Despite reporting a 160% increase in first half profits last week, shares of Blackmores Limited (ASX: BKL) still ended the week down by nearly 5%. This takes the vitamin company's year-to-date share price decline to nearly 28%.
To put this in perspective however, the shares have still gained around 250% over the past 12 months and more than 390% (excluding dividends) over the past five years – long term shareholders, therefore, won't have too much to complain about!
Blackmores, along with Bellamy's Australia Ltd (ASX: BAL), were possibly the two biggest momentum trades of the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) last year and investors must now wonder if the good times are over or whether this is just a temporary bump in the road.
There are a number of reasons that could explain why Blackmores' share price has fallen from more than $220 per share down to $157 in just a matter of months including:
- Profit taking – Traders and investors who have ridden the wave up over the last year will have wanted to lock in profits before the company released its earnings just in case their was some unexpected surprise or earnings expectations miss.
- Speculation of Chinese Government intervention – As reported last week, the Chinese government is proposing laws to tighten restrictions on the importation of products such as baby formula and vitamins being sold to consumers through the so called 'grey market'. Renowned fund manager Geoff Wilson cited this as the reason for his recent sell-down in Blackmores saying the risk of a crackdown was just too big to ignore.
- Increasing scepticism about the efficacy of its products – Although some of its products have a genuine health benefit to consumers, the majority of its products lack rigorous scientific evidence to support their claims. This may seem insignificant while sales are booming (especially into Asia), but voices about this issue are getting louder and this could be seen as a risk moving forward.
- Valuation concerns – At $220 a share, Blackmores was trading on a trailing price-to-earnings (P/E) ratio of around 83. While this appeared extremely expensive, its forecast P/E ratio for FY16 before the release of its first half results was closer to 37. Although the forecast multiple is not outrageous, with the broader market getting heavily sold off at the start of the year, there was always the risk some investors would get nervous and move to limit their exposure to high valuation companies.
- Increased threat of competition – The level of growth Blackmores has achieved will naturally bring new competitors into the market looking to get a piece of the action. Although Blackmores has a brand that consumers trust, there is always the risk of new competitors entering the scene with aggressive marketing campaigns that have the potential to impact sales.
What now?
The earnings report released by Blackmores last week confirmed it remains on track to deliver huge earnings growth for the remainder of FY16. Furthermore, according to Commsec, analysts are projecting FY17 earnings per share of $7.18 – more than two-and-a-half times what it earned in FY15.
While this seems extraordinary, there is a good chance that Blackmores could generate profits higher than this especially if its new baby formula venture is successful.
Buy or avoid?
The decision to buy or avoid comes down to whether you believe Blackmores will be able to continue on its current growth trajectory or whether issues like government restrictions will impact the company's sales to foreign markets.
It could be argued that the recent share price decline has already factored in most of these risks, but I feel there could be further uncertainty in the short term and investors should remain watchful for new developments or further falls in the share price before allocating a large portion of their portfolio to Blackmores.
