Dairy Farm International - CIMB Research 2016-12-05: Margin recovery to drive stock recovery

Dairy Farm Int'l - CIMB Research 2016-12-05: Margin recovery to drive stock recovery DAIRY FARM INT'L HOLDINGS LTD D01.SI

Dairy Farm Int'l - Margin recovery to drive stock recovery

  • DFI’s investment thesis is one of recovering margins as the group began closing underperforming stores in 2015. We think we will start to see the rewards in 2H16.
  • We expect recovery to be led by its food segment, where both sales and margins have improved according to the company’s 3Q interim statement.
  • DFI’s operations in Indonesia have also returned to profitability. Maintain 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 arose as it expanded too aggressively, and demand failed 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 has changed?

  • DFI has since undertaken 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 offerings, 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 sustained, and we are very encouraged that the group reported both positive sales growth and improved profitability in 3Q.

Expecting better Indonesia and Singapore performance

  • By geography, the problem countries previously were Indonesia, Singapore and Malaysia. We think Malaysia is still struggling as its consumer climate remains poor. However, PT Hero reported much better numbers in 9M16 and has returned to profitability (prev. loss-making). 
  • We also expect Singapore to do better and our channel checks show DFI has even cautiously returned to bid for new stores.

Potential headwinds in health and beauty segment

  • We think the 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.

Reiterate Add on improved margins

  • Overall, we are positive on the stock’s margin recovery initiatives. We believe DFI has turned the corner and the worst is over. 
  • Our TP of US$8.70 is based on 23.7x CY18 P/E, its -0.5 s.d. level. Stock offers a 3% yield. Maintain Add.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2016-12-05
CIMB Research SGX Stock Analyst Report ADD Maintain ADD 8.700 Same 8.700