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PP 7767/09/2010(025354)

29 July 2010

Malaysia Corporate Highlights


RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

V is it Note
29 July 2010
MARKET DATELINE

Hai-O Enterprise Share Price


Fair Value
:
:
RM3.70
RM3.63
FY04/11 Membership To Contract Recom : Underperform
(Downgraded)

Table 1 : Investment Statistics (HAIO; Code: 7668) Bloomberg: HAIO MK


Net Net
FYE Revenue Profit EPS Growth PER C. EPS * P/NTA Gearing ROE GDY
Apr (RMm) (RMm) (sen) (%) (x) (sen) (x) (x) (%) (%)
2010a 511.1 70.9 35.0 35.4 11.1 - 2.4 Net cash 38.7 6.2
2011f 529.8 69.5 34.3 -2.0 10.8 32.7 2.8 Net cash 31.9 6.2
2012f 569.3 75.7 37.3 8.9 9.9 43.5 3.2 Net cash 29.7 6.7
2013f 629.3 84.1 41.5 11.1 8.9 - 3.8 Net cash 28.4 7.5
Main Market Listing / Trustee Stock * Consensus Based On IBES Estimates
♦ Membership to contract in FY11. We believe that due to the revised
Issued Capital (m shares) 202.2
Direct Selling Act (DSA), Hai-O’s membership drive will be affected, as well
Market Cap (RMm) 744.1
as its retention of existing members. We have adjusted our forecast to
Daily Trading Vol (m shs) 0.3
include a net membership contraction of 1,200/mth, which consequently
52wk Price Range (RM) 2.03-4.93
reduces our FY11-13 Core Distribution Force (CDF) assumption by 5.1-10%.
Major Shareholders: (%)
♦ Reasons for contraction. The revised DSA has tightened the regulations Tan Family 30.0
in the MLM industry so as to stop MLM members from front loading stocks,
as this could subsequently lead to its members not being able to sell the FYE Apr FY11 FY12 FY13
excess stocks. It also deters MLM leaders/members who were previously EPS chg (%) (8.0) (11.8) (10.9)
front loading to continue their recruitment activities as they are now unable Var to Cons (%) 4.9 (14.3) -
to make quick profits as they did previously. While the more stringent ruling
PE Band Chart
would lead to a temporary slowdown in recruitment drive, we believe that it
could also lead to negative growth of MLM members, given that some of the
members who were previously making quick profits may drop out of the
company. We are thus cutting our revenue/member growth assumption to PER = 15x
-10% (from -5% previously), for FY11 because we believe that member PER = 10x
PER = 5x
productivity will decline as they are no longer able to front load their stocks.
For FY12-13, however, we are maintaining our revenue/member growth at
1% for each years.
♦ Energy division drawing interest. Although the MLM division outlook is
bleak, the negative impact is cushioned somewhat by the fact that all the Relative Performance To FBM KLCI
other divisions are on track, especially its energy division, which has drawn
interest from various parties with regards to its heat transference
technology. Hai-O Enterprise

♦ Private placement a no-go. Recently announced cancellation of its


proposed private placement is positive news in our view, as the private
placement would have diluted EPS by 6.9% and reduced FY11 projected
dividends to 15.6 sen, from 17.1 sen currently. FBM KLCI

♦ Risks. The risks include: 1) termination of supply agreements from its


suppliers in China; 2) stronger-than-expected strengthening of US$; and
(3) weaker-than-expected increase in consumer spending.
♦ Forecasts. We are reducing our FY11-13 earnings forecast by 8.0-11.8%
after incorporating the contraction in membership numbers and a reduction
in revenue/member as previously highlighted.
♦ Investment case. The temporary setback to the MLM business will affect
earnings significantly in the near term. However, we believe that Hai-O will
be able to pull through and come back stronger in the longer term, with Hoe Lee Leng
members of higher quality and productivity. Nonetheless, we are (603) 92802641
downgrading our call on the stock to Underperform, as we have reduced hoe.lee.leng@rhb.com.my
Hai-O’s fair value to RM3.63 from RM4.06 previously, based on unchanged
10x CY11 EPS.
Please read important disclosures at the end of this report.

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♦ Membership to contract in FY11. Recall that in our briefing note dated 29 Jun, due to the newly revised
Direct Selling Act (DSA), we projected 0/mth net membership growth in FY04/11. We also mentioned that
management did not discount the possibility of members dropping out. After further discussions with
management, we are now of the view that membership will actually contract in FY04/11 and have adjusted our
projections to reflect a net membership contraction of 1,200/mth. As a result, our FY04/11-13 CDF
assumptions have been reduced by 5.1-10%.

♦ Why the contraction? The revised DSA has tightened the regulations in the MLM industry so as to stop MLM
members from front loading stocks, as this could subsequently lead to its members not being able to sell the
excess stocks. It also deters MLM leaders/members who were previously front loading to continue their
recruitment activities as they are now unable to make quick profits as they did previously. While the more
stringent ruling would lead to a temporary slowdown in recruitment drive, we believe that it could also lead to
negative growth of MLM members, given that some of the members who were previously making quick profits
may drop out of the company. Nevertheless, in the longer run, we believe Hai-O would benefit from this given
that their members would be of higher quality and more focused on growing the business in a proper way. We
are thus cutting our revenue/member growth assumption to -10% (from -5% previously) for FY11 because we
believe that member productivity will decline as they are no longer able to front load their stocks. For FY12-13,
however, we are maintaining our revenue/member growth at +1% for each year.

♦ Energy division gains interest. Although the MLM division outlook is bleak, the negative impact is cushioned
somewhat by the fact that all the other divisions are on track, despite only contributing a mere ~20% to total
revenues. We would like to highlight Hai-O’s progress in its energy division, where Hai-O has developed a
technology which is used in heat transferrance, i.e. boilers etc, which allows for a more cost-efficient system.
We understand that the technology has gained interest from various parties, including potential customers who
have requested Hai-O to install samples in their factories. We also note that Hai-O plans to install a prototype
to be shown in the Shanghai Expo soon. The technology is not expected to contribute to earnings significantly
in FY11, although there might be some impact to topline. Due to the lack of clarity in the actual numbers from
the new technology, we are not accounting for it in our forecasts as yet.

♦ Dividends and private placement. Despite the gloomy FY11 earnings outlook, management will maintain its
policy of a 50% net dividend payout. Our projections indicate a net DPS of 17.1 sen for FY11, which is 5.5%
lower than FY10 due to the lower net profit. This translates to a net yield of 4.6%. Also note that Hai-O recently
announced that it was not going through with its proposed private placement, which, if completed, would have
diluted FY11 EPS by 6.9% and would have also reduced FY11 DPS to 15.6 sen. We believe the abortion of the
private placement was due to the lack of investor interest on the stock given the less robust outlook for the
stock. We believe that Hai-O might reconsider the private placement once things get better, although we are
not expecting it to happen in the near term.

Risks.

♦ The risks include: 1) termination of supply agreements from its suppliers in China; 2) stronger-than-expected
strengthening in US$; and 3) weaker-than-expected increase in consumer spending.

Forecast and assumptions

♦ We are reducing our FY11-13 earnings forecast by 8.0-11.8% after incorporating the contraction in
membership numbers and a reduction in revenue/member as previously highlighted.

Recommendations

♦ Investment case. The temporary setback to the MLM business will affect earnings significantly in the near
term. However, we believe that Hai-O will be able to pull through and come back stronger in the longer term,

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with members of higher quality and productivity. Nonetheless, we are downgrading our call on the stock to
Underperform, as we have reduced Hai-O’s fair value to RM3.63 from RM4.06 previously, based on
unchanged 10x CY11 EPS.

Table 2. Earnings Forecasts Table 3. Forecast Assumptions


FYE Apr (RMm) FY10a FY11F FY12F FY13F FYE Apr FY11F FY12F FY13F

Turnover 511.1 529.8 569.3 629.3 Core distributor force (CDF) 132,800 131,600 143,600
Wholesale 43.9 46.1 48.4 50.8 Revenue per active member
18,443 18,628 18,814
(RM/CDF)
MLM 418.1 432.4 467.3 522.3 Opening of new retail outlets 3 3 3
Retail 41.8 44.3 46.7 49.2 Revenue per outlet (RM'000) 643 649 656
Manufacturing 1.8 3.0 3.5 3.5
Other 5.6 4.0 3.5 3.5
Turnover growth 17.4 3.7 7.5 10.5
(%)

Cost of Sales (311.7) (329.0) (352.4) (382.5)


Gross Profit 199.3 200.8 217.0 246.8
EBITDA 100.4 97.9 105.6 116.4
EBITDA margin 19.6 18.5 18.6 18.5
(%)

Depreciation (4.3) (4.4) (4.4) (4.4)


Net Interest (0.1) 1.1 1.5 2.2
Associates 0.0 0.0 0.0 0.0

Pretax Profit 95.9 94.6 102.7 114.2


Tax (23.8) (23.6) (25.7) (28.5)
Minorities (1.3) (1.4) (1.4) (1.5)
Net Profit 70.9 69.5 75.7 84.1

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Chart 1: HaiO Technical View Point


♦ HaiO’s share price slipped into a consolidation
mode after retreating from its all-time high of
RM4.93 in mid-Mar 2010.

♦ From late-Apr onwards, it faced another round of


selling leg following a breakdown from the RM4.40
support level and a formation of a “dead cross” on
the 10-day and 40-day SMAs.

♦ But after bottoming near the RM3.67 support


region in May 2010, it kicked off a powerful
rebound and hit a high of RM4.28 in Jun.

♦ Though it tried to stabilise at above the RM4.12


level, sellers returned in late Jun and hammered it
down towards the RM3.67 support region again.

♦ Since then, it trended sideways at just above the


RM3.67 support level.

♦ In our view, it is likely to extend the current


consolidation near RM3.67 in the near term, given
the sluggish technical readings on the chart as well
as the poor momentum readings.

♦ In other words, its upside potential could be limited


to the 40-day SMA near RM3.88.

♦ In fact, investors should be wary as a breach below


RM3.67 will trigger another round of selling to the
next support at RM3.20.

IMPORTANT DISCLOSURES

This report has been prepared by RHB Research Institute Sdn Bhd (RHBRI) and is for private circulation only to clients of RHBRI and RHB Investment Bank
(previously known as RHB Sakura Merchant Bankers). It is for distribution only under such circumstances as may be permitted by applicable law. The opinions
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The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

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Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or more
over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take on
higher risks.

Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.

Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.

Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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actions of third parties in this respect.

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