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Understanding Best World International Limited’s Recent Volatility – and What to Do About It

Recent volatility in Best World International Limited‘s (SGX: CGN) share price may have given the company’s shareholders a tinge of seasickness. It all began on the morning of 18 February this year, when The Business Times published an article that cast doubts over the company’s sales figures in China. Best World quickly halted the trading of its shares on the same day, made clarifications regarding the Business Times article on 23 February, and only lifted the trading halt on 25 February.

But, the company’s share price still plunged by 32% from S$3.25 on 15 February (the last trading day before The Business Times article was published) to S$2.21 on 25 February. On 26 February, Best World reported positive earnings results for the fourth quarter of 2018. The company’s share price rebounded sharply to S$2.53 on the same day, but it was not a full recovery.

With these incidents occurring in quick succession, some investors may be unsure of what to make of Best World. To give the company’s shareholders some direction on what they could do, here’s a recap of what the Business Times article brought up, Best’s World’s response, and what I think are appropriate actions for shareholders.

Business Times article causes panic

As mentioned earlier, in mid-February, the Business Times published an article reporting that Best World’s China sales were difficult to track. The article said that Business Times could not locate any of the 28 franchisees that Best World said it had in China. Even though Best World said it had successfully transitioned from an export model to a franchise model in the country, the article stated that none of the franchisees were listed on Best World’s website.

The article also pointed out that it was difficult to substantiate Best World’s recent claim that it was the 13th-largest company in China’s premium skin-care market. When Business Times showed the claim to Euromonitor, a spokesman from the market research firm said: “We are not sure about how they rank themselves by the reference of Euromonitor’s source. Indeed, according to our research methodology in 2017, they were not significant enough to be tracked.”

Unsurprisingly, the article cast significant doubt on Best World’s business and even cast fears that the company was inflating its China sales figures and market position. The market reacted swiftly, selling down Best World’s shares as I described earlier.

Best World’s response

Best World responded to the Business Times article on 23 February. The company clarified a few key points, and the most important ones are highlighted below:

1. From 2014 to 2018’s first-quarter, Best World used an export model in China. In the export model, Best World sold its DR’s Secret line of products to an import agent, who then resold the products to independent third parties, which included individuals, wholesalers, and resellers. Best World recognised revenue sold to its import agents.

2. Starting from 2018’s second-quarter, Best World transitioned to a franchise model in China and now works directly with franchisees, who in turn resell the company’s products to end users. The key difference between the franchise and the export model: In the franchise model, the import agent is replaced by Best World’s very own subsidiary, who in turns sells the products to franchisees. The franchise model eliminates the primary import agent margins, effectively increasing sales for Best World.

3. The franchisees are independent third parties, and Best World recognises revenue only when products are sold to these franchisees. There is a no-return policy, and products sold to franchisees are on a cash-payment basis.

4. Best World has now updated its website to include the names of all 28 franchisees.

5. Euromonitor performed customised research on the skin-care industry in 2018 that was commissioned by Best World. Prior to the customised research, “Euromonitor had not previously reported on the Company in its 2018 edition Passport database researched end
2017.” Best World said that based on its conversations with Euromonitor, the market research firm will confirm these findings with  The Business Times.

A Foolish take

I believe that in its announcement, Best World has sufficiently answered most of the questions raised about the company’s franchise model and sales figures. In addition, the announcement shows that the company has taken the right steps to increase transparency for shareholders, such as making the appropriate changes to its website to include the names of franchisees.

Besides the points highlighted above, the company’s statement also included responses to several other claims by The Business Times. Investors who are interested should take the time to read the statement in full.

Although the Business Times article caused panic among investors and a significant drop in Best World’s share price, it forced the company’s management to improve transparency to investors. Improved shareholder transparency is positive for shareholders over the long run. It also enabled investors to better understand the company’s different distribution models in the countries in which it operates.

To further ease any doubts, the company recently appointed an independent reviewer to (1) verify the existence of the franchisees, (2) validate the sales to and cash received from significant franchisees, and (3) identify and make appropriate recommendations on any internal control weaknesses and breaches.

What investors should do

For now, I don’t think existing Best World shareholders should panic. 2019 will mark the first full year in which the company is using the franchise model, which could be a catalyst for sales growth and margin expansion. In addition, sales growth in other geographies could also improve the company’s profit this year.

After the large share-price fall, the company trades at a very reasonable valuation. Best World’s share price is at S$2.58 at the time of writing. This is still well below the all-time high price of S$3.33 and could be a good entry point for potential investors. The share price of S$2.58 gives rise to a price-to-earnings multiple of 19.4. I see it as a reasonable price to pay for a company that has been growing at a double-digit pace for the past few years.

Best World is also an asset-light company that generates significant returns on equity. As of 31 December 2018, it is sitting on a S$195 million net cash position, giving it a stable balance sheet. The trailing dividend yield of 2.4% should also provide investors with more confidence in the reliability of the company’s sales and earnings figures.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Jeremy Chia doesn’t own shares in any companies mentioned.