31 march 2014 osim international limited valuation...

31 March 2014

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MCI (P) 046/11/2013 Ref. No.: SG2014_0042

OSIM International Limited Growth in the Power of uInfinity SINGAPORE | CONSUMER | INITIATION REPORT

Rating: Accumulate

Initiate at S$2.87 Initiate with Accumulate Rating: OSIM is a home-grown company with a pan Asian presence as a well-being and healthy lifestyle products retailer. Its business portfolio consists of three segments: (1) OSIM, a lifestyle products retailer specializing in massage chairs (2) ONI Global (GNC and RichLife), a nutritional supplements retailer and (3) TWG Tea, a luxury tea retailer. Why Invest?

Sustainable growth traction. OSIM has achieved amazing results of 5 years of record profit and 20 consecutive quarters of bottom line growth after returning to profitability in 1Q09. OSIM has maintained its profitability traction with a more efficient cost control and operations management, a strong product pipeline, tighter control of channel distributions and strong branding. Since then, OSIM has managed to grow both its top and bottom line at 8% CAGR and 44% CAGR respectively over FY09-13. This year, OSIM will focus on 2 aspects for revenue growth: (1) to improve the sales per store and (2) to ramp up the number of TWG stores.

Premium branding, innovative products and strategic market positioning to drive revenue. OSIM has strong brand equity in the Asia region and continues to drive revenue growth with both new product launches and competitive positioning with better product mix to capture a wider target audience. For example, the compact design uAngel is priced at an affordable price of S$1888 to tap on a new market for young families who have space constraints at home. For the coming quarter, OSIM will launch an upgraded version of the uAngel chair. We believe the improved product will maintain its compact design with enhanced technological features and will achieve similar success as its predecessor. Other popular existing products such as uInfinity, uDivine App and uPhoria Warm will also contribute to the revenue.

Outlook remains favourable. OSIM focuses its operations in 5 markets: Singapore, Malaysia, Taiwan, Hongkong and China, with China being its largest market. China recently has unveiled its urbanisation plan to drive economic growth, aiming to enable 60% of her population to enjoy urbanised city living by 2020. This means that OSIM’s target group, the mid-to-high end income group, will expand considerably. The massage chair penetration rate is currently low in China, thus the potential growth for OSIM is promising. Furthermore, the expansion plans for TWG Tea across Asia could further propel earnings growth.

Investment Action OSIM currently trades at a 17.3x FY14F P/E compared to peers’ 24.7x. We feel that the stock price may encounter a slight dip in near future due to the share dilution from the conversion of the convertible bonds. However, the long term outlook remains positive. We favour the stock for its (1) premium branding, (2) strong balance sheet and (3) experienced management team. We initiate coverage for OSIM with an “Accumulate” rating with a target price of $2.87 based on discounted cash flow (DCF) methodology.

Target Price (SGD) 2.87

Forecast Dividend (SGD) 0.05

Closing Price (SGD) 2.59

Potential Upside

Company Description

Company Data

Raw Beta (Past 2yrs weekly data) 0.56

Market Cap. (USD mn / SGD mn) 1524 / 1923

3M Average Daily T/O (mn) 1.6

Closing Price in 52 week range

Major Shareholders (%)

1. Chye Hock Sim 69.8

2. Franklin Resources 3.6

3. Havenport Asset Management Pte Ltd 3.6

Valuation Method

Discounted Cash Flow (DCF)

Analyst

Caroline Tay

carol inetayyy@phi l l ip.com.sg

+65 6531 1792

12.9%

OSIM is the global leader in branded healthy

l i fes tyle products with i ts massage chairs

being particularly wel l -known. The Company's

products include massage chairs , massagers

(leg, neck, shoulder, neck), fi tness

equipment, vi tamin and supplements and

luxury tea. Establ ished in 1980, OSIM has a

s igni ficance presense in As ia . OSIM's

bus iness reflects i ts hol is tic and integrated

approach to a hea lthy l i fes tyle.

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Volume, mn OSIM SP EQUITY STI rebased

OSIM International Limited 31 March 2014

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Key Financial Summary

FYE DEC FY11 FY12 FY13 FY14F FY15F

Revenue (SGD mn) 554 602 648 746 828

Net Income, adj. (SGD mn) 69 87 97 114 128

EPS, adj. (SGD) 0.09 0.12 0.14 0.15 0.17

P/E (X),adj. 16.7 10.9 13.5 17.2 15.3

BVPS (SGD) 0.24 0.27 0.37 0.61 0.74

P/B (X) 6.4 4.7 4.9 4.2 3.5

DPS (SGD) 0.03 0.06 0.06 0.05 0.05

Div. Yield (%) 1.9% 4.8% 3.3% 1.8% 2.1%

Source: Bloomberg, PSR est.


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TABLE OF CONTENTS

Investment Merits ………………………………………………………………………………………………………………………………………4

Risk Factors …………………………………………………………………………………………………………………………………………………13

Financial Review and Forecast …………………………………………………………………………………………………………………….14

Valuation …………………………………………………………………………………………………………………………………………………….16

Sensitivity Analysis ………………………………………………………………………………………………………………………………………18

Company Profile ………………………………………………………………………………………………………………………………………….19

Key Management Team ……………………………………………………………………………………………………………………………….23


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Investment Merits We present OSIM International Limited with an "Accumulate" rating and DCF-based price target of S$2.87, 12.9% potential upside (including dividend yield). OSIM is an Asia’s leading brand well-being and healthy lifestyle products retailer. It is renowned for its massage chairs, the core of its business, with massage chair sales making up 40% of the revenues. The principle business includes designing, developing, marketing and franchising of a comprehensive range of well-being and healthy lifestyle products. Sustainable growth traction OSIM has achieved amazing results of 5 years of record profit and 20 consecutive quarters of bottom line growth after returning to profitability in 1Q09. OSIM has maintained its profitability traction with a more efficient cost control and operation management, a strong product pipeline, tighter control of channel distributions and strong branding to reduce cost of production and improve productivity per store since the Brookstone write off in 2008. Since then, OSIM has managed to grow both its top and bottom line at 8% CAGR and 44% CAGR respectively over FY09-13. This year, OSIM will focus on 2 aspects for revenue growth: (1) to improve the sales per store and (2) to ramp up the number of TWG stores. Figure 1: Revenue & profit for FY09-13

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Source: Company, PSR Climbing operating margins Most of the OSIM products are subcontracted to their contract manufacturers for production while OSIM focuses on their product development, brand marketing and retailing. In a bid to lower overall purchasing costs, OSIM has, over the years, increasingly shifted its supplier base from Japan to its 30% associate, DT-OSIM Healthcare Appliances (Suzhou) Co Ltd. DT-OSIM now manufactures the bulk of its massage products. With the quality of production improving in China, OSIM has moved the manufacturing of its high-end massage chairs from Japan to China in 2010 to improve its margins. The company has better control on its manufacturing process and inventory management through its associate DT-OSIM. Operating margins has further improved as OSIM reaps the benefits of economies of scale in other areas such as advertising and promotion. EDITDA margin had improved from 15% to 22% over FY10-13.


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Figure 2: Improving gross margin, EBITDA margin and EBIT margin

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Source: Company, PSR Improving store profitability The management team has placed their focus on store rationalization for OSIM and GNC/Richlife outlets to optimize the profitability per store. Although the number of stores only increased less than 1% from 854 to 861 over FY10-13, the revenue had increased by 27% over the same period. The average sales per store had improved steadily over the period. Customer loyalty program and inclusion of incentive component into staff salary were introduced to improve store performance. All OSIM service staff have to undergo comprehensive training to acquire the necessary product knowledge to provide better service to the customers. The management is striving to drive profitability across its retail network by constantly reviewing and closing unprofitable stores. Figure 3: Increasing revenue per store

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Source: Company, PSR


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Strong cash generator OSIM is building up a cash war chest with its strong cash generating business model. It had generated a robust net operating cash flow of approximately $90 mn annually for the past 5 years, thanks to its cash-based business, low working capital needs and a high EDITDA margin. Currently sitting on net cash of about $112 mn, OSIM is financially able to embark on future acquisitions. We expect potential brand acquisitions into related areas that will align to its profile as a well-being lifestyle player to augment its core business growth. Figure 4: Free cash flow generation

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Source: Company, PSR Experienced management team The management team, led by Ron Sim, has extensive experience in Asia and a majority of OSIM staff has been with the company for 10 years or more. The team has seen OSIM through Global Financial Crisis and Brookstone write-off in FY07-FY08 and led the company to re-emerge into its current profitable entity. The know-how of turning the business around enables the team to face future challenges and move OSIM forward. We believe that the current management team will continue to lead OSIM to achieve better performance with incessant innovation and product execution. Figure 6: Long history in 5 key markets

Since No of Years

Singapore 1980 34

Hong Kong 1986 28

Taiwan 1987 27

Malaysia 1990 24

China 1993 21 Source: Company, PSR


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Strong brand equity, innovative products and strategic market positioning to drive revenue Premium branding OSIM is adopting a brand and business model similar to global brands like Apple and Nike with an emphasis on building the brand while outsourcing the manufacturing of products. We can see the success of OSIM brand name with its massage chairs priced at a premium over its competitors’ and yet consumers are willing to fork out more to make OSIM the top preferred brand. In an independent survey by international market research firm Synovate in 2010 and supported by International Enterprise Singapore (IE Singapore), OSIM was named the Most Preferred Healthy Lifestyle Brand and Preferred Massage Chair Brand in Asia. It had also won numerous awards such as “The Most Valuable Singapore Brands,” “The Strongest Singapore Brands” and “The Brand with Exceptional Performance.” The OSIM brand has also won the red dot design award, a highly respected independent international product design competition, on more than one occasion. According to research consultant Frost and Sullivan, OSIM ranked first in the massage chair market in terms of units sold with a market share of 68%, and in terms of sales revenue with a market share of 75% in Hong Kong in 2010. Figure 7: OSIM’s Brand Awards

A strong product pipeline Product innovation is the key to OSIM brand consistency and drive revenue growth. OSIM has been actively renewing its product line to cater to the changing needs of consumers. The management target to launch a new product, or derivative of an existing product every quarter, with two blockbusters each year for better product mix, to drive demand among its customers. For the coming quarter, OSIM will launch a new massage chair to replace the uAngel chair. We believe the new product will maintain its compact design with enhanced features and will achieve the similar success of its predecessor. The management has divulged that the product cycle is about 12 months for small products while it is about 12-18 months for massage chairs. OSIM spends about 2-3% of its revenue each year on R&D and have a R&D team of 30-40 people handling the product design in Singapore. OSIM will also continue to develop their innovative product line with its Japanese JV manufacturing partners. We are optimistic that OSIM will continue to focus on product innovation to drive revenue growth, given the strong track record of product launches. Refer to Figure 8 below to view some of OSIM’s recent popular product launches.


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Figure 8: OSIM’s recent product launches

uAngel Sofa-Tranzformer

(launched in 1Q13)

uInfinity 天王之王

(launched in 2Q13)

uShape

(Launched in 2H13)

uPhoria Warm

(Launched in 2H13) Source: Company, PSR Marketing expertise In a speech at NUS Business School on Marketing in Asia as an Entrepreneur, OSIM’s founder, Ron Sim said “Marketing is about selling perspective. If that perspective is not clear, your marketing is all going down the wrong way.” It is how the marketing of each OSIM product sets it apart from its competitors. OSIM has strengthened its business branding with its successful marketing know-how and careful brand management. The company will allocate about 6-7% of sales to its advertising and promotion budget. The strategy of celebrity endorsement, mostly Asian personalities, has provided a worthwhile return on investment. To market OSIM’s latest innovation, uInfinity, OSIM once again turned to Hong Kong superstar Andy Lau, who has been the company's spokesman for three years. Others included in its line-up of celebrity endorsements are Xiao S (uPhoria), Sammi Cheng (uAngel), Lin Chi Ling (usoffa Petti), S.H.E. (uKimono) and etc. Effective celebrity endorsement utilizes the celebrity’s strong popularity and personality to communicate a brand’s unique proposition and create awareness among the community, thus spurring buying sentiment. In additional to celebrity appeal, OSIM also employs online marketing such as Facebook, Twitter and mobile apps (Launch of TWG Mobile App in Dec 2013) to reach out to the younger mobile generation.

Figure 9: TWG Tea's mobile app as part of e-commerce expansion. The App includes a shopping cart feature for delivery orders.


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Segmented market strategy The general target group for OSIM is middle to high-end customers who are less vulnerable to recessions. Hence the business is more resilient to cyclic demand patterns exhibited in most/many typical consumer companies. Consumers thus are willing to pay a premium for OSIM products, as compared to its competitors’ products. However OSIM does adopt a multi product-price-point strategy to capture a wider target market. For example, for its massage chair range, OSIM has the star product uInfinity ($6988) targeted at the high-end customers and the compact design uAngel ($1888) targeted at the middle income customers who have space constraints at home. OSIM massagers can range from $29.90 (uBuzz) to $6988 (uInfinity). See below for a price list of OSIM massage products. Figure 10: Price list for OSIM massage products

Product Product type Price

uDivine App Massager Chair $4,988.00

uInfinity Massager Chair $6,988.00

uAngel Massager Sofa $1,888.00

uPebble Leg Massager $208.00

uBio Leg Massager $888.00

uFootise Leg Massager $199.00

uPhoria Warm Leg Massager $698.00

uRelax Upper Body Massager $188.00

uCozy Upper Body Massager $98.00

uPen Handheld Massager $45.00

uBuzz Handheld Massager $29.90

uDolly Handheld Massager $79.00

uGem Handheld Massager $38.00

uDurian Handheld Massager $99.00

uVision Eye Massager $68.00

uGalaxy Eye Massager $258.00

uSnooz Neck Pillow $68.00

uSlender Slim Belts $268.00

uGoGo Pulse Massager $388.00

uPixie Pulse Massager $238.00

uShape Innovative Fitness $699.00 Source: Company, PSR


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Specialty retail stores strengthened brand identity OSIM operates a big network of specialty retail stores and franchised outlets worldwide while its competitors sell through authorized dealers, distributors and online sales. We believe that specialty retail concept stores will enhance the customers’ purchasing experience when shopping for discretionary and premium lifestyle products. Self-owned stores & franchisees also help OSIM better control its marketing and brand building. Currently, there are 590 OSIM outlets worldwide. Figure 11: OSIM specialty retail stores



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Outlook remains favourable. OSIM focus its operations in 5 markets: Singapore, Malaysia, Taiwan, Hong Kong and China with a key focus in China. The revenue segmentation by region is as follows: 56% from North Asia, 35% from South Asia and 15% from others. Although China’s economy is slowing, she is still one of the fastest growing economies in the world. We believe the outlook for OSIM remains favourable. Figure 12: FY13 revenue split by region

Others, 7%

North Asia,

55%

South Asia,

39%

Source: Company, PSR Rising China’s affluence with urbanization China was the Number 1 luxury spender worldwide, responsible for 29% of the world's total spending on luxury items in 2013, according to Bain report. This month, China had unveiled urbanisation plan to have about 60% of its more than 1.3 billion people living in urban areas by 2020, up from 52.6% at the end of 2012. This means a population shift of about 100 million into the cities over the next few years. China is focusing to grow her domestic consumption and urbanization is the strongest engine to expand domestic consumption for economy growth. We believe the China’s middle to high incomers will rise with urbanization. Accordingly to McKinsey & Co, the upper middle class (with household incomes in the 106,000 to 229,000 rmb range) consumers are estimated to increase from 14% of urban household in 2012 to 53% of urban household in 2022. The upper middles class consumers who are willing to pay a premium for quality and to consider discretionary goods will emerge as the dominant force in consumption. We believe OSIM’s 20 years of extensive retailing experience in China will enable the company to leverage on the growing affluence to expand its presence in tier one and two cities, and in tier three cities in the long term. Figure 13: Share of urban households (%) by income segments in China

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Figure 14: Urban private consumption (%) by income segment in China

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Great potential in massage chair industry

The global healthcare market is expected to hit US$3 trillion (S$3.7 trillion) by 2015, driven by an increasing demand for home healthcare and other services related to an ageing population. In the last 10 years, healthcare and wellness fitness equipment industry has been developing rapidly, especially in China. The global massage chair market is concentrated in East Asia. Japan market is as the leading mature market, with penetration rate of over 20% of the households owning a massage chair at home. With the improvement of people’s living standard, increasing awareness of healthcare and highly stressful working environment, there will be increasing demand for massage chairs over the next few years. According to management, the penetration rate for OSIM’s massage chair is still low for its five key markets, an estimated 10% in Singapore and Hong Kong, 5% in Malaysia and Taiwan, and less than 1% in China. In short, there is still great potential growth in these markets. TWG Tea – Promising profit contributor The increased stake of TWG Tea will add as an extra boost to the revenue growth. Since its establishment in 2007, TWG has quickly become a leading luxury-tea brand in Asia. Since the short period of time from purchase of TWG Tea business in April 2011, OSIM has managed to bolster TWG Tea into a luxury tea brand, entered new distribution channels such as airlines and hotels, and made profits. The stake was increased to 45% in Jul 2013 and was further increased to 70% in Jan 2014. Holding a majority stake, OSIM had revealed expansion plans of about 20 outlets worldwide annually with focus on Singapore, Taiwan, Hong Kong and China. In our meet-up, the management expressed confidence and excitement in the expansion of TWG Tea business as one of its future revenue booster. We estimated that TWG’s operational metrics, such as sales per store are higher than those of OSIM’s. We therefore expect the TWG stores to contribute about 10% to the revenue in FY14F. Figure 15: Forecasted revenue split by business segments in FY14F

OSIM, 70%

GNC/RichLife

, 20%

TWG, 10%



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Risk Factors Weakening of macro economies may distress demand OSIM’s products are discretionary in nature and are susceptible to reduced demand as they may not be considered as essential health products during economics downturns. Economic wealth declines in key markets especially China will potentially impact the sales negatively since more than 50% of revenue from North Asia, with China as major contributor. With regards to this risk, OSIM has been positioning its products towards the middle to high end customer, who are less vulnerable to recessions. This will add resilience to volatile demand cycles. Based on the historic performance of OSIM since 2009 and the recovery of the US economy, the risk of demand collapse is low. Failure to trace the changing consumers tastes OSIM has prided in its product innovation to drive revenue growth. It is vital for OSIM to continue to be able to predict and uphold the constant changes in consumer preferences, which would allow it to refine its product mix, or introduce new products that are able to drive sales traction and revenue growth. From its strong pipeline of new products and derivatives of existing products launched quarterly, OSIM is constantly reviewing the lifestyle product trends and also its customers’ needs. Competition Competition in the health and wellness equipment market is intense, with the rapid launches of new models, continuous technological advancement and evolving customer needs. While OSIM’s strong branding differentiates it from its rivals, the pricing power and margins may be compromised should competitors come up with new blockbuster that supplant its competitive position. To-date, OSIM has been able to fend off competition and maintain a leadership position through constant product innovation and astute branding. Brand erosion The OSIM brand is the success and key value driver in its business. OSIM will have to strengthen its branding to prevent any dilution and focus on strategic positioning of its core products. Management’s efforts to raise the OSIM brand profile, for instance, via sponsorship of high-profile corporate events and celebrity endorsements to raise awareness and brand presence have been successfully so far.


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Financial Review and Forecast Quick financial review for FY13

Stable sales growth across all regions: OSIM reported FY13 revenue of S$648 mn (7.63% yoy) and PATMI of S$102 mn (15% yoy). There were 3 significant one-offs: (1) S$42 mn fair value gain on TWG; (2) S$31 mn impairment and foreign translation loss on Brookstone and (3) S$6.9 mn impairment of assets of ONI Global (Australia). After adjustments of one-offs, the adjusted PATMI is S$97 mn. The increase in revenue is partially contributed by the first-time consolidation of TWG Tea (from October 2013). Sales grew for markets for all regions underpinned by the successful launch of uInfinity and continued momentum for uAngel. We expect the top-line growth momentum to continue from (1) further store expansion in China, (2) improving margin, (3) aggressive expansion of TWG outlet network and (4) new replacement for uAngel. Figure 16: FY09-13 revenue by region

Revenue by Region (S$mn) 2009 2010 2011 2012 2013

North Asia 259 298 318 335 353

South Asia 160 169 205 230 250

Others 58 42 31 37 45

Total 477 509 554 602 648

Revenue by Region

(Growth Rate %)2009 2010 2011 2012 2013

North Asia 15% 15% 7% 5% 5%

South Asia -2% 6% 21% 12% 9%

Others -16% -28% -26% 19% 22%

Total 4% 7% 9% 9% 8% Source: Company, PSR Healthy balance sheet: OSIM generated free cash flow of S$93 mn in FY13, building the net cash position to S$112 mn (including the convertible bonds of S$119 mn). Most of the debt is from the convertible bond due in 2016. We believe the borrowings will be reduced moving forward with partial, if not all of the convertible bonds will be converted by the Option Redemption Notice 5 July 2014 since the convertible bonds is in the money with adjusted conversion price is at 1.87. Dividends: OSIM issued a full year dividend of 6 cents in FY13, translating into a payout ratio of 43% in 2013, compared to 57% in 2012. OSIM aims to maintain a dividend payout ratio of at least 30%. Figure 17: Dividend and payout ratio over FY09-13

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Earnings forecast We forecasted the earnings of OSIM by estimating store growth and revenue growth per store for its various business segments. As at December 2013, OSIM had 590 stores, GNC / RichLife had 245 stores and TWG had 26 stores. In total there were 861 stores. Management targets for FY14:

(1) Open 20-30 OSIM outlets (2) Store rantionalization for Richlife in 7 key China cities (3) Open 20 TWG outlets (4) Higher annual Capex budget of $25 mn for TWG expansion

In our estimates, we assume OSIM to increase 15 OSIM outlets and 15 TWG outlets annually over the next five years. GNC / Richlife outlets are assumed to remain constant with store rationalization of Richlife offsets expansion of GNC outlets. We have a 25% discount to new store sales to account for the gestation period before sales picks up. We also assume 5% CAGR for sales per OSIM and TWG store and 3% CAGR for sales per GNC/Richlife store. The PATMI is estimated to maintain at 15% growth annually. Based on our assumptions, revenue is projected to increase at 11% CAGR for FY14-18F and the net profit is forecasted to rise at 12% CAGR over the same period. We believe our store expansion estimates to be conservative and earning forecast to be attainable with OSIM’s continued efforts to improve operational efficiency. We have not taken into account of any future acquisitions into our valuation.

Figure 18: Revenue forecast for FY14-18F

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Figure 20: Income statement Income Statement (S$mn)

FYDEC 2009 2010 2011 2012 2013 2014F 2015F 2016F 2017F 2018F

Revenue 477 509 554 602 648 746 828 916 1,002 1,090

Cost of goods sold (177) (176) (172) (181) (193) (229) (248) (269) (288) (307)

Gross profit 299 332 382 421 455 517 580 647 714 783

Other operating income 12 15 13 15 57 13 12 12 12 12

Other operating exp (259) (269) (283) (309) (371) (363) (405) (450) (494) (540)

Dep & Amortisation (13) (11) (11) (11) (14) (18) (19) (22) (25) (27)

EBIT 39 67 100 115 127 149 168 188 208 229

Net finance int / (exp) (1) (1) (2) (3) (0) 2 2 1 3 3

Associate & JV 1 1 (0) 2 3 0 1 1 1 1

Profit before tax 39 68 98 115 129 152 171 189 212 233

Tax (14) (18) (28) (28) (28) (33) (38) (42) (47) (51)

Proft after tax 25 50 70 87 102 118 133 148 165 182

NCI 1 (0) 1 0 0 4 5 3 5 4

Net profit 23 50 69 87 102 114 128 144 160 177

EPS (cents) 3.68 7.38 10.18 11.85 14.03 15.73 17.74 19.94 22.15 24.49

DPS (cents) 1 2 3 6 6 5 5 6 7 2

Assumptions: Average of 15

OSIM stores & 15 TWG stores

added per year. GNC/RichLife

stores to remain constant. The

sale per store to grow at 5%

and 3% annually for OSIM/TWG

and GNC/RichLife respectively

Bottom-line growth to

maintain at 15%

Dividend payout ratio policy

of 30%


CAGR 11% CAGR 12%


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Valuation Discounted cash flow model valuation We derive our S$2.87 target price based on discounted cash flow (DCF) model with key earning assumptions indicated in previous section. We assume a WACC of 8.5% and terminal growth rate of 1.5%. Our target price implies FY14E P/Es of 19.1x, favourable versus OSIM’s current valuation of 17.2x P/E. Osim has S$120m 5-year convertible bonds due in 2016.With the current price last close at $2.59, above the adjusted exercise price of approximately S$1.87, bondholders are likely to convert their bonds to shares. Management has seen about 30% of conversion to-date and will expect more conversion for coming months. About 65mn new shares will be issued in the market upon full conversion, representing close to 9% of the total shares. We have factored the full share dilution into our DCF model. We have compared OSIM with its massage chair peers, regional and global speciality retailers. The average industry P/E for the peers currently stands at 24.7x for FY2014E. OSIM is currently trading at a 30% discount compared to its peers while delivering a higher Return on Equity (ROE) and net margin. Our target price of $2.87, giving a potential upside of 12.9% remains attractive in our eyes. Figure 21: OSIM’s DCF valuation and WACC calculations Calculation of FCFF 2013 2014F 2015F 2016F 2017F 2018F

CFO 104 121 148 162 180 197

Less: CAPEX, net (11) (26) (26) (26) (26) (25)

FCF 93 95 122 137 154 172

Add: Interest expenses*(1-tax rate) 5 2 2 3 1 1

Free Cash Flow to Firm: 98 97 124 140 155 173

Equity Value 2014F WACC Components

Terminal growth, g (%) 1.50% Debt to Total Capitalisation 10%

WACC 8.5% Equity to Total Capitalisation 90%

Cumulative PV of FCFF 568 Tax Rate 25.0%

Terminal FCFF 1,429 Cost of Debt (after tax) 3.4%

Less: Net Debt 268 Risk free rate 3.0%

Less: MI 4 Market risk premium 8.5%

Intrinsic Value (S$ 'mn) 2,265 Beta 0.72

Divided by outstanding no. of shares ('mn) 788 Cost of equity 9.1%

Target Price (S$) 2.87 WACC 8.5% Source: Company, PSR


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Figure 22: Peers comparison

Market Operating Profit

Bloomberg Cap Div Yield Margin Margin

Company Ticker (US$m) FY13 FY14E FY13 FY14E FY13 FY14E FY13 FY14E FY13 FY13 FY13

OSIM INTL LTD OSIM SP Equity 1,546 13.7 18.2 4.9 4.7 9.2 11.3 37.3 26.3 3.3 19.6 15.7

Massage Chair Peers

OTO HOLDINGS LTD 6880 HK Equity 30 64.0 28.5 0.8 - 2.3 - 0.8 3.2 0.0 1.4 0.8

XIAMEN COMFORT-A 002614 CH Equity 1,088 81.4 61.3 1.1 - 34.1 - 1.4 5.2 1.1 -0.3 1.6

PANASONIC CORP 6752 JT Equity 28,625 24.7 22.2 1.2 1.9 4.4 5.4 -47.2 9.3 0.0 2.2 -10.3

Mean 56.7 37.3 1.0 1.9 13.6 5.4 -15.0 5.9 0.4 1.1 -2.7

Regional Peers

BELLE INTERNATIO 1880 HK Equity 8,361 13.1 11.1 2.3 1.8 7.7 6.5 18.7 17.2 1.1 15.6 12.4

MAN WAH HOLDINGS 1999 HK Equity 1,506 11.8 12.6 1.9 2.8 8.4 9.7 17.3 23.4 3.8 11.2 11.7

CHOW TAI FOOK JE 1929 HK Equity 15,855 19.2 16.6 3.2 3.2 13.9 12.5 17.8 20.2 2.1 12.2 9.6

ESPRIT HLDGS 330 HK Equity 3,246 - 107.3 1.4 1.5 - 16.8 -27.3 1.6 0.0 -7.2 -16.9

PRADA S.P.A. 1913 HK Equity 18,884 27.0 20.7 7.3 5.0 15.9 11.5 30.2 25.5 1.4 27.0 19.0

PORTS DESIGN LTD 589 HK Equity 297 8.0 6.1 1.5 - 4.8 - 19.1 17.9 5.9 22.9 16.7

L'OCCITANE INTL 973 HK Equity 3,484 28.6 24.0 4.8 3.2 16.2 13.0 17.8 13.9 1.2 15.3 11.8

ASICS CORP 7936 JT Equity 3,875 21.7 23.4 2.3 2.5 13.0 13.2 11.6 11.3 0.8 7.2 5.3

PADINI HLDGS PAD MK Equity 375 14.6 13.1 3.3 3.1 7.6 6.8 24.0 24.5 4.2 14.8 10.8

EU YAN SANG INTL EYSAN SP Equity 293 18.6 19.4 2.3 2.4 12.9 11.9 12.8 12.3 2.9 7.0 5.5

FJ BENJAMIN FJB SP Equity 85 32.1 - 1.1 - 17.2 23.9 3.3 1.7 2.0 1.1 1.2

Mean 19.5 25.4 2.9 2.8 11.8 12.6 13.2 15.4 2.3 11.5 7.9

Global Peers

LVMH MOET HENNES MC FP Equity 92,087 19.3 17.1 2.5 2.3 9.9 9.3 13.4 13.6 2.3 20.7 11.8

NIKE INC -CL B NKE US Equity 65,216 22.9 24.9 4.9 5.9 13.7 14.8 23.1 23.4 1.3 12.9 9.8

CIE FINANCI-REG CFR VX Equity 53,397 16.7 17.7 3.3 3.2 10.9 12.1 21.4 19.3 1.3 24.0 19.8

MICHAEL KORS HOL KORS US Equity 19,055 28.8 30.0 10.9 11.0 16.0 17.4 52.9 45.7 0.0 28.9 18.2

BURBERRY GROUP BRBY LN Equity 10,110 22.8 18.0 5.8 4.9 10.6 9.8 27.0 30.0 2.2 20.9 12.7

HUGO BOSS -ORD BOSS GR Equity 9,217 21.7 17.6 10.0 8.0 12.8 11.0 49.8 47.0 3.2 18.8 13.5

CHRISTIAN DIOR CDI FP Equity 33,930 16.5 13.7 2.2 1.2 6.6 6.1 - 10.8 2.2 20.4 4.8

L'OREAL OR FP Equity 97,877 25.8 21.4 3.4 3.2 15.6 14.2 13.6 14.6 2.0 16.9 12.9

PROCTER & GAMBLE PG US Equity 216,397 19.1 18.9 3.2 3.2 13.4 12.5 17.1 17.5 3.0 17.6 13.4

ESTEE LAUDER EL US Equity 26,136 24.6 23.5 7.8 6.5 13.4 12.4 33.9 31.1 1.6 15.3 10.0

Mean 21.8 20.3 5.4 4.9 12.3 12.0 28.0 25.3 1.9 19.6 12.7

Overall Mean (ex OSIM) 25.3 24.7 3.7 3.8 12.2 11.9 15.3 18.3 1.9 13.6 8.6

P/E (x) P/B (x) ROEEV/EBITDA (x)

Source: Bloomberg, PSR


Page | 18

Sensitivity Analysis

Target price sensitivity to WACC and terminal growth rate OSIM’s target price is more sensitive to variance in the WACC assumption versus that of the terminal growth rate assumption. The target price varies 4-9% for every 0.5% change in WACC assumption whereas the variance is 3-7% for same change in terminal growth rate. Figure 23: DCF valuation sensitivity to WACC and terminal growth rate

7.5% 8.0% 8.5% 9.0% 9.5%

2.5% 3.76 3.46 3.22 3.01 2.83

2.0% 3.50 3.25 3.04 2.86 2.70

1.5% 3.29 3.07 2.87 2.73 2.59

1.0% 3.11 2.92 2.76 2.62 2.49

0.5% 2.95 2.79 2.65 2.52 2.41

Term

inal

gro

wth

rat

e

S$WACC

Source: PSR Target price sensitivity to other key variables We have identified the following 2 variables that are vital to the earnings performance and price target: (1) Change in the number of stores and (2) Sales growth rate per store. We have assumed 15 new OSIM stores will be added annually for the next 5 years in our valuation. In the below study, we will vary the change in number of OSIM stores by 15 units and the sales growth rate per OSIM store by 5%. Other variables are kept constant. According to our analysis, the target price is more sensitive to the change to the sales growth rate per OSIM store as compared to the change in the number of OSIM stores. Every 5% change in sales growth rate per store will impact the target price by 7-9% whereas every 15 new OSIM store will impact the target price by 3-4%. This indicates that the management’s focus on store rationalization is imperative to the growth of the company. Figure 24: DCF valuation sensitivity to change in number of stores and revenue growth rate per store

Bear: 0 Base: 15 Bull: 30

Bull: 10% 3.00 3.12 3.24

Base: 5% 2.77 2.87 2.98

Bear: 0% 2.57 2.66 2.75

Change in the number of OSIM stores

Re

ven

ue

gro

wth

rate

pe

r O

SIM

sto

re

S$

Source: PSR


Page | 19

Company Profile OSIM, founded by Mr Ron Sim Chye Hock in 1980, is an Asia’s leading brand in well-being and healthy lifestyle products. The principle business segment includes designing, developing, marketing and franchising of a comprehensive range of well-being and healthy lifestyle products through its specialty retail outlets worldwide. Its business portfolio consists of three segments: (1) OSIM, a lifestyle products retailer specialising in massage chairs (2) ONI Global (GNC and RichLife), a nutritional supplements retailer and (3) TWG Tea, a luxury tea retailer. It also owned a 55% effective stake in Brookstone, a US-based retailer which was acquired in 2005 but has been fully written off since 2008. OSIM’s products have four broad areas: health, hygiene, fitness and nutrition. As of December 2013, OSIM operates a wide point-of-sales network with 861 specialty retail outlets in 32 countries worldwide. Figure 25: OSIM’s business structure

Source: Company, PSR Figure 26: Extensive network of outlets

Network of Outlets 2009 2010 2011 2012 2013

North Asia OSIM 301 386 385 392 395

South Asia OSIM 189 178 172 162 164

Others OSIM 39 39 29 23 31

GNC/RichLife 188 251 270 253 245

TWG 0 0 10 16 26

Total 717 854 866 846 861 Source: Company, PSR In long term, the strategy is to develop the OSIM International Ltd into an umbrella brand for healthcare and lifestyle products via investments into budding brands in related business areas, complimenting its core business growth. OSIM OSIM is the retail arm for the Group’s healthy lifestyle products which includes its flagship range of “OSIM” branded massage chairs and other related products (leg massagers, upper body massagers, handheld massagers, fitness equipment and air purifier). Massage chairs make up 40% of its total sales and the management team reveals that it continues to be strong particularly in China. The lifestyle unit is a major contributor at about 70% of the group revenue. Unlike the past where one product significantly contributed to the bottom-line, OSIM now has a better product mix for diversified sales so that business performance will be less sensitive should one particular product loses its market share. The current popular OSIM products are uInfinity, uAngel, uDivine App, uShape, uPhoria Warm and etc.


Page | 20

GNC / RichLife ONI Global is the OSIM’s retail arm for its range of nutritional supplements. It is the sole franchisee for GNC in Singapore, Malaysia, Australia and Taiwan and also distributes OSIM’s in-house products under GNC outlets. OSIM first acquired 29.9% of ONI Global (Global Active – old name) in April 2003 and subsequently increased its stake to 95%. OSIM entered the nutrition market in China with the launch its own brand of RichLife outlets in 2008 after it failed to agree to the terms of the GNC franchise in China. The products under the RichLife brand are all manufactured in the US. The management indicates that the RichLife business is still undergoing store rationalisation as they will focus the business in 7 cities. OSIM had received numerous awards from GNC US such as Best International Store of the Year and Highest Sale per square foot worldwide. GNC business is a cash cow, generating stable recurring income. Figure 27: GNC store in Singapore Figure 28: RichLife store in China

Source: Company, PSR Source: Company, PSR Figure 29: GNC Awards

Source: Company, PSR Figure 30: LAC StemC and LAC Liver Protector



Page | 21

TWG TWG is the OSIM’s retail arm for its range of luxury tea. TWG Tea is a finest luxury tea company established in Singapore by TWG (The Wellness Group). OSIM marked its foray into luxury tea segment with the first acquisition of a 35% stake in TWG Tea (parent) for S$31.4 mn in April 2011, along with the setting up of a 60:40 JV OSIM-TWG (North Asia), which will focus on four markets in North Asia: China, Hong Kong, South Korea and Taiwan. TWG has over 800 tea selections on its menu. In Jan 2014, OSIM has increased the stake in TWG Tea to 70% from 53.7% with S$25mn. TWG positions its stores in prime locations, such as in Ion Orchard and the Marina Bay Sands in Singapore. According to management, TWG generates about 80% of sales from its boutiques with the remaining 20% through distribution to hotels, restaurants and airlines. About 60-70% of sales are derived from tea products and accessories sales, with the rest directly through in-house F&B sales. OSIM will leverage on its extensive retail experience in Asia to expand the TWG store network across Asia with focus on Hong Kong, China, Singapore and Taiwan. Figure 31: TWG shareholding structure

Source: Company, PSR Figure 32: TWG Seoul – Largest flagship store worldwide in Cheongdam, Korea


Figure 33: TWG Tea gift packs



Page | 22

Brookstone Brookstone is a US speciality retailer selling a range of consumer lifestyle products, including OSIM massage chairs. In 2005, OSIM together with its consortium partners, Temasek Holdings and JW Childs, acquired Brookstone Inc for S$752m (US$456m) as an attempt to gain a foothold in US consumer market. OSIM contributed US$90 mn (S$146 mn) for a 55% stake in the company. However, Brookstone become a drag on OSIM’s figures with its significant losses during the global financial crisis in 2008, on lower sales and high debt service costs. This prompted OSIM to completely write-off the Brookstone investment in 2008 and Brookstone makes no contribution to OSIM today. We do not include any value from Brookstone in our forecasts. Figure 34: Brookstone store in US



Page | 23

Key Management Team

Name Position Role

Ron Sim Founder, Chairman & CEO

A multi-awarded businessman

Lead the team in setting and achieving OSIM's vision,

goals and direction

Peter Lee Executive Director & CFO

Responsible for corporate finance, investor

relations,human resources and information system

Joined OSIM in 2000

Board member since 2005

CFO of the Year at the Singapore Corporate Awards in

2009

Charlie Teo Executive Director& COO (South Asia)

Responsible for managing the Group's operations in

South Asian countries

Joined OSIM in 1989

Appointed to the Board since 2000

Richard Leow Executive Director & COO (China)

Looks after the Group's China business which spans

more than 40 cities from Shanghai, China.

Joined OSIM in 1987

Appointed to Board since 2000

Tan Kia Tong Chief Technology Officer

A Chartered Engineer

Responsible for OSIM's R&D department

Joined OSIM in 2002

Awarded the Public Administration Medal (Bronze) in

2000

Celine Cha Chief Merchandising Officer

Responsible for the Group's product design,

development and merchandising and quality assurance

Joined OSIM in 1995

Held the role of Chief Merchandising Officer since June

2005

Cynthia Poa CEO & Executive Director, ONI GlobalPte Ltd

Founder of Nature's Fram in 1982

Joined OSIM since its acquistion of Global Active in

2003

Responsible for GNC in Singapore, Malaysia, Taiwan,

Australia and Richlife in China

Taha Bouqdib President & CEO, TWG Tea Company Pte Ltd Co-Founder of TWG Tea in 2008 Source: Company, PSR


Page | 24

FYE DEC FY11 FY12 FY13 FY14F FY15F FYE DEC FY11 FY12 FY13 FY14F FY15F

Revenue 554 602 648 746 828 PPE 20 21 25 39 51

EBITDA 112 127 140 167 187 Intangibles 17 20 190 184 178

Depreciation & Amortisation (11) (11) (14) (18) (19) Associates & JVs 44 47 18 19 20

EBIT 100 115 127 149 168 Investments 17 28 15 15 15

Net Finance (Expense)/Inc (3) (6) (6) (2) (2) Others 10 11 14 15 17Other items 1 3 5 4 4 Total non-current assets 109 126 262 271 279

Associates & JVs (0) 2 3 0 1 Stocks 52 54 73 76 81

Profit Before Tax 98 115 129 152 171 Receivables 51 52 53 62 69

Taxation (28) (28) (28) (33) (38) Due from affli l iated co 1 4 1 1 1

Profit After Tax 70 87 102 118 133 Cash & Cash Equivalents 194 202 267 327 416

Non-controlling Interest 1 0 0 4 5 Others 24 33 24 24 24

Net Income, reported 69 87 102 114 128 Total current assets 323 344 418 490 591

Net Income, adj. 69 87 97 114 128 Total Assets 431 471 680 761 870

Short term loans 16 25 155 59 59

Accounts Payables 84 90 102 101 111

Due to affl i l iated co 23 13 16 16 16

Others 17 19 24 24 24

FYE DEC FY11 FY12 FY13 FY14F FY15F Total current liabilities 141 147 297 201 211

Long term loans 117 117 0 0 0

EPS, reported 0.10 0.12 0.14 0.16 0.18 Others 5 7 39 39 39

EPS, adj. 0.09 0.12 0.14 0.15 0.17 Total non-current liabilities 122 124 39 39 39

DPS 0.03 0.06 0.06 0.05 0.05 Non-controlling interest 3 4 73 77 82

BVPS 0.24 0.27 0.37 0.61 0.74 Shareholder Equity 169 200 344 521 620

FYE DEC FY11 FY12 FY13 FY14F FY15F FYE DEC FY11 FY12 FY13 FY14F FY15F

CFO P/E (X), adj. 16.7 10.9 13.5 17.2 15.3

PBT 98 115 129 152 171 P/B (X) 6.4 4.7 4.9 4.2 3.5

Adjustments 24 14 2 15 17 EV/EBITDA (X), adj. 8.9 6.9 9.2 10.1 8.6

Cash from ops before WC changes 122 129 132 167 187 Dividend Yield (%) 1.9% 4.8% 3.3% 1.8% 2.1%

WC changes (5) 0 2 (13) (2) Growth & Margins (%)

Cash generated from ops 116 129 133 154 185 Growth

Taxes paid, net (17) (27) (29) (33) (38) Revenue 54.2% 8.7% 7.6% 15.2% 10.9%

Cashflow from ops 99 103 104 121 148 EBITDA 68.0% 13.2% 10.9% 18.8% 12.1%

CFI EBIT 79.3% 14.9% 9.8% 17.8% 12.3%

CAPEX, net (13) (13) (11) (26) (26) Net Income, adj. 48.3% 25.9% 11.8% 17.1% 12.8%

Dividends 0 0 2 0 0 Margins

Purchase/sale of investments (54) (26) (7) (1) (1) EBITDA margin 20.2% 21.0% 21.7% 22.4% 22.6%

Others (12) 3 13 4 4 EBIT margin 18.1% 19.2% 19.6% 20.0% 20.3%

Cashflow from investments (79) (36) (3) (23) (22) Net Profit Margin 12.6% 14.5% 15.7% 15.9% 16.1%

CFF Key Ratios

Interest Paid (1) (4) (2) (2) (2) ROE (%) 12.1% 47.1% 37.3% 26.3% 22.5%

Purchase of treasury shares (27) (15) (8) 0 0 ROA (%) 7.4% 19.3% 17.7% 15.8% 15.7%

Loans, net of repayments (2) (0) 4 0 (0)

Dividends (22) (36) (36) (36) (34) Net Debt/(Cash) (60) (60) (113) (268) (357)

Others 148 1 0 0 0 Net Gearing (X) Net Cash Net Cash Net Cash Net Cash Net Cash

Cashflow from financing 98 (54) (41) (38) (36)

Net change in cash 118 13 60 60 89

Effects of exchange rates 2 (5) 6 0 0

CCE, end 194 202 267 327 416

Source: PSR

Income Statement (SGD mn) Balance Sheet (SGD mn)

Per share data (SGD)

Cashflow Statements (SGD mn) Valuation Ratios


Page | 25

Total Returns Recommendation Rating

> +20% Buy 1

+5% to +20% Accumulate 2

-5% to +5% Neutral 3

-5% to -20% Reduce 4

<-20% Sell 5

We do not base our recommendations entirely on the above quantitative return bands.

We consider qualitative factors like (but not limited to) a stock's risk rew ard profile, market

sentiment, recent rate of share price appreciation, presence or absence o

Ratings History

PSR Rating System

Remarks

12345

0.8

1.3

1.8

2.3

2.8

Jan-1

1

Apr-1

1

Jul-1

1

Oct-1

1

Jan-1

2

Apr-1

2

Jul-1

2

Oct-1

2

Jan-1

3

Apr-1

3

Jul-1

3

Oct-1

3

Jan-1

4

Apr-1

4

Jul-1

4

Oct-1

4

Source: Bloomberg, PSRMarket Price

Target Price


Page | 26

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Page | 27

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31 march 2014 osim international limited valuation...

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