Description

(Note: this isn’t dirt cheap from a tangible NAV perspective, but we feel it is too cheap for what it is – a leading developed-Asia skincare brand with a growing overseas presence that essentially sells daily-use skin vitamins with best-in-class margins, ROE and cash returns to shareholders)

Dr. Wu Skincare: Proven Cash Cow with Growth, a 5% “Floor” Dividend Yield, and a Large Discount to Peers

Summary

Dr. Wu is a skincare brand structured as a pure marketing company with no manufacturing. Because Dr. Wu was one of Taiwan’s earliest movers in its category (facial serums), it established top market share in key sales channels.

The firm’s figurehead, Dr. Wu Ying-Chin, is a renowned dermatologist to local celebrities with multiple clinics outside the listed company that essentially provide free R&D and word-of-mouth marketing. His son, Eric Wu (a Columbia graduate with experience at PwC and AIG), decided in 2003 to monetize his father’s reputation by launching Dr. Wu as a skincare products company.

The first decade in business attracted the investment of LVMH’s L Capital, who tried to “grow the brand in mainland China” but ultimately failed. By early 2020, L Capital fully exited by dumping Dr Wu shares on the Taiwan Exchange. In November 2020, Dr. Wu sold 100% of its China trademarks and other assets to a mainland Chinese distributor (Yatsen, US ticker YSG, a Hillhouse-backed venture) for a surprisingly large cash consideration (over 20% of Dr Wu’s average market cap). In return, Dr. Wu received a low-risk, high profit margin percentage-of-sales royalty structure in China that has been incrementally positive to the bottom-line from 2023 onwards. 

As of today, Dr. Wu was a) flush with cash, b) no longer showing China losses, c) proving the strength and pricing power of its Taiwan business, d) selling more online (1/3 of sales), e) succeeding in new markets like Japan (the single largest overseas market in 2023), and f) trading at below-average EV multiples for its industry.

Further, Dr. Wu has long guided that a large percentage of its cash will be for dividends. We think minimum cash distributions can remain at a mid-high single digit percentage of current market cap. Given Eric Wu’s finance background and the company’s >20% ROE in the years when mainland China was not a drag, shareholders can feel confident that cash won’t be hoarded going forward. In fact, Dr. Wu already paid shareholder distributions worth 53% of average market cap from 2020-2023.

Despite +16% YoY 1H2024 revenue growth and very rosy full-year guidance (i.e. double-digit sales growth and profit growth), on July 17, 2024 Dr. Wu traded at 14.8x trailing P/E (11.9x ex-cash P/E) with a 5% trailing dividend yield, far cheaper than most developed Asia peers (see below).  

In our view, Dr Wu’s discounted valuation today owes to:

a) small market capitalization, low free float, and just 8.14% foreign ownership (with one investor accounting for the bulk of that)

b) cross-straits geopolitics generally (more specifically, the natural potential acquirers of Dr Wu are all mainland Chinese, de facto blacklisted buyers), and

c) under appreciation for the ex-Taiwan, ex-China growth story – especially in Japan, the company’s single largest overseas market in 2023. If this 15% overseas contribution can rise to 30% or more, the firm’s “normal” P/E could rise toward the loftier levels observed in Japan / Korea.

Even if none of the above concerns dissipate, at current 5% cash dividend yields (almost certain to continue/increase in our view), investors only need 5% earnings growth to reach 10%+ total returns without factoring in 1) faster-than-expected profit growth from initiatives like D2C sales (now 5% of total revenue from nothing a few years ago), and 2) P/E re-rating.

What’s Special about Dr Wu?

First, Dr. Wu is among the most dividend-focused companies we know in Taiwan (i.e., 53% of the average market cap has been paid out in cash since 2020).[1]  Management has effectively communicated to the market (and can afford) a “floor” dividend yield of approximately 5% based on an NT$2.00 per share quarterly dividend and the July 17, 2024 closing price of NT$160.00.

Second, Dr. Wu is among the few strong domestic Taiwanese brands we know (see Watsons shelf space below) that is truly a “brand” overseas, especially mainland China (see comments below by Yatsen, Dr. Wu’s mainland China distributor and trademark JV partner). Dr. Wu has even observed high sales growth to non-Chinese consumers on Amazon in Japan (its single largest overseas market in 2023). Dr Wu used to only be recognized in Taiwan/Hong Kong/mainland China and the Chinese-speaking parts of ASEAN (Singapore/Malaysia), so the fact that there’s been a recent breakthrough in Japan (selling to locals online, not Chinese tourists in drugstores) speaks volumes about the product quality and brand – this really could be an inflection point in the company’s overseas growth story and M&A attractiveness by non-PRC biders.

Above: Dr. Wu shelf space in a Taipei branch of Watsons in December 2020.

Above: comments on Dr. Wu’s popularity in mainland China from Yatsen (distributor and trademark partner).

Lastly, Dr. Wu just strikes us as “too cheap for what it is.”  On one hand, Dr. Wu’s specialty – branded facial serums with >70% gross margins – are essentially daily-use skin vitamins that, unlike color cosmetics, aren’t fashion-sensitive (i.e., stable demand).  On the other hand, Dr. Wu’s valuation multiples since COVID-19 give the impression that demand is unstable.  This does not make any sense to insiders or the outsiders that follow the company closely.

While we know of one other publicly traded, daily-use skincare company in South Korea (NeoPharm) trading at lower P/E multiples today, that company has a worse record of investor relations transparency, dividend payout (i.e., the 2023 dividend is unchanged from 2020 despite a massive cash pile) and growth. Other than the NeoPharm outlier, we are not aware of another similar publicly traded Asian skincare company that trades at the same ex-cash P/E as Dr. Wu (where the cash has been, and should continue to be, actually paid to shareholders).  According to Bloomberg, Dr. Wu’s dividend yield as of July 17, 2024 is still by far the highest of any publicly traded comparable in Asia. 

Catalyst

Catalysts:

1. Additional overseas sales, especially from Japan (single largest overseas market in 2023) where the company as publicly guided their transition to a larger distributor in 2H2024 (they ran out of sales runway with the old distributor who could not accommodate the sales growth and future ambitions).
2. Additional highest-OP margin D2C sales (5% of sales YTD 2024 versus 0% a few years ago)
3. Further royalty growth from mainland China (a 100% gross margin revenue source as all the costs of that activity are borne by Yatsen)
4. New product launches (the first-ever sunscreen product line is launching in 2H2024)
5. Additional price increases in Taiwan (historically hike prices had no effect on demand)
6. Additional special dividends (there’ve been 4 specials in the last 4 years on top of the normal $2.00/quarter pattern)