A Look At DXN

Someone asked me about DXN the other day.

Well DXN, the stock, had been a lemon since it was listed back in 2003.

Here's how the stock performed from its listing to Aug 2009.

But since then... I am well aware, the stock has done considerably well. (LOL! I know that's an understatement. :P )


Yeah, the stock recently, went into orbit too!

Now there's a "First Interim Dividend of 4% less 25% tax and 4% tax exempt per ordinary share of RM0.25 each" which will go ex on 20th Sep 2010.

And DXN had played some really decent dividends the last year fiscal year. A set of 4 interim dividends were paid.

1. 15th Sep 2009 1st interim dividend 3% less 25% tax
2. 3rd Dec 2009 2nd interim dividend 4% less 25% tax
3. 19 March 2010 3rd interim dividend 4% less 25% tax
4. 30 June 2010 4th interim dividend 3% less 25% tax

And the last reported earnings seemed interesting too! Quarterly rpt on consolidated results for the financial period ended 31/5/2010 - DXN reported earnings was some 10.076 million and its previous year, same quarter, earnings was a mere 5.012 million.

An interesting development?

Of course I could be wrong but the very first thing I would want to discover is why is the stock such a lemon earlier?

As simple reference, I use two research reports. RHB initiated coverage on DXN back in 2005.

• 5 October 2005
  
  RHB Highlights
  
  􀁘 Initiation of Coverage: DXN Holdings Berhad (rm0.69) : “Take a Chance” on Lingzhi TRADING BUY
  
  􀁘 DXN Holdings Bhd (DXN) is principally involved in the manufacture and sale of health supplements via direct selling, as well as cultivation of mushrooms.
  
  􀁘 Amway remains the biggest local direct seller with a 10% market share compared with DXN’s 3.5%. In terms of revenue contribution by geographical area, in 1QFY02/06, 41% came from the Philippines, followed by Malaysia (23%), India (11%) and the US (7%).
  
  􀁘 DXN is at its growth stage, manifested in its current expansion plans and activities include among others, going upstream in manufacturing one of its core raw materials, production of new product categories (skin care and cosmetics and enzyme based juice drinks) and construction of a production plant in China.
  
  􀁘 Indicative fair value of RM0.88 is based on 9x FY02/06 EPS that represents a 40% discount to the consumer sector’s 1-year forward PER of 14x. The discount is to reflect the market’s reduced appetite for stocks with a small market capitalisation. Management has informally committed to a dividend payout of 40% of FY02/06 earnings. TRADING BUY.
  
  Background: DXN is engaged in the manufacture and sale of health supplements via direct selling, as well as cultivation of mushrooms. (See Chart 1 for corporate structure). Its products fall into six main categories, namely health food supplements, food and beverages, personal care products, household products, skin care and cosmetics and water treatment system. Main products manufactured and sold are made from Ganoderma (a scientific name for red mushrooms or lingzhi) mushroom extracts. Its best-selling products are mushroom-based Reishi Gano (Ganoderma mushroom essence), Ganocelium capsules and tablets, and 3-in-1 lingzhi coffee.
  
  DXN operates seven manufacturing facilities located in three countries where the labour cost is relatively cheap, namely Malaysia, Indonesia and India. Its plant in China is currently under construction.
  
  DXN’s products are primarily sold via direct selling. A plus side on DXN is that it requires upfront cash payments from stockists and distributors before goods are delivered, hence lowering credit risk. Also, all overseas sales transactions are denominated in USD, lowering DXN’s foreign exchange exposure to local currencies in the countries they operate in. As a manufacturer and a direct-selling company, DXN‘s costs mainly consist of raw materials, labour, manufacturing overheads and bonus payments to stockists and distributors. Core raw materials such as creamer and sugar are locally sourced under 2-year supply and purchase contracts with two main suppliers in the region.
  
  DXN is setting up a production plant in China to capitalise on the lower production cost in China, and better market penetration into China.
  
  DXN’s direct-selling focus reduces competition with bigger brands and other homogeneous products currently available in hypermarkets and supermarkets. Also, this focus means DXN is not vulnerable to unfavourable credit terms with these hypermarkets and supermarkets as these parties have stronger bargaining power.
  
  DXN’s business operational structure of having access to both its upstream and downstream supply chain gives the group a better position in controlling its product price.
  
  Given its increased number of and average revenue contributed by stockists and distributors, we believe there is a strong potential growth in revenue and earnings.
  
  Corporate Structure:
  
  Earning Outlook: We expect DXN’s revenue to grow by at least 10% p.a over the medium term, underpinned by: (1) The rising consumerism in the region; and (2) Greater market reach via its expanding distributor/stockist network. Despite the rising commodity prices and operating costs in general, we expect DXN’s margins to sustain thanks to DXN’s strategy of:
  
  (1) Putting up new production facilities in a low-cost country, i.e. China; (2) Moving upstream to produce some of the raw materials which DXN can produce cheaper in-house. With sustained margins, we expect the 10% p.a. topline growth to filter down to 10% growth in profit for FY02/06.
  
  Recent Developments: DXN is investing in a new plant in China that is expected to come on stream within a year from now. This plant will cater to demand from the Philippines. In September 2005, the Group signed an MOU with Ministry of Agriculture and Food Industry Sabah to commercialise Spirulina cultivation, Ganoderma and Cordyceps production, Enzyme production, integrated Kenaf cultivation and processing, sericulture, and vermiculture in Sabah.
  
  Investment Risk: Dependency on Philippines market. As mentioned earlier, this market contributes 41% to DXN’s revenue. There is an associated country risk attached to this dependency, such as political, economic and currency risks which in concert can affect consumers’ spending power in the Philippines.
  
  Low share liquidity/ small market capitalisation. The market’s weak appetite for stocks with a small market capitalisation currently. This means DXN may not trade up to our indicative fair value over the immediate to short term.
  
  Cyclical downturn in the global economy. This may affect consumer spending over the short term.
  
  Balance Sheet: DXN’s balance sheet is strong. As at 28 February 2005, its net cash stood at RM29.3m, translating to RM0.12/share.
  
  Valuation: Indicative fair value of RM0.88 is based on 9x FY02/06 EPS that represents a 40% discount to the consumer sector’s 1-year forward PER of 14x. The discount is to reflect the market’s reduced appetite for stocks with a small market capitalisation.
  
  Recommendation: We like DXN for: (1) its current business structure of controlling and effectively managing the supply chain both upstream and downstream; (2) its strong foothold in the regional market and it is ahead of many competitors in regional expansion; and (3) stable and strong financial position, apparent management team synergy and good dividend yield of 5.8% for FY02/06. We are initiating coverage on DXN with a TRADING BUY recommendation.

* RHB's earnings estimates for FY 06, FY 07 and FY 08 was 24.3 mil, 26.7 mil and 29.4 mil.

And I got a copy of iCap's notes on DXN in 2007. (BB --> :P )

• DXN Holdings Berhad (DXN, 5074)
  
  [Updated on 27/07/2007 14:41:00]
  
  Principal activities: Direct selling of health supplements,etc and property development
  Major shareholder/s: DXN Group Sdn Bhd
  
  Financial highlights (RM mln) – 28 February
  
  This week, i Capital updates DXN Holdings Bhd (DXN), a company that is principally involved in multi-level marketing (MLM). Since its listing on 30 Sep 2003, the performance of DXN’s share price has been lacklustre. This seems to be unjustifiable when we look at the group’s historical financial performance.
  
  i Capital feels that the depressed DXN share price is due to the lack of investor confidence in the group’s strategy of diversifying into other non-core activities such as property development and biodiesel. Unlike the MLM business, property development and biodiesel projects require high initial investments, which have, in the short term, affected the group’s financial position. As at FY2007, the group’s borrowings have escalated to over RM100 mln against a cash balance of RM45 mln, putting the group in a net debt position – see figure 1. What is even more worrying is that the group’s net operating cash flow has been going downhill over the past 2 years. The huge increase in property development cost and trade receivables (due to longer credit terms granted to overseas customers) has caused the group to generate a negative net operating cash flow of RM14.8 mln in FY2007.
  Before assessing the prospects of the group’s existing and new businesses, for the benefit of newer subscribers, i Capital shall briefly discuss the group’s operations.
  
  Multi-level marketing: One world, one market – a global MLM company DXN was started in 1995 by Dr Lim Siow Jin, who discovered the health benefits of Lingzhi mushroom and decided to popularise this miraculous herb and the benefits that can be derived from it. Over the years, the group has expanded its production to about 80 over Ganoderma mushroom-based products, ranging from health food supplements to personal care products. Its top three selling products are the “3-in-1” Lingzhi coffee series, Reshi Gano & Ganocelium and toothpaste products, which respectively contributed about 37.5%, 32.9% and 4.0% to the group’s total MLM revenue in FY2007. Its new product, Spirulina, contributed about RM7.1 mln or 3.7% to the group’s MLM revenue in FY2007, making it the fourth best selling product.
  R>As DXN is able to source most of its raw materials locally, it is less exposed to shortages of raw materials. For example, rubberwood sawdust and rice chaff, which are used as organic substrate to grow the Ganoderma mushroom, are available in Kedah, while Ganoderma mushrooms and Ganoderma Myceline, which are used as raw ingredients to manufacture various products, are grown on its own farm in Jitra, Kedah. Although the group currently sources its coffee powder from three suppliers, it faces pressure from the increase in coffee prices in recent years. Nevertheless, the economies of scale derived from its vertically integrated production gives the group a competitive advantage to sell its products at lower prices compared with its competitors.
  
  Unlike most MLM companies who are still struggling to gain a foothold in the local market, DXN has successfully expanded its footprint to many different parts of the world – see figure 2. Currently, the group’s top three markets are the Philippines, Malaysia and India, which respectively contributed about 47%, 21% and 11% to the group’s revenue in FY2007. The group’s global success can be attributed to its innovative marketing concept, “One world, one market”, which allows its distributors to enjoy worldwide bonuses with a single membership card. As at May 2007, the group has 3.2 mln distributors worldwide, of which 600,000 are active members. With a single membership card, DXN members are able to establish their business anywhere around the world. When the group gains a certain level of demand for its products in a particular country, it will set up an international branch to increase its visibility, as well as to provide better support for its distributors in that particular country. Although the MLM business does not require high capital investment, there are barriers for other MLM companies that want to penetrate the overseas markets. For instance, the company will need to ensure that its products are manufactured from internationally recognised Good Manufacturing Practice (GMP)-certified factories and that it must have a reliable enterprise software system to keep track of its sales and distributors’ points (points that distributors receive upon making a sale).
  
  Due to the group’s success in expanding its product range and customer base, revenue from its MLM business has been growing steadily over the past 5 years – see figure 3. However, viewing its MLM business as a cash cow and that growth from its MLM business has been slowing down over the past 3 years, the group decided to venture into other business activities that will hopefully sustain the group’s growth.
  
  Property development
  
  The return of property arm to the group
  Unknown to many, DXN has been in the property business since 1998. Under the name of DXN Development Sdn Bhd, the company was involved in residential building, industrial building as well as the building of GMP-certified factories for the group. However, when DXN underwent listing in 2003, it decided to make the group a pure MLM company and thus spun off its property business. Nevertheless, it continued to maintain a dormant property company known as DXN (KL) Sdn Bhd, which subsequently changed its name to DXN Land Sdn Bhd (DLSB) to inject the property business back into the Group. Currently, there are two subsidiaries under DLSB, Richmont Saphhire S/B and Yiked DXN Stargate S/B.
  
  Richmont Sapphire Sdn Bhd
  Richmont Sapphire Sdn Bhd (RSSB) was acquired by DLSB on 12 Oct 2005. The company has just completed a residential project, comprising 94 housing units, in Jelutong, Penang. To date, RSSB has managed to sell 23 housing units, with another 7 units pending buyers’ ability to secure housing loans from their respective banks. As the price of each housing unit is about RM568,000 (promotional price), the Richmont Residential project is targeted at middle to high income earners. With its show unit ready in early Jul 2007, the group aims to sell 50% of the 94 units by this year, with the remaining units targeted to be fully sold by the end of 2008.
  
  Yiked-DXN Stargate Sdn Bhd
  Yiked-DXN Stargate Sdn Bhd was set-up on 11 Aug 2006 as a joint venture company between Yayasan Islam Negeri Kedah (Yiked) and DXN Development Sdn Bhd to carry out a mixed development project in Mukim Pengkalan Kundur, Alor Star, Kedah.
  
  The proposed mixed development project is designed as a self-contained project, which will provide a mixture of low, medium and high cost residential units together with a wide range of supporting activities such as hypermarket, fast food restaurant and petrol station. The 307-acre project will be developed in 5 major phases, spanning 7 to 9 years, with an estimated total investment cost of RM360 mln. The first phase, encompassing 52 acres comprises 220 shop houses, 1 hypermarket and 1 petrol station. The buying interest for the first phase is encouraging, with all 220 shop houses being sold out in its initial launch and the company has even received earnest money from people who are interested in buying the shop houses that are to be developed in the second phase.
  
  Being positive over its mixed development project, DXN expects its property business to contribute significantly to its earnings over the next few years.
  
  Biodiesel expansion
  With the group’s expertise in biotechnology, it has decided to expand its research activities into bio-fuel whereby the group aims to cultivate Jatropha and Castor for the production of biodiesel. Biodiesel is a renewable fuel produced from plants. Currently, the main crops used to produce biodiesel are rapeseed (Europe), soybean (US), Jatropha (Africa and India), castor bean (Africa, China and South America) and palm oil (tropical areas). Although there are potential markets for biodiesel, the successful implementation of the biodiesel projects require intensive market research, as well as high technological capabilities.
  
  DXN has chosen to cultivate Jatropha and Castor for biodiesel production as the oils extracted from both crops are non-edible, making it cheaper and less controversial than other edible oils such as palm oil and soybean oil. As Jatropha and Castor are drought resistant plants, they grow in marginal soils, which make them non-competitive with other food crops for agricultural land. In addition, as the major demand for biodiesel comes from the US and European countries, Jatropha and Castor oil-based biodiesel can also potentially help to overcome the problem of the crystallisation of other types of biodiesel in cold climate.
  
  The group has been facing difficulties in finding suitable soils for cultivating Jatropha and Castor. In 2006, it has signed Memorandums of Understanding (MOUs) with parties such as Molek Engineering Sdn Bhd and Entrep Resources Sdn Bhd with the intention of cultivating Jatropha and Castor on a commercial basis. However, the MOUs were terminated due to the difficulties encountered in finding suitable soil to farm Jatropha and Castor.
  
  Originally, DXN proposed to develop 2 biodiesel plants with annual capacities of 400,000 tonnes each in Pahang, as well as 2 more biodiesel plants with similar capacities and 1 palm oil mill with an annual capacity of 500,000 tonnes in Sabah. However, due to the difficulty of cultivating Jatropha and Castor in time for its biodiesel plant to start commercial production, the group has decided to cut down its downstream investment (ie biodiesel plant). Due to the rapid rise in CPO prices, DXN feels that it is not lucrative to invest heavily in biodiesel plant at this point in time.
  Nevertheless, the group has found a piece of suitable land to cultivate Jatropha and Castor in the northern part of Thailand, and it is expected to take about 2 to 3 years for the crops to yield.
  
  Meanwhile, the group has already started a 10,000 tonnes/annum pilot plant in Pahang, which is currently producing biodiesel additives for its own vehicles. The group will be building another 220,000 tonnes/annum biodiesel plant in Pahang, which is expected to cost about RM50 mln. Although the group has already acquired 871,200 square feet of land in Sabah for its biodiesel project (costing RM10.4 mln), it remains conservative in making any further investments, as it is still conducting studies on the demand for Jatropha and Castor oil-based biodiesel, as well as building up its technological capabilities to meet the quality standards of the European and US markets.
  
  Conclusion and Advice
  
  At RM0.72, DXN is capitalised at RM173.4 mln. For this, what do investors get in return?
  
  Although it is disheartening to see the group falling into a net debt position and its failure to fully implement its biodiesel project, i Capital remains positive about the prospects of its MLM and property businesses and continues to see great potential in the group’s MLM business, as it continues to expand into other countries such as Mongolia, South Africa and the UK. To improve the profit margin of its MLM business, the group intends to revise its product prices on a quarterly basis rather than on a yearly basis to make it more in line with the movement in raw material prices. The group will also be exploring vertical integration, whereby it will have more control over its raw material prices and supply chain. Given that the group’s coffee product has been its top-selling product for many years, i Capital sees great potential for the group to move further downstream, such as setting up coffee cafes. While we expect revenue from the Group’s property business to contribute significantly to its earnings over the next three to five years, contribution from its biodiesel project will only be materialised from 2010 onwards. Even then, the contribution will still be insiginificant and it is also uncertain when the group will be able to breakeven with regards to its biodiesel project. While the group’s high level of debt puts it in a risky position, its MLM business continues to generate positive cash flow and the income from its property development will also help to reduce some of its bank borrowings.
  
  Currently trading at a low forward PE of 6 times and historical price to book ratio of 1.2 times, the share price of DXN remains attractive. However, i Capital revises its rating for DXN to a medium-term Buy below RM0.80.

Yeah, now I remember. :P

DXN diversified into property development on Oct 2005!!!

From a MLM player to a property developer. Yeah cows can do pole dancing too! (ps: DXN attempted to diversify into TIMBER business back in 2008! Yeah... horrors!! :P )

Anyway, what struck me most was iCapital's opening comments.

• Since its listing on 30 Sep 2003, the performance of DXN’s share price has been lacklustre. This seems to be unjustifiable when we look at the group’s historical financial performance

Ok.. let me compare that to my notes...

What would be your 'honest' evaluation of a business with those set of numbers? (*DXN raised some 28.633 million from its IPO)

Me?

1. From earnings perspective? Lacklustre and below average.
2. Balance sheet? Did not like what I see in the loans.

How else could I call it? (Ok.. dividends, is probably the only bright point)

And for me, I feel that it was justifiable that the share performance had been poor too!

So what has changed lately?

With the property divserification, here's the yearly segmental earnings table from DXN.


Ahh... that would be as a good 'indicator' of what's driving the current company's fortunes.

First, without a shadow of a doubt, the property and the 'investment' business should be flushed down the toilet! LOL! Someone should GO into DXN's office and drill into the boss head that DXN should quit their property and investment business and concentrate on what they know best, which is MLM!

Yes, the MLM is hot. Very hot. It's the driver of the company's success.

Now I was surprised that DXN fy 2011 numbers came out 'so good'. Why? Hai-O was warning about its MLM business and here is DXN.. doing great 'when' compared to its previous quarter.

But.... it's slightly... 'complicated' or 'distorted'.

Here's DXN earnings link in July 2010: Quarterly rpt on consolidated results for the financial period ended 31/5/2010

• The Group reported higher revenue of RM 67.8 million in the current quarter ended 31 May 2010 as compared to RM 60.1 million in the preceding quarter ended 28 February 2010. The increased was due to higher sales generated from multi-level marketing segment. The Group’s PBT for the current quarter was RM 12.5 million as compared to RM 7.3 million in the preceding quarter. The increased in the PBT was mainly due to the provision of RM5.65 million for diminution of investment in CLO subordinated bond in the preceding quarter

Profits increased due to the 5.65 million provision boosted gain. How? This is a one time boost, yes?

Now this is where it gets interesting. The previous quarter, April 2010: Quarterly rpt on consolidated results for the financial period ended 28/2/2010

• The Group’s PBT for the current quarter was RM 7.3 million which included the one off provision of RM 5.65 million for diminution of investment in CLO subordinated bond. By excluding the provision, the PBT achieved shall be RM12.95 million as compared to preceding quarter of RM 12.1 million, whereas the PBT margin increased from 19.4% in preceding quarter to 21.5% in current quarter. The slight increased in PBT margin was due to cost efficiency.

Eh? Profit for the prvious quarter was actually lower due to 5.65 million provision. Excluding the provision, PBT should be higher at 12.95 million.

LOL! A plus here and a minus there. :P

And so here we are.

Company is making better profits through its MLM business, balance sheet looks much, much better and the company is paying decent dividends.

How?