It's safe to say that vitamins and supplements supplier Blackmores Limited (ASX: BKL) has proved me wrong over the past year or so.
I'd virtually written the company off in a number of articles published in 2013 and 2014, as Australian and New Zealand sales stagnated, and I couldn't see growth in Asia filling the hole.
From 2011, when net profit was $27.3 million, the next three years produced earnings of $27.8m, $25.0m and $25.4 million. Clearly, Blackmores was struggling to generate growth.
Profit margins fell to their lowest levels since 2005 (as the chart below shows), despite revenues still rising. It seemed like the supermarket juggernauts Woolworths Limited (ASX: WOW) and Coles – owned by Wesfarmers Ltd (ASX:WES) were exerting their influence on Blackmores, much like they've done to other suppliers like Coca-Cola Amatil Ltd's (ASX: CCL) SPC Ardmona, Patties Foods Ltd (ASX: PFL) and a host of other producers.
But all that appears to have changed in the last year or so. In the six months to December 2014, the vitamin producer saw a net profit of $18.6 million, up 54% higher than the previous year, as revenues jumped 22%, driven by sales through pharmacies such as Chemist Warehouse.
The signs were there that Blackmores could generate strong growth previously. In 2013, the company grew revenues by 25%, but that didn't translate to net profit, which fell 10%, hit by a decline in profit margins. In October 2013, the company saw its first-quarter profit fall by 31% – with the company labelling the Australian retail market 'highly challenging'.
Those margins appear to be on the mend, rising strongly in the last half from 7.3% last financial year, to 9%. Incidentally, that's very close to Blackmores' long-term average profit margin of 8.5%.
So how has the company turned it around?
One only needs to take a closer look at management commentary around recent results to find that out.
In the 2014 annual report, chairman Marcus Blackmore wrote,
"The key growth indicators within our business may be modest, although I believe we have turned a corner and have promising prospects for the coming year."
He wasn't wrong about that.
The acquisition of Fit-BioCeuticals in July 2012 certainly has helped. The company primarily sells health products with higher dosages that can only be purchased on recommendation by doctors or naturopaths. BioCeuticals delivered $4.6 million in earnings before interest, tax, depreciation and amortisation (EBITDA) in 2011. In 2014, BioCeuticals delivered $6.8 million in earnings before interest and tax (EBIT), nearly 20% of group EBIT, before corporate costs. In the last half, the division delivered again, with a 17% increase in sales.
But the biggest gains have come from the Australian business thanks to strong pharmacy sales and growing demand for Blackmores' products from Chinese consumers. (Is this the making or strengthening of a competitive advantage – the Blackmores' brand?).
Sales into Asia are also rising, although Thailand appears to be a recalcitrant child.
Management also appear to have focused on improving margins through cost cutting, expense management and repaying debt – which has fallen from $87 million 2013 through to $63 million at the end of December 2014, with net debt at $36.7 million. Increasing benefits of scale through higher production runs are also improving fixed costs and adding to improved margins.
All in all, it means higher revenues and more cents in the dollar dropping through to the bottom line.
A juiced up price
There are a few problems, and the main one is the share price — currently around $77.50. Blackmores' shares have rocketed up more than 120% since the beginning of this year alone.
Based on estimates for net profit this financial year, Blackmores' shares are trading on a prospective P/E ratio of more than 30x earnings. The company's long-term average is around 16-17x.
That suggests that the market expects the vitamin maker to continue pumping out strong growth for at least the next few years.
If Blackmores can do that, then today's price might be justified. The problem is that the company might be unable to push its EBIT margins much higher, so earnings growth is unlikely to grow at such a fast clip in future.
Other issues include steadily falling returns on capital (ROCE), equity (ROE) and assets (ROA) — although I'll qualify that they are still impressive by market standards (ROE of 25%) – but it's something to watch.
I'll be keeping an eye on Blackmores. It's definitely one of the higher-quality companies on the ASX, but I'd like a cheaper price to buy in at.
