1

1 EV = Market Cap + (Debt + Minority interest + preferred shares) – (cash and cash equivalents)

Blackmores Limited (ASX:BKL)

12 October 2013 | Consumer Health Australia

An Unexpected Journey

This report provides potential investors with an analysis of Blackmores

LTD (BKL), a leader in the Vitamins and dietary supplements

production industry in Australia with operations in New Zealand, and

Asia. While there are significant challenges in Asian operations we can

expect progressive earnings growth in all its operating regions by

exploiting changing demographics and social trends.

Valuation of $34.16 reflects a decreased valuation from 2012. It reflects

the increasing competition in the VDS industry and Blackmore’s

struggles in China as it attempts to establish itself as a late comer to an

established competitive market. However, the high intrinsic value

affirms the view that it is in good position to leverage on its quality

products to ride the growing health conscious Asian market.

FY13 marked the eleventh consecutive year of sales with sales rising

approximately 25% (incl. BioCeutical brand), despite its market share in

Australia decreasing to 16.9% in 2012 from its high of 18.8% in 2009 as

competitive pressures continued to increase.

All profitable ratios that were examined including gross profit margin,

EBIT margin, EBITDA margin and net income margin declined during

2012/13. The highly fragmented nature of the market and increasing

competition in the VDS markets in both Australia and abroad will pose

to be a challenge. FY14 will see continued revenue growth from Asia

relative to that of Australia. Sales growth for Blackmores is expected to

increase to 27% in FY14 and decrease steadily to approximately 4% by

FY18 as we expect the market to mature and growth be slightly above

GDP growth in the long term

Key risks to target price include barriers in Asian markets –

regulations, consumer tastes, culture, and political unrest. Heavy PR

efforts have established foreign VDS brands as quality products in Asian

markets and Blackmores can exploit these conditions. Strong Australian

dollar could be an additional downside risk for Blackmores.

Rating

Target Price:

BUY

$34.16

Stock Data

Price at 16 Oct 2013: $25.58

Intrinsic Value: $34.16

52 Week High: $33.89

52 Week Low: $24.23

Average Price: $28.82

Market Cap (mn): $429.26

Shares

Outstanding(mn): 16.90

Daily Volume (Avg): 9.35 K

Source: Yahoo Finance, BKL Data

Key Financial Data FY13 End

Debt/Equity 77.34%

Net Debt/Equity 58.53%

Dividend Yield 4.91%

PE 17.48%

Price/Book 4.47%

EV1/EBITDA 11.1x

Source: BKL Data

BKL Share price (AUD)

This report does not in any way reflect

a professional recommendation of

BKL shares. It is produced for

educational purposes as part of

university assessment (reconfigured

for hwasungyou.wordpress.com)

23.00

25.00

27.00

29.00

31.00

33.00

35.00

2

Figure 1: Sales and EBITDA margin

(AUD 000s)

See Appendix 1 for relative performance against its GICS sector

Source: Euromonitor

Figure 4: Blackmore Operations

Source: BKL

Business Description

Blackmores Ltd (ASX:BKL) – founded in 1932 and based in Sydney – is the

leading brand in the Australian consumer health industry. According to

Euromonitor International, Blackmores has a 7% market share in consumer

health and 17% market share in vitamins and dietary supplements (VDS).

Blackmores develop and market products in the VDS sector with a view on

natural approaches to health across many Asian countries such as Thailand,

Malaysia and Singapore. Asia is increasingly becoming an important market

for Blackmores and long term growth in this region is expected to be strong,

particularly from mainland China. The BioCeuticals business, through the

acquisition of Fit-BioCeuticals in July 2012, allowed Blackmores to ride the

growing healthcare practitioners-only market.

Industry Overview

Australia

Growing VDS industry and underlying trends In CY12 the Australian VDS industry grew 9%, bringing it to a total value of

$1.8 billion (Euromonitor 2013). The factors driving the growth in this

market are Australia’s increasing health awareness and trend towards an

ageing population. According to Australian Bureau of Statistics it is

estimated that over 63% of adult Australians and over 25% of children aged

5-17 are overweight, making Australia the fifth obese nation in the world.

The percentage of people aged 65 and over is also increasing in relation to

the whole population and is expected to be 25.7% of the total population by

2050. The VDS industry is highly correlated to these wave of changes and

the demand for its products will continue to increase as consumers

increasingly turn to supplements to bridge the gap in their diet and nutritional

needs to maintain a healthy lifestyle. As the leading brand in Australia,

Blackmore’s is well positioned to take full advantage of this trend.

Refer to Appendix 1 for SWOT and Porter’s 5 forces analysis.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2009 2011 2013

Sales EBITDA margin

0%

20%

40%

60%

80%

100%

120%

140%

Figure 2: BKL relative performance

Blackmores S&P/ASX 200

71.57

%

9.20%

9.26%

13.68

%

3.83%

Figure 3: Revenue by

segment

Australia Thailand

Other Asia BioCeuticals

3

Figure 6: Market Share of major

brands in Australia

Figure 5 : Estimate of global VDS

market size (2012)

Country Market size

(US$ mn)

China 12230.9

South Korea 3770.6

Taiwan 1962.9

Australia 1669.7

Thailand 1159.5

Hong Kong 588.0

Malaysia 517.3.1

Singapore 487.8

New Zealand 201.5

Source: Euromonitor at 16 Oct 2013 exchange rates

Source: Euromonitor, IBIS

Asia Growing market: The expansion into the Asian market is increasingly

becoming an important revenue source for Blackmore and this trend is

expected to continue. Sales grew by 14% and reported profits by 24% for the

Asian region compared to the previous year, while over the same period

Australian sales grew only by approximately 5.14%. The sales growth is

backed by wider distribution channels that are available in this region

including highly connected online market, pharmacies, health food stores,

specialty stores, hospitals, department stores, home shopping and direct

selling.

China: The economic growth in China has slowed dramatically from its

double digit figures prior to the financial crisis. According to the World Bank

the Chinese economy grew by 7.8% in CY12 and has forecasted that it will

grow by 7.5% in CY13, much in line with International Monetary Fund’s

forecast of 7.75% over the same period. Strong single digit growth in the

vicinity of 7-8% is expected for years to come. The VDS industry has seen

stable growth over the years reaching market size of approximately US$11.31

billion in CY12 and this trend is expected to continue with the growth in

Chinese consumers’ disposable income, health awareness and knowledge and

demand for higher quality life.

The VDS industry in China is also highly fragmented with the leading brand

being Amway at 17% of market share (Euromonitor 2013). Amway leads

sales in direct selling and has a portfolio of diverse products tailored to the

needs of Chinese consumers. Blackmores could integrate direct revenue

stream through online orders into the Chinese online retail industry and tap

into the Chinese internet population of approximately 591 million.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2009-2010 2011-2012

Blackmore SwisseCenovis Nature's WayNature's Own HerronBerocca

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

2008 2009 2010 2011 2012

Figure 7: Historic VDS sector growth vs. BKL sales

growth

Blackmores

sales growth

Australia

China

Malaysia

Singapore

South Korea

Thailand

4

Competitive Positioning

Source: Euromonitor

Australia: Blackmores is the market and brand leader in Australia’s highly

fragmented VDS market. The VDS market in Australia is fragmented with

a number of dominant suppliers including Blackmores, Nature’s Way,

Pfizer, Swisse Vitamins and Nature’s Own. Such competitive environment

combined with the size of the Australian market has limited growth

potentials in the Australian market. Blackmores’ strategy in Australian

VDS market has been to retain market share through investment in

advertising and channel promotions, increasing its online presence and new

sustainable product ranges (Blackmores 2013).

Asia: Blackmores is recognised as the most trust brand in Thailand and

Malaysia with sales growing by 21.99% in Thailand. The rapid increase in

sales across Southeast Asia has been backed by improved health standards

across the region, causing demand for immunity products to increase

(Euromonitor 2013). Blackmore faces competitive pressures from Amway

in Malaysia (19%) and Cerebos in Thailand (38%) although its core

products and operations in these regions do not compete directly with its

competitors’ products.

Blackmore expanded its global footprint with expansionary efforts into East Asia, in particular China and South Korea.

These markets have long established market leaders that have products that meet consumer tastes including traditional

Chinese medicine and ginseng. In order to adapt to the market, Blackmores’ partnered with Eu Yan Sang in Hong Kong to

take advantage of local tastes and to commit to its expansion into China. Blackmores’ Australian based production line is

a competitive advantage it has over its competitors as it signals quality. Compliance with TGA standards in addition to the

recent launch of Blackmores Institute reinforces quality and helps Asian consumers identify the brand with quality

(Blackmores 2013).

Company Strategy

In order to maintain its competitiveness and market position, Blackmores continued to diversify its product range through

innovation and reformulation, launching 120 new products across the group in FY13 (Blackmores 2013). The aggressive

product development and improvement seems to be a response to the increasing competition in the VDS market in Australia

and its consequent lack of market share growth. To retain its leading position it also successfully diversified itself from

traditional retailing activities by reaching out to practitioner segment through its BioCeuticals brand. It is well positioned

as the market leader in practitioner only segment to capture this growing market.

Corporate value chain analysis

The production, distribution and storage facilities of Blackmores located at Warriewood campus in Sydney. The campus

is equipped with up to date technology, such as RTL's voice picking RF and pick to light systems, which enhances the

company’s materials handling and distribution with more accuracy and thus, facilitates stronger synergies between the

supply chain and customer service. With heavy emphasis on innovation and improvement, its products are developed

through a combination of scientific research and traditional knowledge. The Blackmores range is produced under the PIC/S

(Pharmaceutical Inspection Convention and Pharmaceutical Inspection Co-operation Scheme) standards of manufacturing

practice with ensured quality. Furthermore, Blackmores has moved to an ecofriendly production process with emphasis on

sustainable and reliable products from research to finished product.

16.9%

13.7%

6.4%

5.6%

4.4%2.3%2.0%

48.7%

Figure 8: Australian VDS

market share by product

brand (2012)

Blackmores Swisse

Cenovis Nature's way

Nature's own Herron

R&D Manufacture DistributionMarketing &

SalesServices

5

Accounting analysis

The remuneration system of Blackmores includes both fixed and performance-based incentives that are mainly based on

key performance indicators of the company, such as the revenue growth. This creates potential incentives for managers to

manipulate the numbers for reasons such as pay-per-performance. Additionally, the preparation of financial statement that

complies with the AASB provides managers a certain degree of judgments that enlarge this opportunity.

A. Revenue and Other Comprehensive Income Adjustment In order to reflect the true performance of Blackmores from its reported operating activities, we adjust the revenue by

excluding the interest revenue from bank deposits, royalties, membership and other income (See appendix for details of

adjustment). Furthermore, other comprehensive income are not included in our income statement analysis as we believe

that some of the other comprehensive income items may be used to distort the true operating performance of the company.

B. Lease Adjustment In Blackmores’ 2013 annual report, we detected that its financial lease liability was much lower than its operating leases.

Since a company reporting a lease as an operating lease may typically show higher profits, higher return measures and a

stronger solvency position in early years than an identical company reporting it as a finance lease, an adjustment is made

on capitalizing the operating lease obligations of Blackmores to reflect the true performance of the firm. As a result, both

non-current assets and non-current interest bearing liabilities will increase accordingly for each year considered for analysis.

Consequently, the following accounts were also adjusted: depreciation expense, interest expense and net income (See

Appendix 2).

C. Other Adjustment We believed that the estimation of all the other items, such as provisions and allowances for doubtful debts are reasonable.

Furthermore, no impairment loss is detected in 2013 and the intangible assets of Blackmores are performing well in 2013,

no further adjustment is made on these items.

Financial analysis

A. Time-series analysis Dupont Analysis: Blackmores’ ROE has shown a decline from 38.62% in 2009 to 28.10% in 2013, with a temporary

increase in 2011. Table 1 presents the decomposition of ROE under both the traditional method and the alternative method.

The results of the traditional decomposition suggest that the ROE trend, especially the large drop between 2011 and 2013

is due to the movement of the ROA and net profit margin. The alternative decomposition, after applying the three level

analysis (Appendix 4), indicates that the change of ROE in the past five years, especially the sizable drop in 2013, was

mainly driven by the increase COGS and intangible assets turnover. The increase in COGS is caused by both the squeezed

price premium from intensified competition and $2.8 million inventory write-offs in 2013, as reported in the FY13 annual

report.

Table 1: Return on equity

2009 2010 2011 2012 2013

ROE¹ 38.62% 35.78% 37.37% 33.57% 28.10%

Traditional Decomposition

Net profit margin 10.50% 10.85% 12.03% 10.64% 7.93%

Asset turnover 1.55 1.46 1.51 1.57 1.57

ROA 16.24% 15.79% 18.15% 16.71% 12.49%

Leverage 2.38 2.27 2.06 2.01 2.25

Alternative Decomposition

Operating net profit margin² 10.94% 11.53% 12.86% 11.42% 9.03%

Operating asset turnover 2.34 2.24 2.27 2.27 2.24

Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18%

Spread 22.76% 21.07% 22.19% 19.63% 13.54%

Net financial leverage 0.57 0.47 0.37 0.39 0.59

ROE 38.62% 35.78% 37.37% 33.57% 28.10%

6

Note: (1) The net income used here is adjusted for revenue and lease adjustment. See Appendix 1 for the detailed

adjustment and calculation. (2) See Appendix 4 for the calculation of NOPAT, net assets, spread and net financial

leverage.

Profitability: As explained in three level analyse in Appendix 4, all of the profitability ratio for Blackmores has declined

in 2012 and 2013 after the increase recorded for the period from 2009 to 2011. Comparison of market share allows the

conclusion that this was due to the increasing competition in the Australian VDS market.

Table 2: Summary of margins

2009 2010 2011 2012 2013

Gross profit margin 56.33% 58.13% 59.53% 56.89% 52.30%

EBIT margin 15.39% 16.47% 18.53% 16.11% 12.27%

EBITDA margin 26.11% 25.48% 20.55% 18.12% 14.23%

Net income margin¹ 10.50% 10.85% 12.03% 10.64% 7.93%

Note: (1) The net income we used here is adjusted for revenue and lease adjustment, which is not the NOPAT we used

in the Dupont analysis. The difference and how NOPAT is derived from net income (adjusted) and their relevant

calculation are discussed in detail in Appendix 4.

A1. Investment management

Working Capital Management: The deterioration in the operating working capital turnover from 8.9 in 2009 to 6.04 in

2013, indicates that Blackmores’ capacity to generate operating revenue from its operating working capital invested have

declined. The decline, however, has narrowed in 2013, implying an improved efficiency during the year. This trend is

attributable to an improved operational management, which is reflected in the increase in accounts receivable turnover,

inventory turnover and accounts payable turnover in 2013 after the fall from 2009 to 2012. Overall, the results in Table 3

suggest that Blackmores has improved its working capital management in 2013 as it collected receivables, sold inventories

and paid payables at a faster pace than in 2012.

Table 3: Analysis of working capital management

Long-Term Asset Management: Despite the improved efficiency on the use of PP&E from 2010 to 2013, as seen through

the increase in PP&E turnover from 3.17 to 4.66 after the decline in 2010, Blackmores’ use of long-term asset has been

fluctuating during the past five years and have recently deteriorated as a result of decline in net long-term asset turnover in

2013. One possible reason is in the large increase of intangible assets and goodwill in 2013 due to the acquisition of

BioCeuticals as reported in the 2013 annual report.

Table 4: Property Plant and Equipment turnover

2009 2010 2011 2012 2013

Net long-term asset turnover 3.17 3.09 3.33 3.60 3.55

PP&E turnover 3.23 3.17 3.49 3.86 4.66

Note: (1) Refer to Appendix 8 for the reformulation and calculation of Net long-term assets (2) PP&E is adjusted with

the lease adjustment from Appendix 2

2009 2010 2011 2012 2013

Operating working capital to sales ratio 11.24% 12.25% 13.96% 16.15% 16.55%

Operating working capital turnover 8.9 8.16 7.16 6.19 6.04

Accounts receivable turnover 6.02 5.74 5.72 5.26 5.55

Inventory turnover 5.21 4.66 4.10 4.05 4.35

Accounts payable turnover 3.05 2.51 2.67 2.52 2.74

Days receivable 60.64 63.55 63.86 69.43 65.74

Days inventory 70.05 78.33 89.07 90.13 83.96

Days payable 119.87 145.44 136.82 144.90 133.31

Note: Refer to Appendix 8 for the reformulation and calculation of operating working capital

7

A2. Financial Leverage and Decision Analysis

Figure 9: Liquidity ratios

Liquidity Despite of the decline in operating cash flow ratio

from 0.8 in 2010 to 0.55 in 2013, Blackmores’

overall short-term liquidity has strengthened with

the growth of its current ratio, quick ratio and cash

ratio in the past three years.

Table 5: Operating cash flow ratio

2009 2010 2011 2012 2013

Current ratio 2.18 2.34 2.36 2.39 2.75

Quick ratio 1.68 1.68 1.65 1.63 1.87

Cash ratio 0.47 0.69 0.35 0.35 0.45

Operating cash flow ratio 0.74 0.8 0.67 0.59 0.55

Note: Operating cash flow is adjusted for the lease adjustment from Appendix 2

Figure 10: Solvency ratios

Solvency Due to funding of the BioCeuticals acquisition,

Blackmores was experiencing higher solvency ratios

and lower interest coverage ratio in 2013 as a direct

result of increased debt level. Such an increase in

solvency risk will not cause an issue for Blackmores as

the acquisition performed well during the year and has

started to contribute profits to the parent.

Table 6: Solvency measures

2009 2010 2011 2012 2013

Liability-to-equity ratio 1.35 1.23 1.03 0.97 1.21

Debt-to-equity ratio 82.65% 75.96% 60.53% 54.72% 77.34%

Net-debt-to-equity ratio 57.23% 47.25% 36.67% 38.65% 58.53%

Interest coverage ratio 20.60 14.24 14.67 13.88 7.98

A3. Cross-sectional analysis

0.00

0.50

1.00

1.50

2.00

2.50

3.00

2009 2010 2011 2012 2013

Current ratio Quick ratio

Cash ratio Operating cash flow ratio

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90.00%

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25.00

2009 2010 2011 2012 2013

Interest coverage ratio Debt-to-equity ratio

Net-debt-to-equity ratio

8

As a multinational healthcare company in VDS industry with operations that are geographically similar to Blackmores,

despite in a much smaller scale, we believe that the cross-sectional comparison with Vita Life Sciences (VLS) will provide

us with a better understanding of Blackmores’ strategy and relative performance. In order to make the analysis consistent,

the accounting adjustment for VLS has been adopted in Appendix 5. The reason for limiting our analysis to profitability

and working capital management analysis and the drawbacks of our cross-sectional analysis are discussed in detail in

Appendix 6 and 7, respectively.

Profitability: Although VLS reported higher gross profit margin than Blackmores from 2011 to 2012, both of its EBIT and

net income margin are lower than Blackmores. Because VLS is a multinational company who entered the Asia market,

especially China, earlier than Blackmores, the market it operates is more diversified than the market Blackmores operates.

The resulted higher gross profit margin of VLS is consistent with Blackmores’ strategy of diversification and expansion to

Asia markets. The lower EBIT and net income margin, however, implies that the cost management of VLC is not as

efficient as Blackmores.

Table 7: Profitability comparison

Profitability Vita Life Sciences Blackmores

2011 2012 2011 2012

Gross profit margin 64.77% 64.65% 59.53% 56.89%

EBIT margin 6.01% 9.42% 18.53% 16.11%

Net income margin 4.81% 7.71% 12.03% 10.64%

Working capital management: VLS’s overall working capital management is less efficient than Blackmores’ as indicated

by the lower NOWC turnover and inventory turnover despite of the strong receivable turnover, which is not believed to be

sustainable in the long run. This trend again, indicates Blackmores’ efficiency in it operational management.

Table 8: Working capital management (VLS vs. BKL)

Valuation

A. Assumption and Forecasting We used four different valuation methods in calculating the intrinsic value of Blackmores and here is the summary of the

forecasted inputs of relevant models (Refer to Appendix 10 for detailed analysis):

Table 9: Summary of forecasts and assumptions in valuation

Vita Life Sciences Blackmores

2011 2012 2011 2012

Operating working capital to sales ratio 13.89% 17.02% 13.96% 16.15%

Operating working capital turnover 7.2 5.87 7.16 6.19

Accounts receivable turnover 3.94 7.34 5.72 5.26

Inventory turnover 2.39 2.29 4.10 4.05

Days receivable (days) 92.6 49.75 63.86 69.43

Days inventory (days) 152.44 159.23 89.07 90.13

Note: Refer to Appendix 5 for detailed calculation of net operating assets and net working capital

2014 2015 2016 2016 2017 2018

DCF, Abnormal Earnings and Abnormal Returns Model¹

Sales growth rate 27% 16.77% 10.41% 6.47% 4.02% 2.49%

NOPAT/sales 9.5% 9.3% 9.1% 8.9% 8.7% 8.5%

Beginning NOWC/sales 14.86% 14.66% 14.46% 14.26% 14.06% 14.06%

Beginning NOLT assets/sales 26.55% 26.05% 25.55% 25.05% 24.55% 24.55%

Net debt/book value of net capital 42.91% 41.91% 40.91% 39.91% 38.91% 38.91%

Cost of debt 4.06%

Market risk premium 5.80%

Risk free rate 5.16%

9

B. Sensitivity & Scenario Analysis DCF: Since the result of DCF and residual income methods rely heavily on the multiple assumptions and forecasts we have

made above, it is necessary to run the sensitivity and scenario analysis to the check the effect of those assumptions on the

equity value and assign a range of value based on different scenarios. According to the sensitivity analysis of each

individual inputs (See details of sensitivity analysis in Appendix 11), we determined that changes in NOPAT/sales ratio,

perpetual sales growth rate and cost of equity are the major assumptions that affect the share price the most. As a result, by

assigning the worst and best scenarios of these inputs explained in more detail in Appendix 12, we obtained the range of

the intrinsic value of Blackmores from our DCF method as follow:

Table 10: Summary of scenario analysis - DCF

DCF, Abnormal Earnings and Abnormal Returns Method Share price

Worst case $22.49

Base case $36.07

Best case $53.36

DDM: By conducting the sensitivity analysis for DDM by changes of the only assumption of constant dividend growth

rate from 2014 – 2018 in Appendix 13, we obtained the range of intrinsic value from DDM method as follow:

Table 11: Summary of scenario analysis - DDM

DDM Method Share price

Worst case $20.71

Base case $26.51

Best case $45.03

C. Triangulation Till this point, we have applied four valuation methods in valuing the intrinsic value of Blackmores and the summary of

the results is gathered as follow:

Table 12: Summary of scenario analysis – all models

DCF, Abnormal Earning and Abnormal Return¹ DDM²

Worst case $22.49 $20.71

Base case $36.07 $26.51

Best case $53.36 $45.03

Note: (1). Since we assigned the same assumptions and forecasting for discounted abnormal earning and abnormal return

method, they conducted the same results as DCF, which improves the consistency of our calculation (Refer to Appendix

14 for the worksheet for DCF, Abnormal Earning and Abnormal Return method. (2)See Appendix 15 for the worksheet

for DDM method

In order to derive the final range of value for Blackmores from four methods, we run the triangulation by assigning different

weights to each methods according to their degree of fitness (refer to Appendix 16&17 for the discussion of each method

and the justification of the weighting). The final share price of Blackmores calculated after the triangulation ranges from

$22.13 to $51.69.

Table 13: Triangulation

Weightings

DCF, Abnormal Earning and Abnormal Return 80%

Common equity beta 0.62

Cost of equity 8.76%

Discounted Dividend Model

Dividend growth rate 12% 10% 8% 6% 4% 2.5%

Note: (1) Since we apply the same assumptions for all three models as we believe that the assumptions derived from DCF

is reasonable and consistent for the other two, they should result in the same value and we put them into the same basket.

10

DDM 20%

Triangulation

Worst case Base case Best case

Final value $22.13 $34.16 $51.69

Figure 11: Triangulation

Conclusion

In conclusion, Blackmores is believed to be an undervalued company which is recommended as a strong buy based on our

valuation (fair value of $34.16) and its difference from the current market price of $26.28 per share (closed on the 17th of

May 2013 on ASX). According to our market, industry, accounting and financial analysis, it is believed that Blackmores’

current strategy of diversification and expansion will provide company the capability to sustain its growth and maintain its

leading positions in Australia despite of the intensified competition. Although China appears to be a bright opportunity for

Blackmores, further setbacks need to be overcome before the company can fully utilize the market opportunity.

Appendices

Appendix 1: Strategic Analysis

Figure 12: Relative performance against Consumer Staples (BKL GICS classification)

Source: Morningstar

$20.00

$25.00

$30.00

$35.00

$40.00

$45.00

$50.00

$55.00

$60.00

DCF, Abnormal Earning and Abnormal Return DDM Triangulated

Fair value

High

Low

11

Figure 13: Blackmores SWOT Analysis

Strengths1. Market leader in natural healthcare with strong presence in VDS2. 11 years of consecutive sales growth3. Highly efficient operations in Australia 4. Recognised brand with 80 years of experience and trust in quality5. Strong market position and brading in Thailand, Malaysia and exanding into growing and lucrative Asian market6. Long sighted management approach to company growth

Weaknesses1. Revenues are affected by many factors including interest rates, global economic outlook, consumer confidence and the cost of living2. Decreasing bargaining power against its main distribution channel in Australia (i.e. Coles, Woolworths and Chemis Warehouse)3. Asian expansion has not been tailored to the specific market, and currently relying on partnerships with local firms4. Australian business model is not optimal in Asia

Opportunities1. Acquision of FIT-Bioceuticals giving them exposure to the growing healthcare practitioner’s only market and giving organic growth prospects in this sector2. Shfting demographics and health awareness of the general population in Australia and Asia3. Much wider potential distribution channels in Asia including pharmacies, department stores, health food stores, specialty stores and online4. Partnership with Eu Yang Sang (HK) could open up knowledge of traditional Chinese medicine to better align product with the market

Threats1. Highly regualted industry and new regulations could impact sales (e.g. regulatory change in South Korea caused short term prodcut delays in 2012)2. Competition from low cost producers (e.g. Suisse) and other producers leading to margin erosion3. Increaing competition in VDS in Australia where Blackmore generates majority of its sales revenue4. Competition from subsitutes in Asia (e.g. bottled liquid vitamins)5. Competition between discount chemists and traditional retailers adverse impacting on margins on Blackmore products

SWOT

12

Figure 14: Porter's five forces analysis for Blackmores

Appendix 2: Accounting and Financial Analysis

Table 14: Revenue adjustment

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Revenue and other income 201,715 217,093 236,592 262,100 327,539

Other income 519 1,286 1,325 533 936

Royalties 882 873 844 681 -

Membership - - - 54 -

Operating revenue (adjusted) 200,314 214,934 234,423 260,832 326,603

According to Note 3.10.1 of Blackmores’ 2013 annual report, operating lease payments of the company are recognized as

on a straight-line basis over the lease term. By assuming the discount rate as the weighted average interest rate from

Blackmores’ annual report, the distribution of the lease payments and the calculation of present value of operating lease

are illustrated as follows:

Table 9: Lease adjustment

Blackmores Limited

Bargaining Power of Buyers

HIGH

Besides, recent launch of online sales, which is the only direct selling channel, BKL has to maintain good relations ship with their three major buyers who generate more than half of their revenue.

Supermarket chains have significant power over BKL due to their economies of scale

Rivalry among Existing Firms

HIGH

Aggressive competition both in-and out of Australia.

Swisse Vitamins posing to be one of the biggest competitors to Blackmores (In Australia)

Highly fragmented market and competition is fierce with products being easily reformulated by competitors

In East Asia: BKL is a small player competing against well established domestic and global brands

Threat of New Entrants

LOW

Barrier to enter the markets are restricted by high requirements of CAPEX and different legal barriers.

Deteriorating margins mean less lucrative to enter the VDS market at current state

In Asian operations the threat of entrants is HIGH as companies expand into Asia to grab a share of the region's growth

Threat of Substitute Products

LOW

There is minimal threat from freshfoods as consumers continue to trust measurable concentrated nutrients that are lacking in their diets

Chinese medicine is available in Australia, however, remains to be seen whether it will pose to be a threat in the long term. In China it poses to be a significant competitor.

Bargaining Power of Suppliers

LOW

Most of the inputs used by BKL are not highly specialised so bargaining power of suppliers remain weak

Its expansion into Asia could also expand its supplier choices

Future

lease

payment

2013 PV

2013

2012 PV

2012

2011 PV

2011

2010 PV

2010

2009 PV

2009

2008 PV

2008

2014 2311 2221 1426 1360 998 944.4 800 755.3 765 722.2 1,684 1590

2015 1070 988 311.8 284 289.8 259.4 154.5 137.7 166.8 148.6 223.8 199.4

13

Since Blackmores’ operating leases are related to business premises and motor vehicle fleet with lease terms between three

to six years, by assuming the useful life of 6 years and residual life of zero, the estimated depreciation rate and the

corresponding depreciation & interest expense from 2010 – 2013 are calculated as follow:

Table 16: Lease adjustment (depreciation and interest expense)

2013

($000s)

2012

($000s)

2011

($000s)

2010

($000s)

2009

($000s)

Estimated depreciation rate 17%

Interest rate 4.85% 5.68% 5.92% 5.92% 5.92%

Depreciation expense 411.07 323.24 214.48 215.69 394.95

Interest expense 117.27 108.00 74.69 75.11 137.53

As a result, both non-current assets and non-current liabilities of Blackmores are affected by the amount of PV of operating

lease each year. Lease adjustment will also increase the profit before tax, tax expense and net income by the amount

calculated by netting the reported operating lease expense and the depreciation & interest expense calculated above. The

changes on financial statements, including the cash flow statements are indicated below:

Table 17: Lease adjustment (Changes to the financial statement)

2013

($000s)

2012

($000s)

2011

($000s)

2010

($000s)

2009

($000s)

Changes on Balance Sheet (‘+’ increase, ‘-’ decrease)

Non-current assets +6,119.71 +2,418.04 +1,901.41 +1,261.65 +1,268.76

Non-current liabilities +6,119.71 +2,418.04 +1,901.41 +1,261.65 +1,268.76

Changes on Income Statement (‘+’ increase, ‘-’ decrease)

Operating lease expense -2,707 -1,664 -1,391 -1,034 -2,289

Interest expense +117.27 +108.00 +74.69 +75.11 +137.53

Depreciation expense +411.07 +323.24 +214.48 +215.69 +394.95

Profit before tax +2,178.66 +1,232.76 +1,101.83 +743.2 +1,756.52

Effective tax rate

(reported)

26.4% 29.1% 30.6% 30% 28.9%

Tax expense +575.17 +358.73 +337.16 +222.96 +507.63

Net income +1.603.49 +874.03 +764,67 +520.24 +1,248.89

Changes on Cash Flow Statement (‘+’ increase, ‘-’ decrease)

Lease payment -2,707 -1,664 -1,391 -1,034 -2,289

Interest payment +117.27 +108.00 +74.69 +75.11 +137.53

tax payment +575.17 +358.73 +337.16 +222.96 +507.63

CFO +2,014.56 +1,197.27 +979.15 +735.93 +1,643.83

CFF -2,014.56 -1,197.27 -979.15 -735.93 -1,643.83

Appendix 3: The Red Flag from Blackmores’ 2009 Balance Sheet Reporting

Although we have included FY09 in our financial analysis, it is important to note that there are some inconsistencies in

terms of balance sheet reporting of FY09 performance from 2009 and 2010 annual reports. Both assets (current and non-

current) and liabilities (current and non-current) reported in 2009 annual report are different from those reported in 2010

annual report. The possible reason for the inconsistency could be that Blackmores followed the auditors’ opinion or

2016 1070 950 311.8 270 289.8 245.5 154.5 130.0 166.8 140.3 223.8 188.3

2017 1070 913 311.8 258 289.8 232.3 154.5 122.8 166.8 132.5 223.8 177.8

2018 1070 877 311.8 246 289.8 219.8 154.5 115.9 166.8 125.1 223.8 167.8

2019 218 172

Discount

rate

4.06

%

4.85

%

5.68

%

5.92

%

5.92

%

5.92

%

Total 6119.71 2418.04 1901.42 1261.65 1268.76 2323,21

14

suggestions in 2010 and changed relevant items accordingly. Thus, we believed that the data for 2009 reported in 2010

annual report is more appropriate and have applied it for our analysis.

Appendix 4: Three level analysis of ROE

A. Level 1 Analysis

The alternative decomposition indicates that the change of ROE from 2009 to 2013 is caused by both operating ROA and

spread, and is partly offset by the changes of net financial leverage starting from 2010. To illustrate, although the spread,

which stands for the economic effect of borrowing (operating ROA – effective interest rate after tax), has changed

accordingly to the movement of ROE, its effect is offset by the net financial leverage as Blackmores’ overall financial

leverage gain to the shareholders has actually improved in 2013 (from 7.59% in 2012 to 7.92% in 2013) while the ROE is

experiencing a large drop (from 33.6% to 28.12% in 2013). Therefore, it is the operating ROA that mainly drives the

changes of ROE, which leads us to the level 2 analysis.

Table 18: Financial leverage gain

Alternative Decomposition

2009 2010 2011 2012 2013

Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18%

Spread 22.76% 21.07% 22.19% 19.63% 13.54%

Net financial leverage 0.57 0.47 0.37 0.39 0.59

Financial leverage gain 13.03% 9.96% 8.14% 7.58% 7.92%

B. Level 2 Analysis

By decomposing the operating ROA into operating net profit margin and operating asset turnover, the resulting outputs

indicate that the change of operating ROA is driven by both the operating net profit margin and operating asset turnover.

In order to determine the key drivers of these two factors, we applied the level 3 analysis below to further decompose the

operating net profit margin and operating asset turnover.

Table 10: Decomposing Operating ROA

2009 2010 2011 2012 2013

Operating net profit margin 10.94% 11.53% 12.86% 11.42% 9.03%

Operating asset turnover 2.34 2.24 2.27 2.27 2.24

Operating ROA 25.60% 25.82% 29.24% 25.99% 20.18%

C. Level 3 Analysis

Operating net profit margin

The operating net profit margin can be further broken down by using the common-sized income statement, as in Table

below. From the common-sized income statement, we observe COGS as the main source of change of operating net profit

margin for the past 5 years, especially to the recent drop of net operating profit. According to the market analysis above,

the large increase of COGS to sales ratio from 2011 to 2013 can be partly explained by the squeezed price premium from

the intensified competition. Furthermore, $2.8 million of stock write-off in 2013 due to the decreased sales in Australia

also contribute to the increase of the COGS (BKL annual report 2013). Additionally, the decrease of SG&A to sales ratio

from 2011 to 2013 indicates that company has improved its cost management during the past three years.

Table20: Common-size income statement

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Values

Sales 200,314 214,934 234,423 260,832 326,603

COGS 87,482 89,996 94,874 112,451 155,800

SG&A 52,957 60,397 82,034 90,395 110,458

Other 7,574 9,786 9,331 10,711 13,882

Effective tax rate (adjusted) 28.9% 30% 30.6% 29.1% 26.4%

15

Tax 8,550 9,995 12,433 11,396 9,291

NOPAT 21,919 24,784 30,148 29,799 29,486

Ratios as a percentage of sales

COGS 43.67% 41.87% 40.47% 43.11% 47.70%

SG&A 26.44% 28.10% 34.99% 34.66% 33.82%

Other 3.78% 4.55% 3.98% 4.11% 4.25%

Tax 4.27% 4.65% 5.30% 4.37% 2.84%

NOPAT 10.94% 11.53% 12.86% 11.42% 9.03%

Operating asset turnover

By formulating the inverse common size balance sheet, the operating asset turnover can be broken down into individual

asset turnovers as follow. It is important to note that the cash turnover is excluded in the analysis as the breakdown is based

on the net operating assets of the company, which does not include cash and other equivalents. According to the inverse

common size balance sheet, the recent drop of operating net asset turnover is driven by the decrease of intangible asset

turnover and some decrease of inventory turnover. The decrease of intangible asset turnover is caused by the large increase

of intangible assets from the acquisition of BioCeuticals while the drop of inventory turnover is probably due to the

increased inventory from the decreased sales in Australia.

Table 111: Operating asset turnover

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Values

Average receivables 33,282 37,421 41,012 49,614 58,827

Average inventory 16,789 19,314 23,152 27,768 35,839

Average fixed assets 62,082 67,741 67,119 67,581 70,067

Average intangible assets 205 563 1,364 2,135 10,095

Average other assets 1,753 1,914 2,018 2,081.5 2,456.5

Average net operating assets 85,623 95,973 103,121 114,655 146,111

Turnover Ratio

Receivable turnover 6.02 5.74 5.72 5.26 5.55

Inventory turnover 11.93 11.13 10.13 9.39 9.11

Fixed asset turnover 3.23 3.17 3.49 3.86 4.66

Intangible asset turnover 977.14 381.77 171.86 122.20 32.35

Other asset turnover 114.27 112.30 116.17 125.31 132.95

Operating net asset turnover 2.34 2.24 2.27 2.27 2.24

Appendix 5: Vita Life Sciences

Revenue adjustment

Similar to the adjustments on Blackmores, the revenues of Vita Life Sciences are adjusted by excluding the other income

to reflect the operating revenue as follows:

Table 22: Revenue adjustment (VLS)

2011

($000s)

2012

($000s)

Revenue and other income 24,477 30,354

Other income 210 163

16

Operating revenue (adjusted) 24,267 30,191

Non-operating item adjustment

The share of associate’s profit/loss is excluded in the profit calculation as they are assumed as non-operating items.

Lease adjustment

The same lease adjustment applies to the Vita Life Sciences as well and the followings are the results of the lease adjustment

for Vita Life Sciences:

Table 23: Lease adjustment - Vita Life Sciences

Future lease

payment

2012

($000s)

PV in 2012 2011

($000s)

PV in 2011 2010

($000s)

PV in 2010

2013 203.00 195.08 263.00 250.83 206.00 194.49

2014 24.00 22.16 59.75 54.35 48.50 43.23

2015 24.00 21.30 59.75 51.84 48.50 40.81

2016 24.00 20.47 59.75 49.44 48.50 38.53

2017 24.00 19.67 59.75 47.15 48.50 36.38

Discount rate 4.85% 5.68% 5.92%

Total 278.68 453.61 353.44

Note: (1) Since company does not release any information related to finance lease, the interest rate is assumed to be same

as Blackmores’

2012

($000s)

2011

($000s)

Non-current assets (PP&E) +278.68 +453.61

Non-current liabilities (Interest-bearing liabilities) +278.68 +453.61

Operating lease expense (Occupancy expenses) -302 -295

Interest expense +25.77 +20.92

Depreciation expense +149.69 +116.64

Profit before tax +126.54 +157.44

Effective tax rate 18.48% 13.55%

Tax expense +23.38 +21.36

CFO +252.85 +252.72

Note: (1) The depreciated rate is estimated as 33% because the average life of the leased assets is reported as 1-3 years

and is assumed as 3 years. (2) The effective tax rate is calculated by dividing the income tax expense to the profit before

tax.

Table 24: Adjusted income statement for VLS

2011

($000s)

2012

($000s)

Sales ¹ 24,267 30,191

Cost of sales 8,549 10,674

Gross profit 15,718 19,517

Expenses

Distribution 2,071 2,570

Marketing 1,804 2,278

Occupancy ² 344 417

Administrative ³ 9,638 11,113

Other 402 296

Profit before interest and taxes 1,458 2,843

17

Finance income 78 113

Finance costs 185 163

Profit before income tax 1,351 2,794

Income tax expense 183 516

Net profit for the year 1,168 2,277

Loss attributable to minority interest - -51

Profit attributable to the parent 1,168 2,328

Note: (1) Adjusted for revenue adjustment (2) Adjusted for lease adjustment (3) Adjusted for lease adjustment

Table 25: NOPAT (VLS)

2011

$000s

2012

$000s

Net interest expense after tax

Interest expense 185 163

- Interest income 78 113

= Net interest expsnese(income) 107 50

*(1-Effective tax rate) 86.45% 81.52%

= Net interest Expense after tax 93 41

Net Operating Profit after tax

Net operating income (adjusted) 1,168 2,328

+ net interest expense after tax 93 41

= net operating profit after tax 1,261 2,369

Net operating Income to common

Net income 1,168 2,328

- Preferred dividends - -

= Net operating income to common 1,168 2,328

Table 26: Calculation of net operating assets, net working capital and net debt (VLS)

2010

($000s)

2011

($000s)

2012

($000s)

Net Working Capital = Total current operating assets - Total current operating liabilities

Accounts Receivable 8,564 3,749 4,481

+ inventory 3,440 3,701 5,612

+ Other current assets 245 285 469

- Accounts payable - current 4,302 3,917 4,591

- Provisions - current 242 414 542

- Current tax liabilities 20 34 289

- Others - - -

= Net working capital 7,685 3,370 5,140

Net Long term Assets = Total long-term assets - Non-interest-bearing long-term liabilities

Long term tangible assets 166 127 126

+ Long term intangible assets 57 67 73

+ other long term assets - - -

18

- Minority interest 478 464 86

- Deferred tax (net) -47 -80 -80

- Other long-term Liability 5 20 41

= Net Long-term assets -213 -210 152

Total Net Operating Assets = net working capital + net long-term assets

net working capital 7,685 3,370 5,140

+ net long-term assets -213 -210 152

= Total Net Operating assets 7,472 3,160 5,292

Net Capital

Short term debt 1,814 - -

+ Long term debt - - -

- Cash and Investments 1,993 5,332 5,964

= Net debt -179 -5,332 -5,964

+ Preferred equity - - -

+ Shareholders' equity (less OEI) 7,651 8,492 11,256

= Total Net Capital 7,472 3,160 5,292

Appendix 6: Justifying the exclusion of liquidity, solvency and other ratios in cross-

sectional analysis

Vita Life Sciences is a much smaller company compared to Blackmores and has a debt balance of zero (in both short- and

the long-term). Its net debt, however, is negative and it is meaningless to apply the solvency and liquidity ratio analysis.

Additionally, the negative net long term assets caused by the large amount of minority interest which is higher than the

total long-term assets makes it unnecessary to compare the long-term asset management between companies (see below

for calculations).

Appendix 7: Limitations of the cross-sectional analysis

Firstly, due to the limited information we have on Vita Life Sciences, some of the ratios, for example, payable turnovers

are not included in our analysis. Secondly, Vita Life Sciences’ financial year ends on the 31th of December instead of 30th

of June. This limits the quality of our analysis and opens up the possibility of data bias due to timing differences and

seasonality in companies’ performances.

Appendix 8: Adjusted IS, NOPAT, NOA, NWC and Net Debt of Blackmores

Table 27: Adjusted income statement (BKL) and calculation of NOPAT

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Sales 200,314 214,934 234,423 260,832 326,603

Total revenue¹ 200,314 214,934 234,423 260,832 326,603

Promotional and other rebates 18,581 19,054 22,907 32,478 49,487

Changes in inventories of finished

goods

-2,437 5,194 2,047 3,422 5,955

Raw materials and consumables used 71,338 65,748 69,920 76,551 100,358

Employee benefits expense 42,212 48,179 52,730 54,910 64,060

Selling and marketing expenses 2,444 4,141 22,102 24,462 34,141

Depreciation and amortization expense² 21,473 19,350 4,743 5,245 6,400

19

Operating lease rental expenses³ - - - - -

Professional and consulting expenses 2,753 2,198 3,303 4,011 3,853

Repairs and maintenance expenses 1,795 1,992 2,221 2,591

Freight expenses 3,091 3,006 3,278 4,149 4,973

Bank charges 662 881 621 642 840

Other expenses 7,574 9,786 9,331 10,711 13,882

Total expenses 169,486 179,529 190,982 218,802 286,540

EBIT 30,828 35,405 43,441 42,030 40,063

Interest revenue 265 427 161 172 174

Interest expense4 1,510 2,517 2,972 3,041 5,043

Net interest expense 1,245 2,090 2,811 2,869 4,869

Profit before tax 29,584 33,315 40,630 39,161 35,194

Income tax expense 8,550 9,995 12,433 11,396 9,291

Net income 21,034 23,321 28,197 27,765 25,903

Effective tax rate (Tax expense/Profit

before tax)

28.90% 30.00% 30.60% 29.10% 26.40%

Note: (1) Adjusted for revenue adjustment (2) Adjusted for lease adjustment (3) Adjusted for lease adjustment (4)

Adjusted for lease adjustment

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Interest expense 1,510 2,517 2,972 3,041 5,043

- Interest income 265 427 161 172 174

= Net interest expense (income) 1,245 2,090 2,811 2,869 4,869

*(1-Effective tax rate) 71.10% 70.00% 69.40% 70.90% 73.60%

= Net interest expense after tax 885 1,463 1,951 2,034 3,584

Net operating income (adjusted) 21,034 23,321 28,197 27,765 25,903

+ net interest expense after tax 885 1,463 1,951 2,034 3,584

= Net operating profit after tax 21,919 24,784 30,148 29,799 29,486

Net Income 21,034 23,321 28,197 27,765 25,903

- Preferred dividends - - - - -

= Net income to common 21,034 23,321 28,197 27,765 25,903

Table 12: Net Operating Assets (NOA), Net Working Capital (NWC) and Net Debt of Blackmores

2008

($000s)

2009

($000s)

2010

($000s)

2011

($000s)

2012

($000s)

2013

($000s)

Net Working Capital = Total current operating assets - Total current operating liabilities

Accounts Receivable 28,216 38,348 36,494 45,530 53,698 63,956

+ inventory 17,506 16,072 22,555 23,749 31,786 39,892

+ Other current assets 2,111 1,373 2,429 1,574 2,549 2,219

- Accounts payable - current 21,035 25,820 26,575 25,843 34,937 38,369

- Provisions - current 3,351 2,855 3,230 3,653 4,456 5,219

- Current tax liabilities 3,407 2,119 3,992 3,570 2,117 -

- Others - - - - 37 848

= Net working capital 20,040 24,999 27,681 37,787 46,486 61,631

20

Net Long term Assets = Total long-term assets - Non-interest-bearing long-term liabilities

Long term tangible assets¹ 56,092 68,073 67,410 66,827 68,334 71,801

+ Long term intangible assets - 410 716 2,669 2,914 35,508

+ other long term assets 10 12 14 19 21 124

- Minority interest - - - - - -

- Deferred tax (net) -1,158 -1,734 -2,321 -2,330 -3,623 -3,683

- Other long-term Liability 600 682 741 792 908 995

= Net Long-term assets 56,660 69,547 69,720 71,053 73,984 110,121

Total Net Operating Assets = net working capital + net long-term assets

Net working capital 20,040 24,999 27,681 37,787 46,486 61,631

+ Net long-term assets 56,660 69,547 69,720 71,053 73,984 110,121

= Total Net Operating assets 76,700 94,546 97,401 108,840 120,470 171,752

Net Capital

Short term debt - 1,109 660 141 363 599

+ Long term debt² 40,279 48,625 48,618 41,915 48,091 93,516

- Cash and Investments 13,930 13,751 23,667 12,328 14,264 20,414

= Net debt 26,349 35,983 25,611 29,728 34,190 73,701

+ Preferred equity - - - - - -

+ Shareholders' equity 50,351 58,563 71,790 79,112 86,280 98,051

= Total Net Capital 76,700 94,546 97,401 108,840 120,470 171,752

Note: 1&2. Adjusted for lease adjustment

Appendix 9: Detail Analysis and relevant assumptions on valuation models

A. Revenue growth rate forecast

The revenue growth forecast of Blackmores is undertaken based on both company’s own strategic analysis and market

analysis of countries where Blackmores operates. Since Blackmores is a multinational company that operates in many

countries within the Asia Pacific region, our market analysis focused on three major markets that we believe contributed

or will contribute the most for company’s overall revenues.

Australia

Blackmores will continue to lead the market in Australia maintaining its market share of approximately 17% for the

foreseeable future. Their revenue in this region is backed by its popularity and high penetration rate amongst consumers

with up to 70% of Australian currently using VDS (Blackmores 2013). The increasing health awareness in the Australian

society also means the VDS industry will continue to grow. Blackmores expects the VDS sector to grow at 9% p.a. at the

retail level for the next 3 years. However, increased competition, especially from Swisse Vitamins, is posing to be a

potential challenges for Blackmores. Its revenue growth rate has decreased dramatically from 8.7% in 2012 to 3.94% in

2013. Taking these factors into account, Blackmores’ ability to realise the market overall growth will be hindered by the

increasing competition and market maturity. Its expansion in Australia is likely to slow as viable locations become

increasingly scarce in Australia. As a result, we expect that Blackmores’ revenue growth rate in Australia in the next 5

years will remain constant at 2013 levels.

Table 29: Australian revenue growth rate by Blackmores

2012 2013

Revenue growth rate 8.7% 3.94%

Thailand

Considering that the revenues generated from Thailand has been stable and factoring in the increase of approximately 20%

from 2011 to 2013, Blackmores is expected to enjoy continued steady revenue growth for the next 5 years.

21

Table 30: Thailand revenue growth rate by Blackmores

2011 2012 2013

Revenue growth rate 20.79% 21.01% 21.99%

Asia (excluding China)

Blackmore’s main operating markets in Asia (excl. China) include Malaysia, Hong Kong, Korea and Taiwan. Going

forward these markets are expected to be relatively stable and contributing steadily to Blackmores’ revenue growth.

Malaysia, one of the key Asian markets for Blackmore, has delivered impressive growth for the year 2013. Such increase

in the region’s sales growth was offset by the short-term product delays from Korea as a result of the regulatory changes.

While anomalies due to regulation cannot be built into our expectations we adjust our revenue growth rate accordingly and

conclude that it will remain stable at current level for the next five years.

China

Due to the size and growth of the Chinese market Blackmores will generate significant revenue growth from this region,

despite being a latecomer. With improved living standard in cities and a heightened belief that vitamins contribute to better

health, the demand for VDS products in China is expected to increase (Lu, 2012). It is estimated that the sales of VDS, as

well as food and drug additives in China will reach $95.2 billion by 2015 (Lu, 2012). Furthermore, according to recent

research, China has overtaken the United States in terms of the total number of pharmaceutical medical sales representatives

employed by multinationals (Parekh et al, 2012). Apart from the factors discussed above, such a strong growth is further

fuelled by demographic trends, continuing urbanisation, increasing disease burdens and government’s support as Chinese

12th five-year plan indicates that government will support and encourage the development in the healthcare sector (Parekh

et al, 2012). As a result, Blackmores’ management is confident about company’s future prospect in Chinese market

(Blackmores, 2013). Despite these trends and market prospects Blackmores’ sales revenue is expected to increase at a

slowing rate, once we factor in the fierce market competition and Blackmores’ late entrance into the market with little local

knowledge and tastes. The following factors were also considered:

22

Figure 15: Factors that could potentially retard Blackmore's growth in China

BioCeutical Segment

The last revenue contribution for Blackmores stems from its recent acquisition of BioCeutical. Due to the limited

information about the acquired company and its outstanding performance after the acquisition, it is assumed that the

revenue growth rate will remain constant as 2013 for the next five years.

In order to assess Blackmores’ future revenue growth it has been projected that the Chinese market will play a significant

role and other markets, including BioCeuticals, are expected to show stable growth at the current level. The prediction is

that sales revenue growth will increase in the next year to 27% with Blackmores’ continued expansion and exploitation

into the Chinese market, followed by a gradually decrease from 2015 to 2019 as market competition builds into the prices

and fundamental challenges to the business model as markets evolve. It is expected that Blackmores will reach its constant

long term growth rate of 2.49% in 2019 and into perpetuity, in line with the inflation rate, refer to Appendix 8 for the

calculation. By assigning a compound factor of 0.621, the forecasted compounding sales growth rate is illustrated as follows:

Table 31: Sales growth rate forecast

Historical Forecast TV

2013 2014 2015 2016 2017 2018 2019

Business model

- Blackmores currently employs adistribution/retail partnership business model inChina, which is argued by the ignorance of fastgrowing direct selling channel.

- Although winning in the retail pharmacychannel is important, retail pharmacies onlyaccount for 25% of overall health supplementsales of China in 2012, which is lower thandirect sales and modern trade model (Parekh etal, 2012).

- The one fold business model will not onlyattract more competitions in terms of winningretailers, but limits the sales increase forBlackmores as well

Increased competition

- It is anticipated that Blackmores willcontinue to face increased competition fromboth other large multinational companies andrapidly improving local competitors, which willsqueeze the market share and revenue ofBlackmores in the medium term.

- Traditional Chinese medicine holds a uniqueplace in Chinese healthcare and is widelyaccepted by the Chinese population, Blackmoreswill be confront with other competition fromtraditional Chinese medicine market (Parekh etal, 2012).

Regulatory and cultural issues

- Exploitable distribution channels will berestricted by the huge cultural difference betweenChina and Blackmores’ lack of experience

- Chinese government plays an active role inshaping the structure of the healthcare industry,implying that the market is deeply affected bypolicy interpretation and implementation (Parekhet al, 2012).

- The continued government pressure on reducinghealthcare product prices to ease the burden onpatients will further deteriorate the expectedmargin contribution from Chinese market for BKL.

23

Sales growth rate 25.22% 27.00% 16.77% 10.41% 6.47% 4.02% 2.49%

B. NOPAT margin forecast

According to our financial analysis, the decrease in NOPAT margin of Blackmores for the last year was mainly due to the

increased competition and price premium squeeze from the Australian market. Such a decrease, however, is believed to be

partly offset in the short-term as company continues expanding into Asia market, and China in particular, and investing in

the profitable BioCeutical brand. Thus, the NOPAT margin is expected to improve in 2014 but deteriorate steadily by 0.2%

each year from 2015 to 2018 and reach 8.5% in perpetuity as competition increases across the board.

Table 31: NOPAT margin forecast

Historical Forecast TV

2013 2014 2015 2016 2017 2018 2019

NOPAT margin 9.03% 9.5% 9.3% 9.1% 8.9% 8.7% 8.5%

C. Beginning net operating working capital to sales forecast

The forecasted beginning net operating working capital to sales ratio in 2014 is calculated based on sales forecast for 2014

and the net operating working capital of 2013 calculated in Appendix 5. This increase is consistent with the increase in net

operating working capital from the acquisition of Fit-BioCeuticals in 2012. It is assumed that Blackmores will not

undertake an acquisition in the forecast period. According to the decrease in the beginning net operating working capital

to sales from 2012 to 2013, it is expected that Blackmores’ management will continue to improve its operational efficiency.

Hence, the beginning net working capital to sales ratio is expected to decrease slowly at merely 0.2% per year from 2014

to 2018 until it reaches 13.94% in perpetuity.

Table 32: Beginning net operating working capital to sales ratio forecast

Historical Forecast TV

2013 2014 2015 2016 2017 2018 2019

Beginning net operating

working capital to sales 14.23% 14.86% 14.66% 14.46% 14.26% 14.06% 14.06%

D. Beginning net operating long-term assets to sales forecast

The beginning net operating long-term assets to sales in 2014 is projected as 26.34% by applying the same methodology

as discussed above. The increase in the ratio in 2014, is credited again to the increase in intangible assets and goodwill

from the acquisition of Fit-BioCeuticals (Blackmores, 2013). The forecasted trend, therefore, is expected to decrease by

0.5% for the next four years until it reaches 24.34% in perpetuity as its practitioner only sales slows down.

Table 33: Beginning net operating long-term assets to sales forecast

Historical Forecast TV

2013 2014 2015 2016 2017 2018 2019

Beginning net operating

LTA to sales 22.65% 26.55% 26.05% 25.55% 25.05% 24.55% 24.55%

E. Capital structure forecast

With the acquisition of Fit-BioCeuticals, Blackmores’ debt ratio increased sharply in 2014. After taking company’s strong

cash flow from operation and targeted capital structure between 30%-50% into account, it is expected that the management

will repay its debt from next year but at a slow rate of 1% till maturity as most of the operating cash flow and proceeds of

maturing financial assets will be used to meet other obligation, as well as the continued investment in its Chinese market

expansion and practitioner market (Blackmores, 2013). It is further noted that it is assumed company will utilize both cash

and equity in funding any future acquisitions.

Table 34: Debt ratio forecast

Historical Forecast TV

2013 2014 2015 2016 2017 2018 2019

Debt ratio 28.38% 42.91% 41.91% 40.91% 39.91% 38.91% 38.91%

F. Cost of equity forecast and calculation

The CAPM method was adopted to calculate the cost of equity:

24

Cost of equity = Risk-free rate + Company beta (Market risk premium)

By applying the values derived through our forecasts and assumptions, the resulting cost of equity for Blackmores is 8.76%.

At a fundamental level, the CAPM method is attractive as it has theoretical backing and is intuitively sound as it uses the

links between company and market risk (Fama & French, 2003). The problem, however, lies in its impractical assumptions

and the fact that it only considers market risk (Fama & French, 2003). A caveat is therefore of order when using the CAPM

method, and its limitations should be recognised.

Table 35: Cost of equity calculation and related assumption

Value Source

Market risk premium 5.80% Historical average based on Australian equity market returns

(Damodaran, 2013)

Risk free rate 5.16% Calculated from averaging the 10-year monthly Australian government

bond interest rate (2013)

Tax rate 30% Assumed as Australian corporate tax

Common equity beta 0.62 From Morningstar (2013)

Cost of equity 8.76% CAPM model

G. Cost of debt forecast

The measure of cost of debt was taken to be the weighted average interest rate of 4.06% of interest rate swaps reported in

Blackmores’ annual report (2013). This was because we considered that the interest rate swap rate is a more accurate

reflection of the market rate of debt.

H. Dividend Discount model – dividend growth rate forecast

DDM model values company’s equity by discounting all the future dividends shareholders are expected to receive by the

cost of equity. Based on company’s dividend policy, past dividends trend and the performance for 2013, we estimated that

Blackmores will increase its dividend payment next year by 12%, backed by continued market expansion and strong

performance by the BioCeutical brand. This growth rate, however, is expected to decrease gradually by 2% per year from

2015 to 2018 as the industry becomes crowded and Blackmore reaches maturity in some markets. The perpetual dividend

growth rate, starting from 2019, is thus assumed to remain at 2.5%, which is the estimated inflation rate in 2018.

Table 36: Dividend growth rate forecast

Historical Forecast TV

2011 2012 2013 2014 2015 2016 2017 2018 2019

Dividend growth rate 10.7% 2.42% 0% 12% 10% 8% 6% 4% 2.5%

Under two assumptions: (i) Dividends are expected to occur forever (ii) Constant growth rate of dividends occurs forever

Appendix 10: Calculation of terminal sales growth rate

In order to derive the perpetual growth rate for Blackmores, we calculated the average of the estimated next five years

inflation rate of its participating markets from IMF.

Table 37: Summary of forecasted inflation rate

2014 2015 2016 2017 2018 Average

Australia 2.61% 2.22% 2.51% 2.52% 2.52% 2.48%

China 2.97% 3% 3% 3% 3% 2.99%

New Zealand 2.17% 2.22% 2.02% 2.02% 2.02% 2.09%

Thailand 1.98% 2% 2% 2% 2% 2.00%

Singapore 2.74% 2.67% 2.37% 2.47% 2.2% 2.49%

Malaysia 2.6% 2.6% 2.4% 2.2% 2.2% 2.40%

Taiwan 2% 2% 2% 2% 2% 2.00%

Hong Kong SAR 3.5% 3.5% 3.5% 3.5% 3.5% 3.50%

Average inflation rate 2.49%

(Source: IMF 2013)

25

Appendix 11: Sensitivity Analysis – DCF

In order to capture the effect of the changes of each forecasted inputs on the share price, we conducted sensitivity analysis

of each individual items by assigning a (-0.4%, +0.4%) change.

A. Sales growth rate forecast

We applied the compounded factor to generate our sales growth rate every year by assigning an assumed target perpetual

growth rate. The sensitivity analysis of sales growth rate is generated by changing the perpetual growth rate as variables

because it will affect the compounded factor and the sales growth rate of each year.

Table 38: Sensitivity analysis – perpetual growth rate

Estimated perpetual growth rate Compounded factor Share price

Base value 2.49% 0.621 $36.07

1.77% 0.58 $32.61

1.93% 0.59 $33.32

2.10% 0.6 $34.11

2.39% 0.61 $34.99

2.47% 0.62 $35.97

2.68% 0.63 $37.07

2.90% 0.64 $38.32

3.13% 0.65 $39.64

3.38% 0.66 $41.27

B. NOPAT margin ratio

Table 39: Sensitivity analysis – NOPAT margin

Changes of NOPAT/sales from 2014 to 2018 (yearly)

Share price

Base value -0.20% $36.07

-0.60% $27.62

-0.50% $29.73

-0.40% $31.85

-0.30% $33.96

-0.20% $36.07

-0.10% $38.19

0.00% $40.30

0.10% $42.41

0.20% $44.53

C. NWC/sales ratio

Table 40: Sensitivity analysis – beginning net operating working capital to sales ratio

Changes in NWC/sales from 2014 to 2018 (yearly)

Share price

Base value -0.20% $36.07

-0.60% $36.52

-0.50% $36.41

-0.40% $36.30

-0.30% $36.19

-0.20% $36.07

-0.10% $35.96

0.00% $35.85

26

0.10% $35.74

0.20% $35.63

D. NL assets/sales ratio

Table 41: Sensitivity analysis – beginning net operating long term asset to sales ratio

Changes of NLA/sales from 2014 to 2018 (yearly)

Share price

Base value -0.5% $36.07

-0.90% $36.52

-0.80% $36.41

-0.70% $36.30

-0.60% $36.19

-0.50% $36.07

-0.40% $35.96

-0.30% $35.85

-0.20% $35.74

-0.10% $35.63

E. Debt ratio

Table 42: Sensitivity analysis – debt ratio

Changes of debt ratio from 2014 to 2018 (yearly)

Share price

Base value -0.10% $35.99

-1.40% $35.91

-1.30% $35.95

-1.20% $35.99

-1.10% $36.03

-1.00% $36.07

-0.90% $36.11

-0.80% $36.15

-0.70% $36.19

-0.60% $36.18

F. Cost of equity

Table 43: Sensitivity analysis – cost of equity

Cost of equity

Share price

Base value 8.76% $36.07

8.36% $38.62

8.46% $37.94

8.56% $37.29

8.66% $36.66

8.76% $36.05

8.86% $35.46

8.96% $34.89

9.06% $34.33

27

9.16% $33.79

Appendix 12: Key Variables Selected in Scenario Analysis - DCF

We obtained the range of company’s intrinsic value by assigning both best and worst scenarios to improve our valuation.

The key variable selections in our scenario analysis are summarized as follow:

Table 44: Key variables selected in scenario analysis - DCF

Worst case Base case Best case

Perpetual growth rate 1.5% 2.49% 3%

Changes in NOPAT margin -0.5% -0.20% +0.1%

Cost of equity 9.5% 8.76% 8%

Appendix 13: Sensitivity Analysis - DDM

By assigning a range from -5% to +5% to the changes of constant dividend growth rate from 2014 to 2018, the relevant

effect on the share price is calculated as follow:

Table 45: Sensitivity analysis - DDM

Changes in constant dividend growth rate from 2014-2018 Share price

Base value -2% $26.51

-5% $20.71

-4% $22.51

-3% $24.45

-2% $26.51

3% $38.95

4% $41.90

5% $45.32

Appendix 14: Worksheet for the calculation of DCF, Abnormal Earning and

Abnormal Return Model

A. DCF Worksheet

Table 46: DCF Worksheet

Discounted Cash Flow (DCF) Method

Year Ended June 30 ($000’) Forecast Terminal value

2014 2015 2016 2017 2018 2019

Free Cash Flow to Equity

Net income to common shareholders 37,310 42,695 46,176 48,133 48,993 49,001

- Investment in Net Working Capital 9,365 6,323 3,861 2,075 2,076 2,128

- Investment in Net Long-Term Assets 16,042 10,463 5,988 2,765 3,625 3,716

+ Increase in net debt obligations 8,931 4,896 1,791 -354 2,218 2,274

+ Increase in preferred equity - - - - - -

= Free Cash Flow to Equity 20,834 30,805 38,119 42,938 45,511 45,431

* Discount factor - Common Equity 0.92 0.85 0.78 0.71 0.66 0.60

= Present value of Free Cash Flow to

Equity 19,156 26,044 29,633 30,692 29,912 27,456

PV of FCF to Equity 135,438

+ PV of FCF to Equity beyond Year 5 476,812

= Value of the Equity 612,250

28

Number of shares outstanding (MM) 16,972

Estimated value per share 36.07

B. Discounted Abnormal Earnings Valuation Model Worksheet

Table 47: Discounted Abnormal Earnings Valuation Model Worksheet

Discounted Abnormal Earnings Valuation Method

Year Ended June 30 ($000’) Forecast Terminal value

2014 2015 2016 2017 2018 2019

Net Income to Common 37,310 42,69

5

46,17

6

48,13

3

37,31

0 48,993

- Charge for Common Equity Capital 8,585 10,02

8

11,06

9

11,77

5 8,585 12,229

= Residual Operating Income 28,725 32,66

7

35,10

7

36,35

8

28,72

5 36,764

* Discount factor - Common Equity 0.71 0.92 0.85 0.78 0.71 0.66

= Present Value of Residual Operating Income 26,412 27,61

8

27,29

2

25,98

9

24,16

3 22,038

PV of Residual Operating Income ( years 1-5) 131,47

4

+ PV of Residual Operating Income beyond Year

5

382,72

5

+ Beg. Book Value of Equity 98,051

= Value of the Equity 612,25

0

Number of shares outstanding (MM) 16,972

Estimated value per share 36.07

C. Discounted Abnormal Return Valuation Model Worksheet

Table 48: Discounted Abnormal Return Valuation Model Worksheet

Discounted Abnormal Return Valuation Method

Year ended June 30 ($000’) Forecast Terminal value

2014 2015 2016 2017 2018 2019

Return on common equity 38.1% 37.3% 36.5% 35.8% 35.1% 34.2%

- Cost of equity capital 8.76% 8.76% 8.76% 8.76% 8.76% 8.76%

= Abnormal returns (ROE) 29.30% 28.52% 27.77% 27.04% 26.32% 25.47%

* Discount factore - Common Equity 0.92 0.85 0.78 0.71 0.66 0.60

* Book value of equity growth factor 1 1.17 1.29 1.37 1.42 1.46

= Present Value of Abnormal Returns

on Common Equity 26.94% 28.17% 27.83% 26.51% 24.64% 22.48%

Beg book value of common equity *

PVAB ROE (Yrs 1-5) 131,474

+ Beg book value of common equity of

ABROE (Beyond year 5) 382,725

'+Beg Book Value of Common Equity 98,051

= Value of Equity 612,250

Number of shares outstanding 16,972

Estimated value per share 36.07

Appendix 15: Worksheet for DDM

29

Table 49: Discounted Dividend Model Worksheet

Discounted Dividend Method

Year ended June 30 Historical Forecast Terminal value

Dividends 1.24 1.27 1.27 1.42 1.56 1.69 1.79 1.86 1.91

Discount Factor-Equity 0.92 0.85 0.78 0.71 0.66 0.60

PV of Dividends 1.31 1.32 1.31 1.28 1.22 30.52

Terminal value 20.06

Share Price 26.51

Appendix 16: Strengths and Weaknesses of Each Valuation Method

Table 50: Summary of pros and cons of each valuation method

Valuation Method Summary

The Discounted Dividends Model

The dividend discount model expresses the value of a company’s equity based on its projected future dividends

being discounted to their present values. This model forms the basis for most of the popular theoretical

approaches for equity/share valuations.

Pros Cons

A simple method of valuing a company’s’ stock price

and theoretically it does provide a solid basis to

determine the shares value in present terms.

This model can be useful to analyze a company’s share

value in short term (5 years) and long term if we assume

that the industries are going to be stable

Requires strict assumption that the valuing company

should pay dividends

This model is limited by the structural assumptions in

model implementations, derivation of data inputs and

their interpretation

The Discounted Cash Flow Model

The DCF model expresses the value of the company’s equity value based on its projected future cash flows being

discounted at the company’s cost of capital to arrive at an estimated present value.

Pros Cons

This model relies on the cash flows generated by the

company and therefore considered to be the trust-

worthiest measure among the other models used in the

valuation.

The accuracy of the model relies heavily on the multiple

assumptions and terminal value. Some of the

assumptions are purely dependent on own judgement

and may differ from various opinions and perspectives.

The Discounted Abnormal Earnings Model

The discounted abnormal earnings measure the value of the company’s share/equity as the sum of its book value

and discounted forecast of abnormal earnings return. The abnormal earnings meaning the profit, which is left after

the investors and shareholders has received their earnings.

Pros Cons

This model requires only one assumption that is,

forecast for the growth of the equity or dividends per

share of the company.

Additionally, it relies less heavily on the terminal value

comparing to DCF

As compared to DCF the accuracy of this model is

considered low, first being the cash flow of a company

is trustworthy and secondly as we are using only one

assumed growth rate, and if it is unreliable the outcome

could be huge when compare to the DCF.

Appendix 17: Justification of the Weightings

We assigned only 20% to the DDM model because of its assumptions of constant and continued dividend payment. Due

to the limited information disclosed, we cannot obtain the exact dividend policy of the company. As a result, our assumption

on the dividend payment is purely based on our own judgement, which may be biased toward the management’s expectation

30

and only 20% of the weightings are assigned to DDM. On the other hand, because we assigned same forecast assumptions

for DCF, abnormal earnings and abnormal returns model, 80% weightings on these models are believed to be reasonable.

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