Short Notes on Eu Yan Sang

Article from The Edge (Singapore), Dec 26 2011.

Eu Yan Sang

Interview with Richard Eu:

• As of Sept 11, EYS has 189 stores in SG, M'sia, HK, Macau and China. Also sells products to supermarkets and convenience stores. 23 TCM clinics in SG/M'sia, and 2 integrative clinics in HK.
• Growth can no longer be dependent on further expansion in the TCM space alone, will hit saturation at some point. In the company's early years, growth was 20%... "Now our growth rate is slowing down...How do get into another phase of growth where you can look at 15 to 20% growth? Thats why we have to go beyond TCM."
  
• Plans to acquire a stable of brands to move into the natural wellness space (eg: detox, organic)
• EYS stores already carry a range of natural foods, health supplements such as honey mart honey, zing spa products, ProNature oatmeal.
• Want to separate TCM brand from company. Mentions Nestle: They have their own brand, but also a portfolio of other brands (e.g.: Maggi, Nespresso). EYS must own and develop other brands. "Its going to take years, probably beyond my time."
  
• Article mentions past failures: "Red, White & Pure" restaurant launched in 2006 which combined TCM based cuisine with spa treatment...failed and was disposed of in 2009. "It was the wrong time and wrong location" In Aug 10, EYS paid A$3.56m for Healthzone, esp. for its retail franchise in China. Healthzone collapsed last month, probably has to be written off.

My opinion:

I think this is a slippery slope. From medical, tested and proven treatments, to things which may be beneficial, to things that are rubbish:

• Some of EYS current business is equivalent to (the western idea of) selling medicine or pharmaceuticals (whether prescribed e.g.: antibiotics, or over-the-counter e.g.: panadol). The items sold are backed by (some) scientific research, or 5000 years of TCM tradition, so do generally work.
• Other products are like health supplements (e.g.: birds nest), may be the equivalent of buying vitamins or fiber supplements. Don't know if they work, but it may.
  
• At the bottom, we have practically any cosmetic, weight loss, anti-aging product. These are marketing driven fads....bust cream, slim-10, anti-oxidants, ginko, whatever else....

There are more and more competitors as you move down the slope, with fewer barriers to entry and chances for brand building. It is a riskier business. EYS is good at their core business, but it will be hard to move beyond that, especially if they want to move into a crowded, fickle and marketing driven industry.

Should EYS be valued as a value stock (PE 5-10), rather than as a growth stock (PE 15)?

Eu Yan Sang

Regional TCM company. Main business is M'sia, S'pore and HK, attempting to expand into in China:

What they do (breakdown by 2010 revenue):

• 81%: Retailing. Their main business. Their chain of 171 retail outlets sells their branded TCM and health products throughout HK, S'pore & Msia..
• 11%: Wholesale. Mostly in HK/China. In HK, sold to large chain stores like Mannings/Watsons. In China, sold to pharmacies/hospitals.
• Abt 8%: Clinics and others.

Their main products seem to be of two types:

• Proprietary medicines, taken from a complex traditional formula, put in powder/capsule form, and scientifically tested for results. eg: Bak Foong pill (menstrual symptoms), Bo Ying compound (f0r babies)
  
• Generic products, branded with a label (e.g.: birds nest, essence of chicken)
  

Business model:
Cashflow generated from operations is used to expand their retail network, introduce new products, and start other new businesses. They have been very successful with the first two - in 7 years from 2002 to 2008 (both troughs in recessions), revenue and PBT (excluding exceptionals) have more than doubled.

EYS has been profitable every year since listing in 2001:


Their core retail TCM business has been growing steadily and profitably, but overall profits have been more sporadic. Excluding the exceptional charges smooths out their core profits:

The exceptional charges are usually impairments to non-core businesses, write-offs and exceptional gains from sale of businesses. EYS' previous attempts to diversify into other areas have mostly failed:

Year	Exceptional Charges
01	none
02	-0.7 (impairment of goodwill: Oxford natural products) -1.4 (provision for diminution in value of investment?)
03	-2.9m (Write off for Oxford Natural Products) -0.7m (Provision for impairment Botanical Health Resources)
04	-1.4 (Impairment of goodwill - Australia (Your Health, Aroma Fresh))
05	-1.5 (Impairment of Goodwill - unknown...possibly Botanical Health?)
06	+3.2m (special gain: divestment of Synco)
07	+1.3 (special gain: sale of property) +1.4 (special gain: sale of Elixir)
08	-2.4m (write off RedWhitePure) -0.5 (YourHealth) -3.9 (impairment of investment in unquoted shares)
09	none
10	none

Only 6 of the past ten years have generated FCF, due to high CFI:

Most of the CFI (orange bar above) was spent on new retail outlets (furnishings and fixtures):

• 02: 7.4m (+9 outlets)
• 03: 7.8m (+13 outlets)
• 04: 5.4m (+9 outlets)
• 07: 4m (+13 outlets). 9.5m construction-in-progress
• 08: 7.5m (+19 outlets)
  

Competitive advantage:
They may have some sustainable competitive advantage due to 'upmarket' branding. Cannot quantify. No market share figures are available. The TCM market is large with no clear segment boundaries (e.g.: many small TCM businesses selling herbs). And no clear competitor in the same up-market segment (in S'pore at least).
I don't know if their proprietary products are truly unique, a quick search shows other brands have have similar products (1) (2).

Since the TCM market is so fragmented, I guess they have little or no pricing power. From a 2004 DBSV report:
The TCM market in Hong Kong and China is highly fragmented with many small retail operators and CPM manufacturers. The supply and retail of raw and processed herbs are carried out by 800 medicinal halls and retail outlets in Hong Kong and significantly more in China. There are, however, only 4 major retail chains in Hong Kong and China, namely Eu Yan Sang, Tung Fong
Hung, Nam Pei Hong and Beijing Tongrentang.


Inventories
Critical for retailers. Generally, EYS seems to stock slightly less than 1 quarter's sales as inventory:

Over the long term, have become more efficient, as sales have risen compared to inventory.

Balance sheet
From their latest Dec 2010 results, they have 5.6m long term loans. Less than one year's earnings.

From their Jun 09 Annual Report: they have 22m operating lease commitments within one year.

Cyclical
Does their business suffer during a recession?

In the 2002 recession and 2003 slowdown (SARS), same store sales suffered:

For 2003, the chairman noted that "SARS had a huge impact on retailing...tourist travel was sharply reduced...consumers stayed away from shopping centers".

However, in the 2008 recession, I can see no effect:
Can't draw a conclusion, other than sales seem affected by long recessions.

Valuations
Typically how low does EYS' valuation go in a bear market? EYS reached a trailing PE of around 6 to 7 in 2002 (long recession), and 9 to 10 in 2008 (short recession).