Betterware de Mexico: A Hold For A Risky Investment

Introduction

Betterware de Mexico (NASDAQ:BWMX) is a direct-to-consumer company that sells household products through a network of distributors and associates. The company has been growing rapidly in recent years. Still, it has faced challenges, such as declining associate numbers, competition from other retailers and e-commerce companies, and slower economic growth. Those challenges have decelerated revenue growth, and the worst part is that most of them are likely to stay for a while. That's why I consider a more pessimistic future. Thus, the company may be a little overvalued at the current prices.

Management

Luis Campos is the chairman and principal shareholder of Betterware de Mexico, owing indirectly 53.65% through Campalier. Moreover, his sons Andres Campos and Santiago Campos occupy the CEO and Chief Transformational Officer positions at Betterware. Thus, we have a familiar business run by the son of the principal shareholder, so at first glance, someone could conclude the management will be aligned with shareholders' interests. Still, I think it's not entirely accurate in this case because the management has had a couple of pitfalls in the past with the acquisition (and posterior sale at a loss) of Gurucomm, a mobile virtual network operator and communications software developer, and the acquisition of Programa Lazos, a firm focused on granting loans and financial leasing or financial factoring operations in Mexico. Both investments are not related to Betterware's core business. In the case of Gurucomm, only one member of the board (Mauricio Alvarez) has knowledge related to software and network themes. Even if the management wanted to include home-smart products in their offerings, the lack of knowledge could make the management reconsider the acquisition.

Moreover, I believe the management's intention to keep diversifying revenue streams is clear, as in the 2Q23 report, they stated they keep evaluating M&A to diversify revenue streams. In my opinion, the principal reason that drives management to look for diversification is trying to reduce the risk of the family's investment in the company, which is significant; however, other shareholders can diversify quickly by buying businesses in other industries, so Betterware's diversification adds no value to their investment.

JAFRA acquisition has been the best acquisition of the company as of September 2023. I think the management has grown revenue and profits from this brand due to the similarities with Betterware's business model. In fact, there have been cost synergies between the two business segments. I hope the management team has learned from the errors in acquiring companies in industries where it doesn't have experience and focuses on international expansion and the acquisition of similar businesses.

However, don't misunderstand me; ignoring some pitfalls (which are entirely normal when management wants to create value for shareholders), I think the management has done an excellent job that can be measured by a revenue annual growth of 57% annually in the last five years and a median average ROIC of 40.2%. Moreover, the focus on continuous improvement, the integration of many technological tools, the constant innovation, and the ability to carry out cost and expense reductions when the business's financial performance begins to deteriorate are good examples of how effective the management is running a business in a highly competitive industry.

Focus on Technology and Innovation

The development of an e-commerce platform for distributors, the development of an app for associates and distributors, the use of Big Data and possible incorporation of AI, and the development of over 500 new products in 2022. All the former are examples of Betterware's commitment to use technology as a competitive advantage. I think they set the company apart from many of its competitors as it constantly seeks ways to satisfy customers and distributors with decisions based on data analytics. With the data, Betterware can rapidly know what products have been successful and what parts of the country report an increase or decrease in sales and adapt to or correct any negative trend.

Logistics and Supply Platform

Mexico is a large country with many small cities and towns spread over the country. In these cities, it is hard to find many companies offering products like Betterware's because investing in those locations may not be viable for large retailers or last-mile logistics companies. Thus, large competitors ignore those small cities, like Walmart Mexico or Home Depot Mexico. Nonetheless, Betterware, through distributors' logistics, can offer last-mile delivery in these towns; at the same time, it may offer better prices than small retailers due to its scale. I think the unparalleled logistics platform gives Betterware a unique competitive advantage, as the company's offering can arrive at any part of Mexico (where the rural population was 18.7% in 2022) and avoid the last-mile delivery costs (which are covered by distributors and associates). However, e-commerce competitors, such as Amazon (AMZN) and MercadoLibre (MELI), have experience building last-mile delivery networks and are strengthening their positions in Mexico through investments in their logistics in the country. In addition, according to an interview with Luis Campos, Betterware generates most of its revenue from 16 cities in Mexico, so even if it has a broad logistics platform, I think most of its income should come from the principal urban centers in Mexico.

Moreover, last-mile delivery is neither free for distributors or associates nor its storage cost. Both have to be borne by distributors, who earn a margin of 24% and 12-16% of their associates' purchases; in contrast, associates only make the 24% margin. Hence, they have to cover all expenses and make enough profit so that the time invested in selling the products is valuable.

The number of distributors and associates exploded during the pandemic (almost tripled). However, after the pandemic, the growth of associates stopped and began to decrease sharply. From my perspective, the rapid growth in the number of associates arose because people saw a way to generate extra income from their homes when almost all the jobs were closed; besides, this growth continued in 2021 as the demand was high, as Mexico's real economy was soaring, but started to decline when the economy growth, hence the consumption, experienced slowdowns. Additionally, as the government dropped the lockdown and there were more vacancies, people returned to their jobs.

In 2Q23, Betterware's average base of associates fell by 17% compared to 2Q22 and remained flat QoQ. The average base of distributors fell by 8.1% compared to 2Q22 and increased by 4.60% QoQ. Regarding Jafra Mexico, the average base of associates increased by 13.7% compared to 2Q22 but decreased by 4.8% QoQ. More importantly, the churn rate declined to 17.6% from 20.4%, which remains high but improving. Seeing the big picture:

The decline stopped in 2Q23 after losing 450,000 associates and 22,000 distributors. The stop can signal a change in the tendency or just a stop and further deterioration. However, I believe the current number of associates and distributors should not decrease more, as the excessive growth experienced through the pandemic has already vanished. Now, evaluating the Jafra Mexico segment, we have seen that the number of associates has grown YoY, but in the last three quarters, it has remained flat essentially.

However, in the last quarter, the Jafra Mexico revenue increased 14.5% YoY, and the gross margin expanded from 81.9% (2Q22) to 83.3%. Thus, even if the number of associates and leaders remains flat QoQ, it still represents a growth compared to 2022.

International Expansion

Betterware already proved to be capable of replicating its business model in Guatemala. In the interview, Luis Campos stated the company might expand to the Colombian and Peruvian markets as, according to him, those markets resemble the conditions of the Mexican market and represent 60% of it. Moreover, the company has only penetrated 23% of households in Mexico. Hence, the opportunity to keep growing organically is still significant, and I believe Betterware has everything to enter new markets and keep expanding in Mexico.

Risks

Competition

Retailers and e-commerce are in fierce competition, seeking money in consumers' pockets through discounts, customer experience improvements, and heavy advertising investment. Key competitors of Betterware are Walmart Mexico, Home Depot Mexico, Amazon, MercadoLibre, Temu Haul, and Aliexpress; these companies focus on selling at the lowest price possible and where there are many products from different brands. Meanwhile, Betterware offers principally own-brand products manufactured in China. Thus, other companies may offer similar products at similar or lower prices in any of the channels named above; however, Betterware protects itself from the competition with a constantly innovative approach by introducing new products in the market that are tailored to customers' needs. Moreover, as the company has an extensive database, it can cater to clients' needs faster than many other companies and evaluate the success or failure of the products.

Meanwhile, other manufacturers and retailers use marketing campaigns to show their products; Betterware relies on word-of-mouth to promote its products through its associates. From my perspective, after 2021, the competition increased as the economic growth slowed, generating adverse conditions for the Betterware segment, whose sales have fallen 9.9% YoY due to a lower number of associates and distributors, who, in my opinion, have left the company owing to low revenue and profits compared to other activities as a stable job. But even if sales are going down, the management has widened the gross margin from 58.3% in 2Q22 to 61.8% in 2Q23. Nevertheless, I believe that the company can develop in a highly competitive market. Still, I doubt the company can keep a median ROIC of 40.2% in the future, as the company does not have a wide moat.

Regarding Jafra, its products have excellent reviews on Amazon (>4.4 stars), but it competes with many other brands inside Mexico and the US. I think Jafra is inside a monopolistic structure with low barriers to entry in which all the brands are trying to differentiate from the others. Thus, it's hard for Jafra to outperform the competition, but the good reviews at least tell its products are good enough to get by.

Economic Conditions

Most of Betterware's products are essentially discretionary. Thus, they are susceptible to general economic conditions and consumer confidence changes. These conditions limit the capacity to raise prices or expand to new markets. Moreover, inflation and supply chain disruptions may increase costs while the company may not be able to increase prices in the same proportion.

Additionally, Betterware had a long-term outstanding debt of $269.3 million as of June 2023. Most of that debt bears variable interest rates, so interest expenses have skyrocketed as interest rates have risen. For instance, the interest expenses grew by 57.2% in 2Q23 (YoY), while the long-term debt decreased by 20.66%. It will limit the capacity of Betterware to make strategic acquisitions.

Loss of Associates, Distributors, and Leaders

Following the competition risk, Betterware de Mexico may lose many associates, the principal drivers of its revenue. Consequently, as competition tries to take market share, Betterware may be unable to offer attractive returns to its associates, losing them and losing revenue. Moreover, economic conditions may deter associates from selling the company's products as they do not find enough customers to make worthy the effort.

Weak Internal Control

Betterware's management has concluded that the company's internal control over financial reporting is ineffective. This is due to many material weaknesses, including:

• A lack of an effective risk assessment process and monitoring activities

• A lack of controls over the business combination process

• A lack of formal accounting policies, procedures, and controls for period-end financial reporting and consolidation

• A lack of specific IT general controls

Betterware is taking steps to address these material weaknesses, but how long this will take is still being determined. In the meantime, investors should know that Betterware's financial statements may need to be more accurate and reliable. Moreover, PwC, as the auditor, confirmed that the company didn't maintain effective internal control measures as of December 31, 2022.

Currency Risk

Over 90% of revenue comes in Mexican Pesos, while it has to pay its manufacturer partners in dollars or renminbi. Consequently, Betterware is vulnerable to depreciation and appreciation of the US dollar.

Valuation

Given the new competitive landscape and the financial deleveraging process, I think Betterware won't generate the returns on equity it achieved before. I will assume a ROE of 40% for the first year, 35% for the second, and 30% for the following years. The dividend payout ratio will be 64%, which is lower than the average, but as the company focuses on growing, acquiring, and reducing debt, I think the ratio should decline. Moreover, the discount rate will be 17%, and the Perpetuity Value will be a P/E of 14.

Conclusion

Given my valuation, Betterware's stocks are slightly overvalued at the current prices, assuming a more adverse competitive environment and slower economic growth in Mexico, which I think will tank Betterware's returns. Furthermore, weak governance and the currency risk (instability of the Mexican economy and politics) increase the investment risk. Consequently, even if Betterware has grown rapidly, achieving high returns, the aforementioned risks make me doubt the company's capacity to maintain such a financial performance.