Dairy Farm - On The Right Track
- We believe Dairy Farm is on the right track, with the implementation of key strategic initiatives to improve margins and operational efficiencies. These measures would help achieve steady profitability, to be evident in the upcoming release of its 2016 results, despite a challenging operating environment thus far.
- With retail sales in its bread-and-butter market, Hong Kong appearing to have bottomed out, we believe things should look up in 2017.
- Dairy Farm remains a conviction BUY, with revised TP of USD8.50 (from USD8.60, 17% upside).
Structural margin improvements at supermarkets to continue.
- Management has been pushing to increase penetration of fresh food sales, which we believe would lead to a favourable change in the margin structure, especially in more developed cities where wet markets are being phased out.
- Along with the push towards more direct/bulk buying, and IT infrastructure investments, we believe there is significant potential for margin upside in the medium term, at its biggest division (55% of group revenue). This trend was evident during 9M16, and we expect it to continue into 2017.
Convenience stores to benefit from rationalisation.
- The company shut down its Starmart business in Indonesia and started rationalising its 7-Eleven stores in Singapore during 2016. Together with the earlier rationalisation and country management changes in China, overall sales and profitability at this division appear to be improving.
- Upside in 2017 could come from store expansion in China if management is able to find the right formula, leveraging on its partnership with Yonghui Superstores (601933 CH, NR) for store locations and sourcing advantages.
Hong Kong retail sales bottoming out.
- The Hong Kong market is Dairy Farm’s bread and butter, contributing an estimated 40-45% of group revenue.
- Retail sales were weak in 2016, mostly due to lower spending by mainland Chinese tourists. However, this situation appears to have bottomed out towards end-2016, with mainland Chinese tourist arrivals up 0.5% in Nov 2016, vs -2.8% in Oct 2016. We believe this bodes well for its business at Mannings in 2017.
- In 2016 however, overall earnings were dampened by its Health & Beauty segment due to lower tourist spending, as well as weakness in Malaysia.
Conviction top pick in 2017.
- Dairy Farm is one of our top picks for both the Singapore market and Regional Consumer sector in 2017.
- We reiterate our BUY call ahead of the release of 2H16 results (in early March), which are likely to be unexciting, but would show positive trends on key strategic initiatives.
Key risks include weaker regional currencies vs USD.
- Expected US rate hikes could result in further depreciation of regional currencies vis-à-vis USD. This would have a negative impact on Dairy Farm as c.55% of revenue is derived from outside Hong Kong, whilst a higher proportion of headquarters costs are in Hong Kong.
- We adjust our 2016-2018F estimates down by 1-4%, partly to take this into account, and our DCF-based TP to USD8.50.