Dairy Farm Int'l - CIMB Research 2016-11-10: Now positive after hints of turning the corner

Dairy Farm Int'l - CIMB Research 2016-11-10: Now positive after hints of turning the corner DAIRY FARM INT'L HOLDINGS LTD D01.SI

Dairy Farm Int'l - Now positive after hints of turning the corner

  • Our read-through from management’s 3Q16 interim statement is that the worst is over.
  • Dairy Farm (DFI) reported positive growth in both topline and bottomline, which is ahead of our expectations.
  • Recovery was led by its food segment, where margin improvement initiatives now reflected in its results. Sales growth was also positive despite store closures.
  • It is now time to revisit the stock. Upgrade to Add, with a higher TP of US$8.70.

Positive read-through from management’s 3Q interim statement 

  • DFI released an interim management statement on its 3Q16 results and we view it positively. 
  • Overall, it reported positive sales growth across all segments, with group earnings up yoy. This is ahead of our expectations, and we now turn positive on the stock. 
  • We strongly believe DFI is now on the right track and the worst is over. 
  • We upgrade our rating to an Add.

Where were the problem areas? 

  • To recap, FY15 was a particularly challenging year for DFI with net profit down 17% yoy on the back of margin pressures. The problems were due to having expanded too aggressively, with demand failing to keep up. 
  • There was also the added impact of slowing arrivals of mainland Chinese in Hong Kong which negatively impacted its health and beauty segment.

What changed? 

  • DFI had since undertook the painful task of rationalising its stores and driving productivity. The group also implemented a slew of initiatives to improve its core food business: 
    1. higher range of fresh produce, 
    2. increased private label offering, and 
    3. increased direct sourcing. 
  • We think it is the combination of all these factors which are now contributing to an earlier-than-expected margin recovery.

Food segment led the recovery 

  • We are most positive on the group’s food segment, which consists of supermarkets/ hypermarkets and convenience stores, and made up c.50% of group EBIT in 1H16.
  • Early signs of recovery first showed up in 1H16, where food’s EBIT grew 4% yoy on the back of a 1% yoy decline in sales (mostly due to store closures). The positive momentum appears to have been sustained, and we are very encouraged that the group reported both positive sales growth and improved profitability in 3Q.

Possible downside lies in the health and beauty segment 

  • We think downside risk to our positive tune could come from the health and beauty segment (c.35% of group EBIT in 1H), as management warned that profitability remained “marginally below the prior year”. This was already evident in 1H16 as EBIT slowed 11% yoy on the back of margin erosion in Hong Kong and Malaysia.

Upgrade to Add, with an increased TP of US$8.70 

  • We are positive on the stock’s margin recovery initiatives and keep our EPS forecasts only because we take a cautious view given the macro uncertainty. Notwithstanding that, we believe DFI has turned the corner and the worst is over. 
  • We roll our valuation forward to CY18F, which lifts our TP to US$8.70 (based on 23.7x CY18F P/E, -0.5 s.d. level). The stock also offers a 3% yield. 
  • Upgrade to Add. We believe earnings delivery will further re-rate the stock.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2016-11-10
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