- In early 2022, the company increased product prices by 12%, but it seems that this is backfiring as revenues and EBITDA shrank by over a third in Q2 ex-Jafra.
- According to the revised 2022 guidance, the second half of the year isn’t expected to be better than the first one.
- In addition, Betterware de Mexico is now leveraged to the bone, and a global recession could push it into a large capital increase.
- Looking for a helping hand in the market? Members of Bears and Resources get exclusive ideas and guidance to navigate any climate. Learn More »
The COVID-19 pandemic proved to be a period of strong growth for Mexican household products direct-to-consumer company Betterware de México, S.A.P.I. de C.V. (NASDAQ:BWMX). I wrote a bullish article on it shortly after the announced purchase of the U.S. operations of international cosmetics company Jafra.
However, this growth slowed significantly when restrictions were lifted and people returned to the office, and the company's margins were put under pressure when global supply chain issues emerged. With inflation around the world rising rapidly, Betterware de Mexico implemented a 12% product price increase at the beginning of the year, but it seems this was a mistake, as Q2 results looked weak. In addition, the company announced a cut in its dividend and the future is looking uncertain at the moment. Let's review.
Overview of the recent developments
In case you haven't read my previous articles on Betterware de Mexico, here is a brief description of the business. This is a multi-level marketing (MLM) company that specializes in smart and cute kitchen and home products. Its name is similar to British MLM company Betterware, as it used to be part of it until 2001, when it was sold to businessman Luis Campos.
Unlike many other MLMs, Betterware de Mexico doesn't offer any commissions to recruit new people, and its distribution network has just two tiers - distributors and associates. The distributors place the orders to the company and then deliver them to the associates. Both tiers get discounts on products.
In December 2020, Betterware de Mexico launched a B2C web app platform that allows users to directly order products from the company. If someone decides to buy products through this channel, the company makes the shipment to the closest available distributor. In my view, Betterware de Mexico has developed an ingenious business model that creates effective word-of-mouth marketing of any product it launches and allows the company to skip the often expensive last-mile delivery step that traditional online stores have to deal with.
Betterware de Mexico puts on the market over 300 new products annually and its margins are pretty good as around 90% of its products are manufactured in China. However, this leaves the company vulnerable to supply chain disruptions and rising freight costs. China's zero-Covid-19 policy has had a significant impact on the results of Betterware de Mexico, and to counter this, the company boosted the level of its inventory in Q1 2022. Betterware de Mexico was optimistic at the end of the quarter, with expectations of progressive improvement of sales during the remainder of the year and resumed growth in the second half of it. For the full 2022, gross margins were expected to stand at between 58% and 60% while the EBITDA margin was seen at between 27% and 29%. Revenues were expected to decline slightly. Well, I said in early May that these expectations seemed overly optimistic, and it seems that I was right.
Betterware de Mexico closed Q2 2022 with net revenues of just above 1.6 billion Mexican pesos ($78.8 million), which represents a slump of 38% year on year. The gross margin looked fine, but EBITDA crashed by 49% to 383.3 million pesos ($18.8 million) due to the lower revenues and operating leverage - SG&A expenses represented 34.9% of net revenues in Q2 2022, compared to 28.8% a year earlier.
What's even more concerning is that the distribution network of the company is continuing to shrink. Betterware de Mexico had 44,400 distributors and 908,000 associates in Q2, which is 25% and 32% lower compared to the same period of 2021, respectively. In Q1, the company had 48,100 distributors and 997,000 associates. Inflation around the world is rising fast and it seems that Betterware de Mexico is unable to effectively pass on higher costs to its customers. In addition, the major economies around the world are slowing down and more and more economists are now predicting that a global recession could be inevitable. This is usually a tough time for consumer discretionary companies, yet Betterware de Mexico seems to be performing worse than competitors and it doesn't seem to be due to the management. For example, take the newly acquired Jafra business. The purchase was completed on April 7 and in Q2, the number of its leaders (similar to distributors) declined by just 7% year-on-year to 22,400, while the number of its consultants (similar to associates) decreased by only 10% to 409,700.
I think the reason Betterware de Mexico's network is shrinking faster could be the 12% increase in the prices of its products at the start of the year.
Turning our attention to the revised guidance, Betterware de Mexico now expects to book revenues of between 6.8 billion pesos and 7.2 billion pesos ($334 million and $354 million) and EBITDA of between 1.7 billion pesos and 1.9 billion pesos in 2022. I think this is grim news as it means that H2 revenues and EBITDA are expected to be roughly on the same level as in H1. The Jafra business, in turn, is forecast to close the year with revenues of between 6 billion pesos and 7 billion pesos ($295 million and $344 million) and EBITDA of between 700 million pesos and 800 million pesos ($34 million and $39 million). Note that these figures include net revenues and EBITDA of 1.7 billion pesos ($84 million) and 158 million pesos ($13 million) for the period between the start of the year and April 6.
I find the guidance for the Jafra business disappointing too considering it had revenues of 3.3 billion pesos ($164 million) and EBITDA of 370 million pesos ($18 million) in the first of the year. It seems that the company doesn't expect any improvement in the results for the next few months. And keep in mind that this is a business that was expected to book EBTDA of about $41 million in 2022 when the purchase was announced just 7 months ago.
With EBITDA dropping and the 2022 guidance looking weak, I think it's no surprise the quarterly dividend was cut to 200 million pesos ($10 million). Yet, I think this level could be unsustainable considering how much leverage has increased. As of June, Betterware de Mexico had a net debt of 6 billion pesos ($295 million) and its shareholders' equity was just 1.1 billion pesos ($54 million). Interest expenses soared by over 800% to 131 million pesos ($6.5 million) in Q2 2022 as a result of the purchase of the Jafra business
Betterware de Mexico increased the prices of its products at the start of the year but it seems that this is backfiring as the decline in revenues and EBITDA accelerated in Q2 2022. Also, the shrinking of the distribution network is showing no signs of slowing down. The revised guidance for 2022 looks weak, including the one for the Jafra business and I think that the dividend is likely to be cut further in the coming months.
In my view, the balance sheet is now in dire straits and I think that a global recession could push Betterware de Mexico into a large capital increase, which is likely to result in significant stock dilution. The company has a market valuation of less than $380 million as of the time of writing, which means that the dividend yield is still above 10%. However, I think Betterware de Mexico is becoming a value trap. In view of this, it could be best for risk-averse investors to avoid this stock for now.
If you like this article, consider joining Bears and Resources. I post my portfolio and shortlist there and you can also find exclusive ideas from our community of investors. I like to focus on undervalued companies that the market is ignoring, like an island of misfit toys. Both long and short ideas.
So, what can you expect to get from this service?
- Exclusive articles
- Access to my portfolio and watchlist
- Interviews, ideas, portfolios, watchlists, and comments from other investors I've invited to the service
- A chat room with access to me and the other investors
This article was written by
Gold Panda has been working as an M&A analyst for over 11 years. He's been investing since 2007. Preferring value to growth, he tends to take a relatively conservative approach in his investing. His focus is on small and micro-cap stocks, which he believes is the area which offers the greatest opportunity to exploit market mis-pricings.Gold Panda is part of the team that runs the investing group Microcap Review. He provides a real-time portfolio to the group. Microcap Review focuses on three areas of opportunity in the micro-cap space: arbitrage and special situations, net-nets and undervalued stocks. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.