Blackmores Limited (ASX: BKL) formulates, packages and distributes dietary supplements primarily through its famous Blackmores brand both here in Australia and in Asia. The company has achieved annual compounded revenue growth of 12.7% in the four years to 2014, driven by health and wellbeing trends, acquisitions and expansion into Asia.
However over the same period, Blackmores profit hardly grew at all, from $24.3 million in 2010 to just $25.5 million in 2014. The industry shift away from small independent pharmacies towards warehouse style discount chains has reduced the company's pricing power.
In response to this threat, management has employed a strategy of strengthening Blackmores' brand and improving operational efficiency. It also aims to be the market leader in product innovation, through development of the BioCeuticals Clinical product line and the work done at the Blackmores Institute.
Recent market updates indicate the strategy is working, with sales up 28% and profits up 76% to the end of the first nine months of 2015, a great achievement for a company of Blackmores' size. Asian expansion is progressing well and margins have improved due to increased scale and less wastage.
Blackmores' Asian business contributes just one sixth to total sales and therefore the company has the potential to grow to many times its current size. However, there is an ongoing debate regarding the effectiveness of many supplements, and over time this could erode demand for Blackmores' products.
It is not surprising that given such efficacy concerns, Blackmores is so focussed on enhancing its brand and devotes time and money towards conducting research alongside respected Australian universities. So far, the approach is working as the company was recently awarded most trustworthy brand in Australia, Thailand, Malaysia and Singapore.
The market is not worried about this though, given the company has an enterprise value of close to $1.2 billion dollars and is likely to deliver earnings in the region of $40 million in 2015. This places it on an enterprise value to earnings multiple (EV/E) of about 30 which means that the market expects Blackmores to keep growing for some time.
A better alternative?
Vita Life Sciences Limited (ASX: VSC) sells dietary supplements through its VitaHealth and Herbs of Gold brands. The company is also looking to grow through expansion into Asia where it already has a solid presence. Just 38% of revenue comes from Australia with the rest split between Malaysia, Singapore, China, Vietnam and Thailand. Management is planning to launch into Indonesia later this year.
Unlike Blackmores, Vita Life has experienced a slowdown in revenues combined with an improvement in margins delivering robust earnings growth to investors over recent years. One reason for this difference is that Vita Life has decided to exclusively supply to independent pharmacies in Australia, therefore maintaining its pricing power despite adverse industry conditions.
I'm not convinced of the long-term success of this strategy if the industry continues to consolidate, since the company is essentially catering to a shrinking market. However, opportunities for substantial growth in Asia remain and these should more than compensate for any loss of revenue in Australia.
Vita Life may not have the scale or brand presence of Blackmores, but it doesn't have the price tag either. Based on management guidance for 2015, I estimate that it is trading on an EV/E of under 11. The company is about one tenth the size of Blackmores in terms of revenue, and typically small companies carry more business risk than their larger counterparts. However, as an investment I would argue that Vita Life is the less risky of the two given you can buy shares for one third of the price of shares in Blackmores.