Blackmores Limited (ASX:BKL)

Rating BUY 12 October 2013 | Consumer Health Australia

Target Price: $34.16

Stock Data An Unexpected Journey

Price at 16 Oct 2013: $25.58  This report provides potential investors with an analysis of Blackmores
LTD (BKL), a leader in the Vitamins and dietary supplements
Intrinsic Value: $34.16
production industry in Australia with operations in New Zealand, and
52 Week High: $33.89 Asia. While there are significant challenges in Asian operations we can
52 Week Low: $24.23 expect progressive earnings growth in all its operating regions by
Average Price: $28.82 exploiting changing demographics and social trends.

Market Cap (mn): $429.26

Shares
 Valuation of $34.16 reflects a decreased valuation from 2012. It reflects
16.90 the increasing competition in the VDS industry and Blackmore’s
Outstanding(mn):
struggles in China as it attempts to establish itself as a late comer to an
Daily Volume (Avg): 9.35 K established competitive market. However, the high intrinsic value
Source: Yahoo Finance, BKL Data
affirms the view that it is in good position to leverage on its quality
products to ride the growing health conscious Asian market.
Key Financial Data FY13 End
Debt/Equity 77.34%  FY13 marked the eleventh consecutive year of sales with sales rising
Net Debt/Equity 58.53% 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
Dividend Yield 4.91%
competitive pressures continued to increase.
PE 17.48%
Price/Book 4.47%  All profitable ratios that were examined including gross profit margin,
EV1/EBITDA 11.1x EBIT margin, EBITDA margin and net income margin declined during
Source: BKL Data
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
BKL Share price (AUD) relative to that of Australia. Sales growth for Blackmores is expected to
35.00 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
33.00
GDP growth in the long term
31.00

29.00  Key risks to target price include barriers in Asian markets –

27.00 regulations, consumer tastes, culture, and political unrest. Heavy PR
efforts have established foreign VDS brands as quality products in Asian
25.00
markets and Blackmores can exploit these conditions. Strong Australian
23.00 dollar could be an additional downside risk for Blackmores.

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)

1
EV = Market Cap + (Debt + Minority interest + preferred shares) – (cash and cash equivalents)
1
Figure 1: Sales and EBITDA margin
(AUD 000s) Figure 2: BKL relative performance

350,000 30.00%
140%
300,000 25.00% 120%
250,000 100%
20.00%
200,000 80%
15.00%
150,000 60%
10.00%
100,000 40%
Blackmores S&P/ASX 200
50,000 5.00% 20%

- 0.00% 0%
2009 2011 2013

Sales EBITDA margin

See Appendix 1 for relative performance against its GICS sector

Figure 3: Revenue by
Business Description
segment Blackmores Ltd (ASX:BKL) – founded in 1932 and based in Sydney – is the
3.83% 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).
13.68 Blackmores develop and market products in the VDS sector with a view on
% natural approaches to health across many Asian countries such as Thailand,
9.26% Malaysia and Singapore. Asia is increasingly becoming an important market
9.20% for Blackmores and long term growth in this region is expected to be strong,
71.57 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.

Australia Thailand
Industry Overview
Other Asia BioCeuticals Australia
Source: Euromonitor Growing VDS industry and underlying trends
In CY12 the Australian VDS industry grew 9%, bringing it to a total value of
Figure 4: Blackmore Operations $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.

Source: BKL

2
 Figure 5 : Estimate of global VDS Figure 7: Historic VDS sector growth vs. BKL sales
market size (2012) growth
Market size 18.0%
Country Blackmores
(US$ mn)
16.0% sales growth
China 12230.9 Australia
14.0%
South Korea 3770.6
12.0% China
Taiwan 1962.9
10.0% Malaysia
Australia 1669.7
8.0%
Thailand 1159.5 Singapore
6.0%
Hong Kong 588.0
South Korea
4.0%
Malaysia 517.3.1
2.0% Thailand
Singapore 487.8
0.0%
New Zealand 201.5
2008 2009 2010 2011 2012
Source: Euromonitor at 16 Oct 2013
exchange rates Source: Euromonitor, IBIS

Asia
Figure 6: Market Share of major Growing market: The expansion into the Asian market is increasingly
brands in Australia 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
20%
Asian region compared to the previous year, while over the same period
18% Australian sales grew only by approximately 5.14%. The sales growth is
backed by wider distribution channels that are available in this region
16% including highly connected online market, pharmacies, health food stores,
14% specialty stores, hospitals, department stores, home shopping and direct
selling.
12%
China: The economic growth in China has slowed dramatically from its
10%
double digit figures prior to the financial crisis. According to the World Bank
8% 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
6% forecast of 7.75% over the same period. Strong single digit growth in the
4%
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
2% billion in CY12 and this trend is expected to continue with the growth in
Chinese consumers’ disposable income, health awareness and knowledge and
0% demand for higher quality life.
2009-2010 2011-2012
Blackmore Swisse
Cenovis Nature's Way The VDS industry in China is also highly fragmented with the leading brand
Nature's Own Herron being Amway at 17% of market share (Euromonitor 2013). Amway leads
Berocca 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.

3
Competitive Positioning
Figure 8: Australian VDS
market share by product Australia: Blackmores is the market and brand leader in Australia’s highly
brand (2012) 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
16.9% 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
48.7% 13.7% advertising and channel promotions, increasing its online presence and new
sustainable product ranges (Blackmores 2013).
6.4%
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
5.6% sales across Southeast Asia has been backed by improved health standards
2.0% 2.3% 4.4% across the region, causing demand for immunity products to increase
Blackmores Swisse (Euromonitor 2013). Blackmore faces competitive pressures from Amway
Cenovis Nature's way in Malaysia (19%) and Cerebos in Thailand (38%) although its core
Nature's own Herron products and operations in these regions do not compete directly with its
competitors’ products.
Source: Euromonitor

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

Marketing &
R&D Manufacture Distribution Services
Sales

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.

4
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%

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 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

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

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

6
A2. Financial Leverage and Decision Analysis
Figure 9: Liquidity ratios Liquidity
3.00 Despite of the decline in operating cash flow ratio
2.50
from 0.8 in 2010 to 0.55 in 2013, Blackmores’
overall short-term liquidity has strengthened with
2.00 the growth of its current ratio, quick ratio and cash
1.50 ratio in the past three years.

1.00
0.50
0.00
2009 2010 2011 2012 2013

Current ratio Quick ratio

Cash ratio Operating cash flow ratio

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

25.00 90.00% Due to funding of the BioCeuticals acquisition,
80.00% Blackmores was experiencing higher solvency ratios
20.00 70.00% and lower interest coverage ratio in 2013 as a direct
result of increased debt level. Such an increase in
60.00%
15.00 solvency risk will not cause an issue for Blackmores as
50.00% the acquisition performed well during the year and has
40.00% started to contribute profits to the parent.
10.00
30.00%
5.00 20.00%
10.00%
0.00 0.00%
2009 2010 2011 2012 2013

Interest coverage ratio Debt-to-equity ratio

Net-debt-to-equity ratio

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

7
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)

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

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

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%
8
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.

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%

9
 DDM 20%
Triangulation
Worst case Base case Best case
Final value $22.13 $34.16 $51.69

Figure 11: Triangulation

$60.00

$55.00

$50.00
High

$45.00

$40.00

$35.00 Fair value

$30.00

$25.00
Low
$20.00
DCF, Abnormal Earning and Abnormal Return DDM Triangulated

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
10
Figure 13: Blackmores SWOT Analysis
Strengths
1. Market leader in natural healthcare with
strong presence in VDS
2. 11 years of consecutive sales growth
3. Highly efficient operations in Australia
4. Recognised brand with 80 years of experience
and trust in quality
5. Strong market position and brading in
Thailand, Malaysia and exanding into growing
and lucrative Asian market
6. Long sighted management approach to
company growth
SWOT
Opportunities
1. Acquision of FIT-Bioceuticals giving them
exposure to the growing healthcare practitioner’
s only market and giving organic growth
prospects in this sector
2. Shfting demographics and health awareness
of the general population in Australia and Asia
3. Much wider potential distribution channels in
Asia including pharmacies, department stores,
health food stores, specialty stores and online
4. Partnership with Eu Yang Sang (HK) could
open up knowledge of traditional Chinese
medicine to better align product with the market
Weaknesses
1. Revenues are affected by many factors
including interest rates, global economic
outlook, consumer confidence and the cost of
living
2. 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 firms
4. Australian business model is not optimal in
Asia
Threats
1. 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
erosion
3. Increaing competition in VDS in Australia
where Blackmore generates majority of its sales
revenue
4. 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
11
Figure 14: Porter's five forces analysis for Blackmores
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
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
Threat of New Entrants
LOW
Barrier to enter the markets are restricted by Threat of Substitute Products
high requirements of CAPEX and different
legal barriers. LOW
Deteriorating margins mean less lucrative There is minimal threat from
to enter the VDS market at current state freshfoods as consumers
continue to trust measurable
In Asian operations the threat of entrants is concentrated nutrients that are
HIGH as companies expand into Asia to lacking in their diets
grab a share of the region's growth
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.
Blackmores
Limited
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

Appendix 2: Accounting and Financial Analysis

Table 14: Revenue adjustment
2009 2010 2011 2012 2013
($000s) ($000s) ($000s) ($000s) ($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

Future 2013 PV 2012 PV 2011 PV 2010 PV 2009 PV 2008 PV

lease 2013 2012 2011 2010 2009 2008
payment
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

12
 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 4.06 4.85 5.68 5.92 5.92 5.92
rate % % % % % %
Total 6119.71 2418.04 1901.42 1261.65 1268.76 2323,21

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 2012 2011 2010 2009
($000s) ($000s) ($000s) ($000s) ($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 2012 2011 2010 2009
($000s) ($000s) ($000s) ($000s) ($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 26.4% 29.1% 30.6% 30% 28.9%
(reported)
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

13
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 2010 2011 2012 2013
($000s) ($000s) ($000s) ($000s) ($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%

14
 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 2010 2011 2012 2013
($000s) ($000s) ($000s) ($000s) ($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 2012
($000s) ($000s)
Revenue and other income 24,477 30,354
Other income 210 163

15
 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 2012 PV in 2012 2011 PV in 2011 2010 PV in 2010
payment ($000s) ($000s) ($000s)
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 2011
($000s) ($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 2012
($000s) ($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

16
 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 2012
$000s $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 2011 2012
($000s) ($000s) ($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 - - -

17
 - 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 2010 2011 2012 2013
($000s) ($000s) ($000s) ($000s) ($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 -2,437 5,194 2,047 3,422 5,955
goods
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

18
 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 28.90% 30.00% 30.60% 29.10% 26.40%
before tax)
Note: (1) Adjusted for revenue adjustment (2) Adjusted for lease adjustment (3) Adjusted for lease adjustment (4)
Adjusted for lease adjustment

2009 2010 2011 2012 2013

($000s) ($000s) ($000s) ($000s) ($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 2009 2010 2011 2012 2013
($000s) ($000s) ($000s) ($000s) ($000s) ($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
19
 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.
20
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:

21
Figure 15: Factors that could potentially retard Blackmore's growth in China

Business model
- Blackmores currently employs
distribution/retail partnership business model in
China, which is argued by the ignorance of fast
growing direct selling channel.
- Although winning in the retail pharmacy
channel is important, retail pharmacies only
account for 25% of overall health supplement
sales of China in 2012, which is lower than
direct sales and modern trade model (Parekh et
al, 2012).
- The one fold business model will not only
attract more competitions in terms of winning
retailers, but limits the sales increase for
Blackmores as well
a Increased competition
- It is anticipated that Blackmores will
continue to face increased competition from
both other large multinational companies and
rapidly improving local competitors, which will
squeeze the market share and revenue of
Blackmores in the medium term.
- Traditional Chinese medicine holds a unique
place in Chinese healthcare and is widely
accepted by the Chinese population, Blackmores
will be confront with other competition from
traditional Chinese medicine market (Parekh et
al, 2012).

Regulatory and cultural issues

- Exploitable distribution channels will be
restricted by the huge cultural difference between
China and Blackmores’ lack of experience
- Chinese government plays an active role in
shaping the structure of the healthcare industry,
implying that the market is deeply affected by
policy interpretation and implementation (Parekh
et al, 2012).
- The continued government pressure on reducing
healthcare product prices to ease the burden on
patients will further deteriorate the expected
margin contribution from Chinese market for BKL.

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

22
 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
14.23% 14.86% 14.66% 14.46% 14.26% 14.06% 14.06%
working capital to sales

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

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:
23
 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
Historical average based on Australian equity market returns
Market risk premium 5.80%
(Damodaran, 2013)
Calculated from averaging the 10-year monthly Australian government
Risk free rate 5.16%
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)
24
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

25
 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

26
 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
19,156 26,044 29,633 30,692 29,912 27,456
Equity
PV of FCF to Equity 135,438
+ PV of FCF to Equity beyond Year 5 476,812
= Value of the Equity 612,250

27
 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
42,69 46,17 48,13 37,31
Net Income to Common 37,310 48,993
5 6 3 0
10,02 11,06 11,77
- Charge for Common Equity Capital 8,585 8,585 12,229
8 9 5
32,66 35,10 36,35 28,72
= Residual Operating Income 28,725 36,764
7 7 8 5
* Discount factor - Common Equity 0.71 0.92 0.85 0.78 0.71 0.66
27,61 27,29 25,98 24,16
= Present Value of Residual Operating Income 26,412 22,038
8 2 9 3
131,47
PV of Residual Operating Income ( years 1-5)
4
+ PV of Residual Operating Income beyond Year 382,72
5 5
+ Beg. Book Value of Equity 98,051
612,25
= Value of the Equity
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
26.94% 28.17% 27.83% 26.51% 24.64% 22.48%
on Common Equity
Beg book value of common equity *
131,474
PVAB ROE (Yrs 1-5)
+ Beg book value of common equity of
382,725
ABROE (Beyond year 5)
'+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

28
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 Requires strict assumption that the valuing company
and theoretically it does provide a solid basis to should pay dividends
determine the shares value in present terms.

This model can be useful to analyze a company’s share This model is limited by the structural assumptions in
value in short term (5 years) and long term if we assume model implementations, derivation of data inputs and
that the industries are going to be stable 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 The accuracy of the model relies heavily on the multiple
company and therefore considered to be the trust- assumptions and terminal value. Some of the
worthiest measure among the other models used in the assumptions are purely dependent on own judgement
valuation. 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, As compared to DCF the accuracy of this model is
forecast for the growth of the equity or dividends per considered low, first being the cash flow of a company
share of the company. is trustworthy and secondly as we are using only one
Additionally, it relies less heavily on the terminal value assumed growth rate, and if it is unreliable the outcome
comparing to DCF 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

29
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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