It has been about a year since I posted about Silk Laser and price has been pounded more since then.
*Long twaddle warning*After careful watch for more than a year, I believe there are several major issues causing such underperformance for Silk Laser:
1) Discretionary Sector in the Recessionary period
2) Rising Interest Rates
3) Near 60% of shares held by "Big hands" with no turnover from them in past year
4) Commodity Services with potential needs of price war to win the market share - Pressure on the Revenue Side
5) Rising Costs in the key categories--> Employee (registered nurse to perform botox injection), Rent (Silk does not own any stores) and most importantly increasing Price of Botox - Pressure on the Cost Side
6) Not much Tangible Assets & No Payouts (Dividend - Buyback unlikely as they just listed, 60% shares are held by big hands and
Issue 1)
With my limited knowledge and biased belief towards our economy, I believe that the cycles come and go, though with our great capitalism, our will to improve & Exchange our productivity and appropriate rule of law to govern our system, we will have more Expansionary period than the recessionary period in very long term - (As Sir Keynes said, however, we all die in the long term).
Anyways, based on this belief, I wouldn't worry too much about it. If we, investors decided to invest in the discretionary sector, this cyclical movement is inevitable.
Issue 2)
Rising Interest Rate is indeed working like a gravity in the valuation and drag down the value of any investment.
During this rising interest rate environment, fund managers do prefer "current value of money" than the "future value of money" - by it means, they prefer something with shorter duration than the longer duration. In addition to this, we are heading to the recession so this tendency with risk averse tendency will definitely push fund managers to prefer "Current Value of Money". However, small caps are generally the outperformer in the beginning of the bull and declining interest rate environment. I don't think interest rate will decline to the low level any soon though.
With these negative environments, there are however, the businesses that can still generate great returns for the investors and one of them are "great outperforming growth" Businesses. I am not talking about "Revenue growth with negative cash generating business" but "High Revenue growth with Actual Cash Generating Businesses".
I'm not suggesting Silk Laser is one of the most attractive "Great" Outperforming growth stock but if we can figure out Silk Laser's reasonable growth rate, we may be able to judge whether current price is overvalued or undervalued.
So the real question we need to ask ourself is what will be Silk Laser's Growth Rate, What are their probability, what are their plans and what shareholder policy would they pursue in the future.
Issue 4), 5)
Silk Laser has 4 operating segments: Injectables, Laser and Skin, Body and Skincare - mainly towards injectables
I am not expert in this area but I know the country non-surgical aesthetic businesses succeeded very well - South Korea.
Their business model is:
1) Options to consult with consultant about their concerns or directly book the service
2) Create a habit for clients to visit occasionally by offering reasonable price of simple skin care
3) Advise them about issues which can be improved by using the products like in-house skin care product and masks or the machine like Microneedling, LED and others - (products/service selling opportunities) and 3) Consult to ensure client's service satisfaction after a month of use and potentially lead clients to injectables and body while asking for any further concerns.
Again, I am not expert in here, our managements are, but I think we need to make some sort of spiral or service chain to beat our competitors with the margin, not the price. I may be wrong but I feel like our non-surgical aesthetic sector is too casual.
It is commodity service business and price is the key but as it is aesthetic business, we still have room to provide service difference and it could be a key in the long-term.
Out of many things I don't know, I know 2 facts are true for the injectables (our main revenue source): 1) injectables are still the growing sector around the world (Thanks to Kardashians) and 2) People prefer to go to somewhere they can trust to get injected.
I am just not sure whether people are going to be price sensitive with the injections - something that is going into your body.
Anyways, our management indicated on the 2022 AGM Presentation that they initiated series of strategic price increases to mitigate cost inflation implemented from 1 July 2022, with no noticeable impact to transaction volumes. So we can interpret that they 'could not' implement price increase before 1 July 2022. Then it is understandable why they had such a reduced Gross margin.
so let's see how this strategic price increase will play out.
Price Increase & Acquisition of laser businesses to increase geographical exposure/Marketshare are not a bad strategy to increase revenue but there are more important things for us: Costs
Employee Expense: As we are skewing more towards the injectables, increasing employee expense is inevitable as only registered nurses are allowed to perform injections.
Occupancy Expense: Increased rent is also something we cannot do anything special
Cost of goods: Mainly the botox - went up more than 15% as there are only two major botox suppliers in the world.
I recently discovered that there are botox supplier in South Korea called Medytox. I don't know about the law but it could be an option to diversify our suppliers if possible
To mitigate this cost inflations and recessionary period, I think our management's skills and strategies are key. I hope they can provide clear guideline of their plan & result in the upcoming meeting.
Issue 6)
If you take a close look at their balance sheet, they have $63m of Net Operating Tangible Assets (my own figure | excluding cash and others)
Of them, $19m is PPE and they consist of Leasehold Improvement (useless) and Equipment and fixtures though it is quite common for the service retail business. Rest of $44m is Working capital & Operating intangibles (i.e. franchise system & network)
Their Cash and other assets roughly net-off with debts & tax liabilities.
From this information, we can see two sides of the coin: Not much tangible assets to back up the price & Little Capital Expenditure needed to expand.
With the assumption 1) Management took appropriate price increase & Sales Strategies to encounter recessionary period and cost inflation to protect margin (assume not much growth is achieved), 2) Tax paid in cash to normalise , and 3) Maintenance CAPEX to be 5-7m, I believe Silk Laser's Free cash flow wouldn't be too horrible (I guess).
But what are we going to do with that FCF is what really matters.
It seems like management wants to focus on the growth by acquiring competitors & buyback the Silk Laser's stores.
I am just unsure if these plans will be value creation or value destruction but if they retain our profit, it should generate above market return for us to justify their retention (or they should payout). Our management indeed grew our portion of revenue and profit through major acquisition with ASC last year but had no luck on the capital side (SP & Dilution)
I do understand that current cost of debt being more expensive than a year go, they want to retain every single profit to grow.
Frankly speaking, I think they have quite a bit of capacity for the dividend even after growth CAPEX (No acquisition is assumed) - which may reward shareholders with 5-7% yield at current price - if they protect their margin.
Under 4-5% Risk Free rate environment, I believe reasonable growth, even under double digit growth with 5-6% dividend yield can make current valuation not that bad.
As mentioned previously we may need some sort of "current value of money" offered to the market to protect against declining SP. I think market is waiting for this kind of news, and some improvement from the Silk Laser to mitigate cost inflations. Of course, growth should follow
I wish Silk Laser's management can balance between growth & Shareholder benefit to help provide different perspective to the market.
Issue 3)
As I mentioned last year, roughly 58% of shares are controlled by: 27% by Silk Related bodies & 21% owned by institutions like Firetrail (average price: $3.63), Ice ($3.57 - with missing info), Fidelity International ($4.34) and Wilson ($3.45) - being substantial holders.
By the ASX reporting rule, these bodies must provide notification if there's any change or more than 1% change. We have not seen any announcement yet so we can assume that recent price decline was caused by rest of 42% investors.
27% of Silk Laser Related bodies are released from Escrow already but they have not shown any movement yet
If I combine the fact from issue 3) with technical analysis, I can get some useful information:
- SP downward pressure continued though market is keep trying to find bottom somewhere
- Failed to sustainably outperform EMA 20
- All institutional Investors are recording loss more than 50%
- Managements haven't sold their second batch of escrow
Based on above facts and "if" Silk Laser is actually a lousy business (IF, I am not saying it is), there is a chance SP may still rebound once for "big hands" to exit. Of course this is my pure assumption and may not play out this way.
In summary, if silk laser can grow by proving they can mitigate the cost increase (margin growth preferred) & implementing successful growth strategies + Some Payout executed for shareholders, Silk Laser may have more upside than downside at the current price.
However, if they fail to execute these, there will be more pounding to come.
Who knows how it will exactly play out.
I guess success of Silk Laser is highly depend on our management more than ever.
Let's see what they will say this 28th first !
