Oriflame - Pumping that Pyramid
All,
Please find our updated analysis here.
As an MLM Oriflame is more volatile than it would be if it were an ordinary company. But its turnaround is a mere question of time, in so far as it can find a solution to stabilise its Asian business and if the Russian business continues despite the obvious tensions. Those are two big IFs, but bonds today are pricing in a certain Loss in Russia and cash conversion remains good. The latter is partially owed to the MLM marketing strategy, but we see the company working within its liquidity and ultimately turning around. Before that happens, however, we think it will get worse before it gets better and that leverage this year will still be rising significantly. Risks remain skewed to the downside.
Investment Considerations:
- We are still not taking a position in Oriflame, but are envisaging a position later in 2023, so long as the Russian business remains operational and the Asian business holds together. The MLM business is more volatile than a normal corporate and should provide a good opportunity at the right time.
- It's a matter of timing. We are bearish for the next two quarters at least and see little chance of the company surprising us with a turnaround in Q123. The company was undergoing an operational restructuring when the pandemic provided both a headwind and a boost. This reorganisation was ongoing when the Ukrainian war broke out, presenting the company with yet more uncertainty. The Russian business is said to be contained, but given the CIS region made up 44% of EBIT in 2021.
- The bonds are creating Oriflame at approx. 5x trough EBITDA of €80-85m. Alternatively, the same valuation creates Oriflame without CIS at 8.5x, roughly where AMWAY trades, although bonds would drop significantly if that scenario were to play out. Moreover, we have performance deteriorating in 2023, which should also see the bonds trade off on rising leverage.
- One aspect to consider would be that the bonds are the fulcrum and fairly well positioned in the cap structure. If the Russian war escalates, the bonds might drop into the 40s, but there should be other paper (gas?) to hedge such a fall efficiently, leaving the company otherwise attractively valued, given the good liquidity position and strong cash conversion it has.
MLM:
- Although MLM companies use a pyramid structure as sales network, we do not consider them a fraudulent scheme in any way. Rather, we see the strategy a bit like Pump & Dump, which is not great, but ultimately not unlike many other companies operating in the affordable segments.
- Due to its low-quality customer relationships it, therefore, breathes more strongly with the ebb and flow of the economy than other companies do in its space (see Douglas for instance) and it’s yet more pro-cyclical.
- As members are dwindling, so is the number of first-timers who are buying the starter kit on higher than normal discounts. Gross margin, therefore, is improving )Price Mix). That should reverse again when member numbers start growing again.
- Its member count is rising and falling along with sales. It’s neither a leading nor a lagging indicator. In the year 2021 the company paid a mere €249m out to its members. Across 2.5m members at the time that equates to less than £100 p.a. and suggests that the vast majority of its members are the true customers - often without knowing it.
- The company ultimately sells cosmetics and hope (of building a business with a downline of other members). Beauty and hope are about the oldest products that have ever been sold and constitute stable business in the long run. In the meantime, Oriflame has to continue pumping the pyramid until disposable income comes back.
CIS:
- Now camouflaged in the larger Europe and CIS segment, it may or may no longer account for 44% of EBIT, but even if following the shift of production to Poland some of the profit has shifted along with it, the Russian business alone could easily still account for 1/4 of EBITDA today.
- Relative to other regions and on par with Europe, CIS performance has been resilient since the pandemic.
- Naturally, given the current geopolitical tensions involving Russia, this business operates under immediate threat. Current bonds-rices however seem to largely factor in a significant loss of business in this region which has so far not happened. We think however that this discount will become justified by Oriflame’s ongoing shrinkage across all regions which should continue for at least another six months.
Asia:
- The Asian business operates in a difficult market in which online orders and parallel distribution via online rob MLMs of their appeal. While China has certainly been greatly disrupted by Covid in 2022, the Asian business seems in more structural decline for some time.
- On the Q422 call management went so far as to say it is ready to shut down the Asian business if it can’t be turned around.
- So far therefore it does not seem like Oriflame have found an answer to the ongoing shrinkage of one of its largest markets.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk