Oriflame - In the Mix

All,

Please find our updated analysis of Oriflame here.

So the Felix household bought a blender the other day. It’s a great way to fix up smoothies in no time and it’s striking to see the ingredients blend to the point where they are no longer recognisable. In a way, Oriflame results in the last six months have been strikingly similar to what comes out of our blender - only not as sweet. Prior to the latest strategy reshuffle, we were observing certain metrics improving in line with peers. But now these are all distorted and we can only hope that the new recipe will taste better soon. At the current rate of deterioration, the latest cost savings plan should afford Oriflame no more than 9 months before it’s all over anyway. So, blender or not, it’s time to stay close to developments next month and perhaps we’ll have some signal either way. In the 20s, the bonds should be cheap enough to find some volume, if results just start to improve.

Investment Considerations:

- We were awaiting a signal that a membership bottom would come into view, but not even management seem confident. As a result, we are still not having any bonds, even at these prices. 

- An apparent Scandinavian bid for the bonds in Q323 suggests a shareholder-friendly party might make a restructuring difficult for bondholders, although the threshold for an instructing group is low. We see this name as a certain restructuring candidate in 2025.

Membership:

- Despite aggressive promotional activity, membership continues in free fall. Moreover, outside of Latin America, volume per member is also falling at the same time. We note the marked deterioration in the latter since management rolled out their plan in H223, but have no answers as to why a price reduction would have that effect. There is a chance that the shift in mix towards higher-priced goods (under promotion) is partially responsible for the recent drop in volume per member, but that should go further in explaining the Q4 performance than Q3. We are not sure. 

- Having been surprised on the negative side over the last two quarters, we have only modelled a schematic normalisation of developments over the next year. We admit, however, that our forecasts are lacking any conviction. We have no idea - just like management themselves.

- We had previously forecast a turnaround in membership. Herbalife and Nu Skin seemed to have already turned a corner (the former more than the latter), but they also are digging deeper now. It is also worth noting the increased investment volume Herbalife are forecasting to boost growth going forward. 

Volumes:

- That volume per member continues to fall - and at an accelerating pace is very worrisome. If the "big" senior members at the top of their chains are staying and it's really mostly the novices that quit even faster than before, then volume per member should be rising. If the company were managing to keep its key members together, then volume per member should be rising. There could admittedly be an inventory effect in the downstream chain that takes a while to clear, but there has been more than enough time now. 

- We had observed the improvement in H123 and had mistaken it for a false dawn. 

- Sales Volume / Member could, however, also be down as a result of inaccurate member count. Sales are easily counted, but when is a member no longer a member and how often is that updated? Also, management have changed membership rules, which could now distort the previously existing relationship.

- The volume drop by 30% is all the more a concern because the company had evidently raised the level of promotions in Q4. We do not know how uniform those promotions have been applied to the product range, but in total even local currency sales are down 15% (before -10% FX headwinds). 

- We are also concerned that Oriflame have "stuffed" their downstream supply chain with hard-to-move product and that this will take some time to clear through the chains.

Price/Mix:

- On a constant currency basis, sales contraction had (slowly) narrowed down to -7% until Q223 (see table above). We had been forecasting this accurately thus far. But Q323 came out markedly worse than expected and Q423 maintained the negative -15% gap, albeit with an even worse mix. Whereas the 12% Price/Mix rise in Q323 had been achieved mostly via price rises, the 15% in Q423 appear to have been achieved with mostly mix. Including promotions, Oriflame dropped prices aggressively in Q4 on a YoY basis. 

- The aggressive price action clearly did not succeed in raising sales or attracting members, leaving sales down YoY by any metric. 

- As a result, the Gross Margin and overall Gross Profit have suffered severely. 

- However, we think we are observing a step change that is more management-induced than reflecting another worsening of market conditions. Management are trying to increase the affordability of Oriflame's products, especially in overseas markets, primarily through a curation of its product portfolio (Mix).

- So we still think the gap between Unit Volume and Price Mix is tightening, but we are resuming from a bigger deficit. The time frame is likely to be another two quarters further away and we expect deficits to continue through Q324 - easily.

Here to discuss,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk