Dairy Farm - DBS Research 2018-03-28: Positive On Rustan Spin-off

Dairy Farm - DBS Vickers 2018-03-28: Positive On Rustan Spin-off DAIRY FARM INT'L HOLDINGS LTD D01.SI

Dairy Farm - Positive On Rustan Spin-off

  • Positive on Dairy Farm International (DFI)’s spin-off of Rustan Supercenter Inc. to Robinson Retail Holdings Inc. (RRHI).
  • Earnings raised by marginal 2-3% to account for stake in RRHI.
  • We assess value of RRHI deal to be worth an additional c.US$0.23 to our Target Price net of debt financing.
  • Maintain BUY; Target Price raised to US$9.77.

Reiterate BUY, more positive on partnership deal with RRHI. 

  • We turn more positive on DFI’s recent deal with Robinson’s Retail Holdings Inc. (RRHI) to spin off Rustan Supercenter Inc. for an 18% stake in RRHI. We assess that the deal will add US$0.23 to our Target Price, raising it to US$9.77. We see the 18% stake in RRHI translating into an immediate net value for DFI as Rustan is still loss making, and hence swapping a loss-making business into shares of RRHI would present upside to both earnings and Target Price.
  • Current share price ex-Yonghui and RRHI values DFI’s core business at just 16x forward PE, below the regional peers’ average and its 9-year historical average forward PE of 24x.

Where We Differ:

  • We are positive that the new CEO Ian McLeod and his initiatives to improve performances of the stores will pay off over the next few years. Already, more emphasis is being placed on store operations on a more detailed basis from merchandising to display, sourcing, pricing space management, cost management, etc. He also has a track record of turning around Coles in Australia.

Potential catalyst: 

  • We see earnings turnaround going forward as a stock catalyst and swapping Rustan for RRHI shares is part of this process. We believe successful implementation of strategies by new CEO Ian McLeod will be key to earnings recovery.


SOTP valuation methodology. 

  • Our target price of US$9.77 is derived from sum-of-parts valuation methodology. 
  • We value DFI's core business at US$7.72 based on DCF, 20% and 18% stakes in Yonghui and RRHI based on the market values at US$2.28 and US$0.31 respectively; and higher net debt at US$0.54 per share (post financing of its 6.1% stake in RRHI).

Key Risks to Our View

Significant earnings disappointment. 

  • We expect earnings growth to accelerate in 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.

WHAT’S NEW - Rustan spin-off to add US$0.23 net (after financing) to our Target Price 

Dairy Farm sells Rustan Supercenter Inc. for stake in RRHI: 

  • Dairy Farm International (DFI) announced on Friday that it will enter into a partnership deal with Robinson’s Retail Holdings Inc. (RRHI). The deal sees DFI
    1. selling 100%-owned Rustan Supercenter Inc. to RRHI for 12.15% new RRHI shares worth US$346m; and
    2. buying up an additional 6.1% shares in RRHI worth US$174m, both valued at a price of P94 per RRHI share, above the current share price. 
  • DFI’s 6.1% shares are facilitated via sale of shares by Gokongwei, while the 12.15% stake in RRHI (from the sale of Rustan) will be paid to DFI via new shares. 
  • DFI will ultimately own 18.25% (12.15%+6.1%) of RRHI, while the Gokongwei family will ultimately reduce their stake from 65% to 51% after the share sale and new share dilution. RRHI will thereafter take in 100% of Rustan into its operations and DFI will take two board seats in RRHI. DFI will fund the additional 6.1% investment of US$174m via internal cash and bank borrowings. 
  • Rustan Supercenters, Inc. operates Rustan’s Supermarkets, the Shopwise chain of hypermarkets and Wellcome. It has a total of around 60 outlets with presence largely centered around metro Manila.

Positive for DFI: 

  • As Rustan posted a net loss in FY17, there is no earnings valuation in this deal. DFI has essentially converted a loss-making operation in Philippines into a 12.15% stake in RRHI, which we think is positive. 
  • Even though it has bought the additional 6.1% of RRHI above market price at a price of P94 per share, this is well compensated by the US$346m that it will receive for spinning off the loss-making Rustan. Furthermore, there is little or no impact on DFI’s earnings as Rustan’s losses only contributes to less than 1% of group earnings. 
  • We do not see any major issue for DFI to finance the US$174m as the company is capable of generating US$200-300m of operating cashflow net of capex a year, and it already has US$332m cash on its books as of FY17.

Negative for RRHI: 

  • The deal is negative for RRHI’s share price as
    1. shareholders will experience earnings dilution by as much as 15%, and
    2. margins will be reduced when RRHI takes in loss-making Rustan. 
  • We know that Rustan continued to post an EBIT loss in FY17 although we do not know the absolute dollar losses. For comparison, Rustan’s net loss for FY15 was P300m, 5.5% of RRHI’s FY17 earnings forecast and 7% of RRHI’s FY15 net profit. Based on our back of the envelope calculations, the target price could be reduced by c.6-7%. 
  • We believe RRHI sees Rustan as a way to compete over the long term, with immediate improvement in market share, store network and presence especially in Metro Manila where it also competes with SM and PGold.

We expect RRHI's earnings contribution to lift DFI’s FY18-19F earnings by 2-3%: 

  • When DFI bought a 20% of Yonghui Superstores in 2015, it accounted Yonghui’s earnings as JV/associate income. We believe accounting for RRHI’s earnings could be the same and hence we factor in upcoming earnings contribution of RRHI, lifting JV/associate income by 9% in FY18F and 12% in FY19F. This translates into a 2-3% earnings revision for FY18-19F.

RRHI deal adds US$0.23 to our Target Price, raising it to US$9.77; maintain BUY: 

  • We estimate that this exercise could add c.US$0.23 to our DFI Target Price. Taking out a loss-making Rustan from DFI presents little or no change to earnings. But the 18% stake in RRHI will add c.US$0.31 with the difference of c.US$0.08 being cash decline used to pay down the 6.1% stake. Post factoring in the impact of RRHI deal, current share price now values core business at 16x FY18F PE. 
  • Based on SOTP Target Price methodology, we now value DFI at US$9.77, with core business at US$7.72 based on DCF, stake in Yonghui at US$2.28 based on market value, gross stake in RRHI at US$0.31 before financing, and higher net debt of US$0.54 (assuming 100% financing of its 6.1% stake in RRHI).

Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2018-03-28
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 9.77 Up 9.540