Zhulian Corporation Berhad: Can a High Dividend Yield Salvage a Deteriorating Earnings Story?

Zhulian Corporation Berhad (KLSE: ZHULIAN) has delivered a mixed bag of results in its second quarter of 2025, with revenue growth clashing against margin erosion and declining earnings per share (EPS). While the company reported a 14% year-over-year revenue increase to RM37.9 million, net income fell 8.7% to RM5.99 million, and profit margins contracted from 20% to 16%. EPS dipped to RM0.013 from RM0.014, signaling a fragile earnings foundation. This raises a critical question for investors: Can Zhulian's attractive 3.7% dividend yield and modest cash flow coverage justify a long-term hold, or is the stock's underperformance a red flag for deeper structural issues?

The Earnings Conundrum: Revenue Growth vs. Margin Compression

Zhulian's revenue growth is a positive, but it's been offset by a sharp decline in profitability. The company's net income fell despite higher sales, a classic warning sign of rising costs or pricing pressures. The 4% margin contraction—from 20% to 16%—is alarming, particularly in a luxury sector where margins typically buffer against economic volatility. Analysts note that expenses, likely tied to operational inefficiencies or competitive pricing, have eroded profitability.

Compounding the issue, Zhulian's Return on Capital Employed (ROCE) of 6.1% lags far behind the 10% industry average. This suggests the company is failing to generate returns that justify its capital expenditures, a critical flaw for long-term sustainability. While the CEO, Danny Teoh, emphasizes a strategic pivot toward manufacturing high-quality beauty and wellness products, there's no evidence yet that this shift has reversed the company's profitability woes.

Dividend Yield: A Double-Edged Sword

Zhulian's 3.7% dividend yield, which outperforms the bottom 25% of Malaysian dividend payers, is a key draw for income-focused investors. However, the payout ratio of 125% relative to earnings is unsustainable. The company is paying out more in dividends than it earns, a practice that could backfire if earnings continue to decline.

The silver lining is cash flow coverage. With a cash flow payout ratio of 67.1%, the dividend is supported by RM27.41 million in trailing 12-month free cash flow (RM0.06 per share). This provides a short-term buffer, but the free cash flow itself is shrinking at an 11.8% annual rate. Investors must ask: How long can this model last? A sudden drop in cash flow—triggered by economic downturns or operational hiccups—could force a dividend cut, triggering a sell-off.

Strategic Initiatives: Promises vs. Reality

Zhulian's management has outlined ambitious plans to leverage manufacturing strengths and expand its product portfolio in beauty and health. CEO Danny Teoh's AGM address highlighted a “long-term value creation” strategy, but the lack of concrete results is concerning. For instance, the company's free cash flow has declined by 30% over five years, and its ROCE remains stagnant.

The recent second interim dividend of 1 sen per share and the unanimous shareholder approval at the AGM suggest confidence in the company's resilience. However, the AGM also revealed shareholder frustrations. The CEO's RM1.7 million compensation package—115% above the industry average—has drawn scrutiny, especially as EPS has fallen 25% over three years. This misalignment between executive pay and performance could erode investor trust.

Risks and Opportunities: A Tenuous Balance

Zhulian's challenges are multifaceted. Its declining free cash flow, weak ROCE, and executive compensation concerns create a high-risk profile. Meanwhile, the company's focus on product innovation and a robust dividend (for now) offer potential upside.

For growth-oriented investors, the company's strategic pivot toward health and wellness is intriguing. The global beauty and wellness market is expanding, and Zhulian's manufacturing capabilities could position it to capitalize on this trend. However, execution is key. Without clear evidence of improved margins or revenue diversification, the stock remains a speculative bet.

Investment Takeaway: Proceed with Caution

Zhulian Corporation Berhad's 3.7% dividend yield and modest cash flow coverage offer temporary appeal, but they cannot offset the structural headwinds. The company's declining margins, stagnant ROCE, and executive pay controversies raise red flags about long-term sustainability. While the strategic focus on product innovation is promising, investors should wait for tangible results before committing.

For now, Zhulian appears best suited for risk-tolerant investors who can tolerate dividend volatility and are betting on a management-led turnaround. Conservative investors, however, might find safer alternatives in the Malaysian market, where stronger balance sheets and healthier margins are more common. In a sector where margins are king, Zhulian's current trajectory suggests it's playing a losing game.