OSIM International Ltd - Resilient retail sales; but macro outlook still gloomy (OCBC)

Maintain BUY

Previous Rating: BUY

Current Price: S$1.14

Fair Value: S$1.52

Withdrawal of TDR application no cause for concern. OSIM International (OSIM) recently announced that it has received approval from the relevant Taiwan authorities regarding its decision to withdraw its proposed TDR application. The group had expected to raise estimated net proceeds of S$76m. Nevertheless, we do not view this as a cause for concern, and had previously opined that we do not expect its expansion plans to be affected even if the TDR listing does not take place. We estimate that OSIM would generate net operating cashflows of S$63.4m in FY11 and end the year with cash balances of S$211.7m (net cash position), thanks to the completion of a S$120m convertible bonds issuance in Jul 2011.

Focus on organic growth for now. While we believe that acquisitions would remain as a key strategic growth driver for OSIM to expand its portfolio of wellness and lifestyle brands given its enlarged 'war chest', we opine that management would focus on organic growth in the immediate term. This would entail growing its newly incorporated OSIM-TWG Tea business as well as targeting for higher same store growth. With respect to inorganic growth in the future, we expect OSIM to exercise strong prudence and due diligence before embarking on any acquisitions. Management highlighted that one of the criteria would be to acquire only profitable companies with a scalable business model such that it would be accretive to shareholders.

China retail sales still resilient. Retail sales of consumer goods in China remained resilient, climbing 17.0% YoY to RMB1.47t in Aug, based on statistics from the National Bureau of Statistics of China. YTD, retail sales of consumer goods have increased 16.9% YoY to RMB11.5t.

Lowering our valuation peg, but still a BUY. Nevertheless, inflationary pressures in China remain persistently high, although easing slightly from 6.5% in Jul to 6.2% in Aug. We further note that China's consumer confidence index fell by three points to 105 in 2Q11, according to Nielsen Holdings. Hence we are trimming our sales and net profit estimates for FY11 slightly by 1.9% and 0.7% respectively (2.8% and 0.6% for FY12) as a conservative measure. Meanwhile, current anaemic macroeconomic conditions are also likely to have an unfavourable impact for high-beta stocks such as OSIM. Coupled with the possible belt-tightening by consumers ahead, we lower our valuation multiple for OSIM from 20x to 15x blended FY11/FY12F EPS, in line with its 1-year average forward PER. We think this is justified as it allows us to capture the current broad market weakness. Our revised fair value estimate of S$1.52 (previously S$2.04) still translates into an upside potential of 33.3%. Reiterate BUY.

Cash is king. We believe that management's main focus would be to concentrate on organic growth rather than acquisitions in the immediate term. This suggests that OSIM's large cash hoard could prove to be a cash drag on the group. While this could be true under normal conditions, we believe that having ample financial resources and a healthy balance sheet in current times of financial instability would help to improve the sustainability of the group. Moreover, OSIM's excellent cash position also means that it would be ready to take advantage of inorganic opportunities should they arise. OSIM's reported cash and cash equivalents amounted to S$86.5m as at 30 Jun 2011 (net cash of S$58.7m), but this would have increased to ~S$206.5m after taking into account its recent S$120m convertible bonds issuance which was completed on 5 Jul 2011.