Dairy Farm Int'l - CGS-CIMB Research 2018-05-30: On The Mend, Just Awaiting SEA Business Uplift

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DAIRY FARM INT'L HOLDINGS LTD SGX: D01

Dairy Farm Int'l - On The Mend, Just Awaiting SEA Business Uplift

• Our view of Dairy Farm International (DFI)’s 1Q18 interim management statement is that its earnings are on the mend. DFI stated that 1Q18 sales and underlying earnings registered y-o-y growth. 
• The strong 1Q18 earnings performance of the Health and beauty (H&B) division, Maxims and Yonghui offset continuing weakness in the food division. 
• We think SEA revenue will improve in 2H18F, aided by the zerorisation of GST in Malaysia. We project H&B, Maxims and Yonghui to post steady net profit y-o-y in 1H18. Hence, we upgrade DFI from Hold to ADD. 
• We raise our target price to US$9.55 on the back of higher FY18-20F EPS estimates and increase in target FY19F P/E multiple. 

Positive read-through of management’s 1Q18 statement

• Dairy Farm International (DFI) mentioned positive y-o-y sales growth across each segment in 1Q18. Despite lower net profits from its food division and flattish earnings from the home furnishing (HF) segment, the group reported higher underlying net profit y-o-y in 1Q18. 
• We view this as primarily due to the strong earnings performance of its JV associates Maxims and Yonghui.

A tough FY17

• To recap, in FY17, DFI saw sales increase by a mere c.1% but normalised EBIT (excluding one-off business change costs of US$73m) shrank 2.6% largely due to weaker 2H17 South East Asia (SEA) supermarket/hypermarket earnings. 
• During DFI’s FY17 analyst briefing, new CEO Ian McLeod stated that DFI would inject new managerial blood and continue to review operations to revitalise its SEA earnings performance.

Health and beauty division leads y-o-y sales & EBIT growth in 1Q18Q

• Dairy Farm International highlighted the strong tourist arrival numbers in Hong Kong and Macau in 1Q18, which resulted in the exceptional sales and EBIT performance of the H&B segment during the quarter. 
• We forecast 1H18F sales/EBIT growth of 4.0%/15.4% for the H&B segment, which may appear conservative in light of the likely continued high tourist arrivals in Hong Kong and Macau in 2Q18.

Maxims and Yonghui are the icing on the cake

• Dairy Farm International noted strong earnings contribution from Maxims and Yonghui in 1Q18. We believe Maxims’ earnings were catalysed by the Starbucks and Genki Sushi franchises in Singapore and Malaysia (acquired in Sep 2017). 
• Yonghui’s 1Q18 net profit (according to Bloomberg) increased by c.2% y-o-y. Our previous forecast for 1H18F associate contribution was an increase of 12.7% y-o-y; but we think this is too conservative.

Earnings on the mend, hence our higher FY18-20F EPS forecasts

• We believe the H&B division, Maxims and Yonghui will drive DFI’s FY18F net profit. Improved consumer sentiment in Malaysia in 2H18F from zero-rated Goods and Services Tax (GST) on 1 Jun onwards could aid the improvement of DFI’s SEA food earnings. 
• We lift our FY18-20F EPS forecasts by 0.5-4.7% for higher H&B, Maxims and Yonghui earnings contribution.

Upgrade to ADD with higher Target Price of US$9.55

• We are heartened by accelerating momentum of DFI’s underlying net profit. Hence, we turn more positive on DFI. 
• We upgrade the stock from Hold to Add, with a higher target price of US$9.55, based on 23.5x FY19F P/E (-0.5 s.d. below historical 5-year average of 26.3x) vs. 21x previously (-1 s.d. below historical average). 
• Potential catalysts are swifter turnaround in SEA earnings growth and EBIT margin expansion. 
• Downside risks are slow recovery in SEA earnings and contraction of profit margins.

Summary of 1Q18 interim management statement 

Food division.

• Dairy Farm International (DFI) guided for positive y-o-y sales growth for this segment in 1Q18, but lower operating profit due to reduced margins across the supermarket/hypermarket businesses, especially in SEA. We note that PT Hero (Not Rated) also reported net losses in 1Q18. The weaker 1Q18 SEA performance is unsurprising, as we previously mentioned that it may take time for initiatives kick-started by DFI’s new CEO Ian McLeod to produce results. The company has embarked on the following strategic measures for SEA, including:
  1. proposed swap of its 100% stake in Rustan for an 18.25% stake in Robinsons Retail Holdings Inc (RRHI PH, Add, TP: Php121). DFI expects the swap to be completed by Sep 2018; and
  2. refreshing its supermarket format in Singapore. In May 2018, DFI reopened its Fusionopolis outlet with new features to attract customers, i.e. new facilities (microwaves and seating area) to consume ready-to-eat meals, a wine-tasting bar and lunch/gathering rooms that are available for rent.
• We previously forecasted the food segment’s 1H18F sales to rise 1.5% y-o-y and 1H18F EBIT to rise 1.4% y-o-y, which appear too bullish judging from management’s statement of lower profits in 1Q18. However, as 2H18F could see improved consumer sentiment aided by the zerorisation of GST in Malaysia, we maintain our forecasts for now.

Health and beauty (H&B).

• Management guided that this division posted stellar 1Q18 revenue growth, driven by the exceptionally-strong earnings performance of Hong Kong and Macau due to strong tourist arrivals. There was no mention of earnings weakness in Malaysia and Indonesia, which were difficult markets in FY16.
• Dairy Farm International mentioned that its Singapore H&B segment posted weak sales growth y-o-y in 1Q18. We think this was because it was hampered by:
  1. discount retailers (Singapore saw a wave of discount and variety stores entering the H&B space in FY17),
  2. stiff competition from strong rivals like Sephora (Unlisted) and Watson [owned by A.S. Watson Group (HK) Ltd, a subsidiary of Hutchison Whampoa Ltd (Unlisted)]; and
  3. rising e-commerce.
• We forecast the H&B division to post 1H18F sales/EBIT growth of 4.0%/8.0% y-o-y, which appear marginally conservative given that the segment registered sales/EBIT growth of 10.2%/8.9% y-o-y in 2H17F when H&B earnings were positive for North Asia.

Home and furnishing (H&F).

• Management mentioned that despite higher sales from new stores opening in Hong Kong, EBIT for this division was flat y-o-y in 1Q18 due to higher operating expenditure during the quarter. 
• We forecast flat 1H18F sales y-o-y and EBIT increase of 9.1% y-o-y in 1H18F. This appears bullish in light of DFI’s 1Q18 management statement that EBIT was flat. However, we maintain our H&F sales and EBIT forecasts for now pending 1H18 results, and in hope that profits will kick start in 2Q18.

Maxims (restaurants) and Yonghui.

• Dairy Farm International (DFI) mentioned strong 1Q18 sales and EBIT contribution from Maxims and Yonghui, ahead of the 1Q17 results. 
• We believe Maxim’s 1Q18 net profit was boosted by the Starbucks and Genki Sushi franchises in Singapore and Malaysia (acquired in Sep 2017). We have forecasted 1H18F associate contribution growth of 12.7% y-o-y for DFI, which may be slightly conservative given that historically, the lowest y-o-y growth in DFI’s associates contribution was c.14.6% y-o-y in 2H17 (and this did not include contribution from the new stores).

Valuation & Recommendation

• Overall, we believe that Dairy Farm International’s 1H18 sales would be in line with our forecast, but EBIT may outperform our previous forecast marginally on the back of the H&B segment’s strong 1Q18 earnings. Hence, we lift our FY18-20F EPS forecasts by 0.5-4.7% for higher H&B and JV and associate contributions.
• We are heartened by accelerating momentum of DFI’s underlying net profit. Hence, we turn more positive on DFI. 
• We upgrade the stock from Hold to ADD, with a higher target price of US$9.55, now based on 23.5x FY19F P/E (-0.5 s.d. below historical 5-year average of 26.3x) vs. 21x previously (-1 s.d. below historical average). Stock is currently trading at 22.0x CY19F closer to levels when earnings were seeing flattish growth versus the 11% expected in FY19F, and below peers at (22.8x).
• Within the Singapore retail space, we believe Dairy Farm International’s convenience stores may face some pressure from supermarket rivals, while its health and beauty segment (Guardian) sees some competition from discount retailers and e- commerce. However, we believe these risks are aptly priced into our target price of US$9.55, based on 23.5x FY19F P/E (-0.5 s.d. below historical 5-year average of 26.3x).

Cezzane SEE CGS-CIMB Research | LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2018-05-30

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