Delfi Ltd - DBS Research 2017-12-19: Position For A Better Year Ahead

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DELFI LIMITED P34.SI

Delfi Ltd - Position For A Better Year Ahead

• Upgrade to BUY; accumulate on hopes of a better 2018
• Project 20% profit growth in FY18F on better sentiment, post product rationalisation.
• Share price at 6-year low and already priced in weak operating environment.
• Despite call upgrade, we cut our TP to S$1.80.

Thesis: Turning the corner; upgrade to BUY. 

• Delfi’s share price is at 6-year low and has slumped by 36% YTD on the back of its disappointing performance. This was due to softer sentiment in Indonesia and product-rationalisation initiatives. 
• Looking ahead, we believe its share price could have priced in the current subdued situation and should improve as we move into FY18F.
• This is on the back of:
  1. low-base effect, coupled with expected improvement in sentiment in 2018;
  2. nearing end of production rationalisation efforts; and
  3. lower raw material costs.

Where we differ: 

Worth a re-look and accumulate despite current weak performance. 

• Despite Delfi’s current weak operating performance, we believe the counter is worth a relook.
• While the upcoming 4Q17 results, expected to be released in Feb 2018, may not register a significant turnaround, we believe it should show a bottoming-out trend at worst.

Potential catalyst: 

• Better-than-expected operating performance could set the stage for a meaningful share price recovery after a couple of years of dismal performance. 
• We now project earnings growth of 20% each year in FY18F/19F, marking a reverse from our previous forecast of profit contraction. Further upward revision could re-rate share price.

Valuation

• Our TP drops to S$1.80 as we slash our forecasts by 32%/ 30%, coupled with rolling over our PE valuations to FY18F/19F, but still based on 26x PE, in line with regional peers.

Key Risks to Our View

Slower-than-expected earnings recovery. 

• Our thesis is premised on expectations of better prospects in 2018. A slower-than-expected earnings recovery arising from higher raw material costs, a weaker rupiah, investment costs, or continued erosion in share price could render our thesis void.

WHAT’S NEW - Position for a better year ahead 

Upgrade to BUY, share price at 6-year low: 

• Despite a dismal operating performance in 3Q17 and YTD, we believe 2018 should turn out to be a better year ahead for Delfi. As we move into the finishing months of 2017, we advocate accumulating the counter and are upgrading it to BUY, with a revised TP of S$1.80.
• Its share price has dipped by 36% YTD on the back of dismal operating performance due to softer-than-expected sentiment and the company’s product-rationalisation efforts.
• Whilst we slash our forecasts by 30%-32% for FY17F/18F, we believe operating performance should have bottomed and looks to be on the recovery path.
• We recognise that operating performance may not show a rapid improvement in the closing quarters of 2017, but its share price is at a 6.5-year low and with the underperformance this year, we believe it could be time to accumulate.

What caused the dismal performance in share price this year? 

• In general, its operating performance has been weak as seen from 1Q17 to 3Q17 results. The weak performance was due to
  1. weak consumer environment in Indonesia; and
  2. impact of the group’s ongoing production-rationalisation exercise to remove underperforming SKUs (stock keeping units). 
  Thus, sales slid by 5% y-o-y in for 9M17, while net profit came in at US$18.2m, down by 19% y-o-y. 
• In fact, if not for a recognition of US$4.6m gain on the back of the divestment of 50% stake in PT Ceres Meiji Indotama Indonesia recognised in 2Q17, 9M17 headline net profit would have been worse. 
• Also, 1H17 also saw a lower interim dividend of 1.22 UScts, down from 1.36 UScts in 1H16, due lower profits.

SKU rationalisation almost done; continued product development.

• Delfi’s share price has declined by c.32% YTD, arising from a weaker-than-expected operating performance. 
• Going forward, management has indicated that its strategy to rationalise its SKUs is almost done and is ready to continue its trend to launch new products. That said, it will also be cognisant of changing customer preferences and look towards relaunching new products, although not at the rate of 25-30 products a year seen prior to 2014.

Looking forward - improvement in sentiment in 2018.

• Consumer F&B companies in Indonesia had a relatively disappointing 2017 YTD, which possibly was due to various factors such as a prolonged weak commodity price environment, higher electricity tariff for households, lower minimum wage increase, tax reform and slow government spending. 
• Looking ahead, our Indonesia consumer team expects a stronger dose of fiscal stimulus that can lead to more efforts in supporting consumers’ purchasing power ahead of Indonesia’s presidential election (PE) in 2019. As such, this could bode well for companies like Delfi which derives a majority of its revenue from Indonesia.

Softer raw material costs could boost margins. 

• In 2016, consumer companies, particularly F&B, has benefited from margin expansion, particularly due to the benign raw material environment seen back in 2015. There tends to be a lagged effect for raw material price movements. 
• Looking into 2018, we expect a repeat of the events in 2016 due again to the generally subdued prices. As can be seen, the prices of several soft commodities have decreased YTD (as of time of writing, such as sugar (-26%), cocoa (-12%) and palm oil (-18%). Notwithstanding the above, we remain cognisant that packaging materials prices could chip some shine off the benefits of soft commodities prices. 
• Overall, we believe the net impact should still be positive for companies like Delfi.

Upgrade to BUY; TP: S$1.80 

Look towards 2018. 

• We revise our forecasts down by 30- 32% to align with the YTD performance and now expect FY17F EPS to register a contraction of -17% on the back of lower sales, coupled with higher operating expenses. That said, we believe the weak performance for 2017 should soon be a thing of the past and investors should look towards the performance in FY18F. 
• We are projecting earnings to reverse and post growth of 20% each year in FY18F and FY19F.

Worth a re-look. Share price at 6-year low, TP: S$1.80.

• Having said all that, we believe Delfi is worth a re-look and accumulating given its share price is at 6-year low, retreating by 36% YTD. Delfi also has a strong distribution network within Indonesia, and is still the market leading in chocolate confectionery despite recent weak operating figures. 
• We upgrade our recommendation to BUY, from HOLD, with a revised TP of S$1.80 that implies 26% potential upside.

Risks: Illiquidity in shares; turnaround in operations. 

• Our positive thesis is on expectations that we are past the worst for Delfi, and 4Q17 should show a bottoming-out trend and 2018 will turn out better. In the event that this fails to materialise, its share price could continue to de-rate. 
• Its shares are relatively illiquid and hence there are days in which there could be unexplained significant movements.

Andy Sim CFA DBS Vickers | Alfie YEO DBS Vickers | http://www.dbsvickers.com/ 2017-12-19

DBS Vickers SGX Stock Analyst Report BUY Upgrade HOLD 1.80 Down 2.260