and super premium market is still growing.”
H&H’s key disadvantage vis-a-vis competitors in the Chinese infant milk formula is that the company does not have a very extensive physical distribution network. Notably, H&H’s penetration of baby specialty stores in China is currently below 50%. Going forward, the company has plans to penetrate another 10,000 baby specialty stores in China in 2H 2020 (on top of the current 30,000 baby specialty stores that it distributes to), with a focus on Tier-4 and Tier-5 cities in the country.
H&H trades at consensus forward FY 2020 and FY 2021 P/E multiples of 16.0 times and 13.3 times, respectively based on its share price of HK$33.20 as of September 28, 2020. As a comparison, the stock’s three-year and five-year average consensus forward next twelve months’ P/E multiples were 17.8 times and 18.2 times, respectively. H&H also offers consensus forward FY 2020 and FY 2021 dividend yields of 3.2% and 3.8%, respectively.
The key risk factors for H&H are stiffer-than-expected competition in the infant formula milk market in China, a longer-than-expected time taken for the recovery of the daigou business, weaker-than-expected profitability, and lower-than-expected dividends for 2H 2020 and beyond.
Note that readers who choose to trade in H&H shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.