Dairy Farm - DBS Research 2017-08-08: Benefitting From Diverse Segments

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DAIRY FARM INT'L HOLDINGS LTD D01.SI

Dairy Farm - Benefitting From Diverse Segments

• Dairy Farm's 1H17 in line led by improvement in Health & Beauty, Convenience Stores and Home Furnishing segments.
• Interim DPS of 6.5 UScts declared.
• Trim FY17 earnings by 2%.
• Maintain BUY, lower TP to US$9.89.

Maintain BUY, on track for better profitability. 

• We maintain our BUY rating on Dairy Farm (DFI), but lower our SOTP-based TP marginally to US$9.89. 
• DFI continues to deliver earnings growth in 1H17, led by Yonghui and margin improvement in Health and Beauty, Home Furnishing and Convenience Stores segments. We factor in slight softness in Supermarket and Hypermarkets segment for 1H17, and hence lower our earnings forecast by a mere 2%.
• We continue to be positive on further cost efficiencies from enhanced operational processes through distribution centres, procurement and IT systems over the long term. Current share price ex-Yonghui values DFI’s core business at just 19x forward PE, below the regional peer average and its 9-year historical average forward PE of 25x.

WHAT’S NEW

1H17 results, benefitting from diverse segments 1H17 earnings in line: 

• DFI's earnings for 1H17 was US$211m (+6% y-o-y), in line with our projection. Revenue was flat at US$5.5bn (-1% y-o-y) as growth in convenience, health & beauty and home furnishing stores were dragged by lower food revenue in Singapore, Malaysia and Taiwan. 
• While EBIT margin (3.6%) trailed our expectations (4.1%), earnings were made up by better-than-expected JV/Associates contribution from Yonghui and Maxim’s. 

EBIT margin improved 0.1ppt from 1H16. 

• Margin improvements in convenience and health & beauty stores were offset by lower food margins. 
• Overall, this set of results highlighted the benefits of DFI’s diverse segments in retail where the softness in an area is off-set with stronger performance elsewhere.
• An interim DPS of 6.5 UScts has been declared, in line with our estimate.

Dragged by food segment, all other segments performed well. 

• Food segment was affected by difficult trading conditions in Singapore, Malaysia and Taiwan. Revenue was down by 4.6% y-o-y to US$3bn. Operating margins were 0.4ppt lower from 1H16 to 2.4%. 
• Convenience stores sales improved 3.3% y-o-y to US$971m led by higher tourists in HK and Macau, and new stores in China. Closure of nonprofitable stores in Singapore resulted in higher operating margins of 3.5% (+0.6ppt from 1H16). 
• Health & Beauty segment also saw higher operating margins of 7.2% (+0.5ppt from 1H16) on operational improvements in the Philippines and profit growth in Hong Kong, Macau and Indonesia. Sales grew +3% y-o-y to US$1.2bn driven by China, Hong Kong, Macau and Indonesia. 
• IKEA continued to record strong sales growth in Taiwan and Indonesia (+7.6% y-o-y to US$304bn). Operating margins remained flat at 11%.

JV/Associates driven by Yonghui. 

• JV/Associates grew 31.8% to US$61.3m led by Yonghui’s 57% profit growth on higher store count and margin improvement from effective merchandising.

Mixed results. 

• This set of results is a mixed bag, but weakness in one area more than offset by another due to diversification. Decline in food segment was compensated by revenue and operating margin growth in the other segments as well as in JV and associates. 
• We were expecting to see overall operating margin expansion and saw this in all other segments delivered except the food business. The drag in the food business resulted in a slight overall operating margin expansion of only +0.1ppt to 3.6%.

Margin expansion to continue. 

• Margin expansion story should continue as the following initiatives are put in place. Margin drivers:
  1. IT systems will enhance merchandising, supply chain etc processes;
  2. establishing DCs in ASEAN (MY and PH opens this year after fresh DC in SG was opened last year); 
  3. private label strategy;
  4. direct sourcing (particularly fresh from Yonghui). 
• The question is how fast the margin recovery is going to come as these are being implemented.

Maintain BUY, TP lowered to US$9.89. 

• We trim our FY17F earnings by 2%. This is to account for the slightly lower core revenue and margins recorded in 1H17. 
• On an ex-Yonghui basis, DFI’s core business currently trades at 19x FY17F PE, below peer average of 24x and 9-year historical average of 25x. 
• Our target price of US$9.89 is based on sum-of-parts valuation methodology comprising 
  • core business at US$8.94 using DCF, 
  • 20% stake in Yonghui at market value of US$1.42 and 
  • net debt of US$0.47 per share.

Where we differ. 

• Market believes margin concerns are over and that risks of online and higher rents have been factored into consensus. While we believe earnings will be led by margin expansion, we expect it to be at a more moderate pace, as margin improvement initiatives will take time to pay off.

Potential catalyst. We see earnings turnaround as a stock catalyst.

• DFI has appointed Ian Mcleod as its new CEO who will assume the role on 18 September. He is known to have turned around Coles in Australia from 2007 to 2014, and has worked for Westfarmers Group in Australia, ASDA in the UK, and Southeastern Grocers in the US.

Key Risks to Our View

• Significant earnings disappointment. We expect earnings growth to accelerate into FY18F as management brings in better operating efficiencies. We believe that earnings would have to disappoint significantly to derail our positive bias on the stock. 
• Nonetheless, our earnings forecast is conservative.

Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2017-08-08

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 9.89 Down 9.960