Del Monte Pacific (DELM SP) - UOB Kay Hian 2016-12-07: 2QFY17 Recurring Net Profit Up 33% yoy But Expect Near-term Headwinds

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DEL MONTE PACIFIC LIMITED D03.SI

Del Monte Pacific (DELM SP) - 2QFY17 Recurring Net Profit Up 33% yoy But Expect Near-term Headwinds

• Del Monte Pacific reported a strong 33% yoy increase in recurring net profit for 2QFY17. However, we expect near-term headwinds and pricing pressure, which are likely to impact group gross margin in the near term. 
• Our key concern of a slowdown in US sales appears to be materialising as US sales continued to fall as major US retailers grapple with intensifying competition, resulting in further cash flow optimisation. 
• Downgrade to HOLD. Target price: S$0.40. Entry price: S$0.34.

RESULTS

Strong growth in recurring net profit. 

• Del Monte Pacific (Del Monte) recorded 2QFY17 recurring net profit of US$21.0m, up 33% yoy (2QFY16: US$15.8m), driven by stronger sales, cost reduction and higher productivity in the Philippines and the S&W brand’s Asia market. 
• The US continued to be impacted by consumers shifting away from canned fruits, resulting in a 9.3% yoy drop in sales for Del Monte. Major US retailers are optimising their balance sheets in light of intensifying competition and a broader shift towards ecommerce channels.

Asia is still the bright spot. 

• Sales in the Asia Pacific region grew 20.9% yoy, driven by strong sales in the Philippines and the S&W brand. The group saw expanded product penetration and increased consumption of Del Monte products in the Philippines. 
• We estimate Philippine sales accounted for 13% of group sales in 2QFY17.

Minimal one-off expenses. 

• One-off expenses fell drastically from pre-tax gains of US$33.4m in 2QFY16 to a pre-tax loss of US$1.5m in 2QFY17. This was attributable to the closure of the North Carolina plant (US$1.2m) and severance packages (US$0.3m).

Preference share guidance pushed into 2017. 

• Del Monte had previously guided for a launch of the preference share offering in 2016 but due to a regulatory approvals taking a longer-than-expected time, management is now guiding for a preference share offering in early-17. 
• In Nov 16, the Philippine Securities and Exchange Commission (SEC) announced the approval of the framework for the listing and trading of US dollar-denominated securities. It will likely take the SEC a month or so to upgrade the trading platform to facilitate such transactions. 
• We expect strong demand as the target market for US dollar-denominated shares will likely be foreign investors and locals with US dollar deposit accounts. Our channel checks indicate US dollar time deposit rates in the Philippines yield about 1.0-1.3% p.a. The successful issuance of the targeted initial tranche of up to US$250m could provide a re-rating catalyst, given the removal of an overhang resulting from high leverage and the continued delay in the offering.

STOCK IMPACT

Expect near-term headwinds and pricing pressure in the US. 

• Del Monte’s US sales have come under pressure due to: 
  1. weakness in the canned fruit industry, 
  2. continued impact of unsuccessful low-margin USDA bids, 
  3. reduced sales in private labels, and 
  4. lower inventory builds on packaged vegetable and plastic fruit cups among major retailers. 
• Ahead of the major holiday season, retailers usually stock up on inventory in anticipation of higher sales. However, retailers such as Wal-Mart have been more careful this year as the grocery segment which has traditionally been the main growth driver experienced intensifying competition as deep discounters such as Aldi expand. 
• And Del Monte has been very proactive in adjusting to consumer trends. It has started using natural sea salt in its products, and transitioned to BPA-free internal can coatings and non-GMO products. This has translated to higher market share in certain segments amidst a consolidating canned food industry.

EARNINGS REVISION/RISK

• We lower our FY17-19 core net profit forecasts by 4-9%. This is mainly due to: 
  1. a lower sales forecast for the US operations partially offset by stronger sales forecast in the Asia Pacific, and 
  2. lower gross margin assumptions for the group due to near-term headwinds and pricing pressure. 
• We have adjusted our US$/S$ assumption to S$1.40 (S$1.30 previously).
• Key risks include: 
  1. continued delay in issuance of perpetual securities due to poor market conditions or regulatory barriers, and 
  2. further slowdown in US sales.

VALUATION/RECOMMENDATION

• Downgrade to HOLD. 
• Our target price is S$0.40 (previously S$0.41), based on 11.3x FY17 PE, and applying a 40% discount to peers’ average PE of 18.9x.

Nicholas Leow UOB Kay Hian | http://research.uobkayhian.com/ 2016-12-07

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