Delfi Ltd - DBS Research 2018-05-08: Turning Around As Envisaged

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DELFI LIMITED SGX: P34

Delfi Ltd -  turning Around As Envisaged 

• Delfi's 1Q18 net profit jumped 33%; turnaround as earlier envisaged. 
• Gross margins improved to 34.5% on higher premium products, helping mitigate higher selling expenses. 
• Acquisition of Van Houten brand rights to strengthen brand portfolio. 
• Expect improvement to continue; maintain BUY, Target Price: S$1.80. 

Turnaround playing out as anticipated; maintain BUY.

• Despite signs of turnaround in place, Delfi’s share price remains around its 6-year low on the back of its disappointing performance since late 2016. 
• We believe this has passed and looking ahead, we should continue to see sequential improvement as we move into FY18F and FY19F. This is on the back of:
  1. low-base effect, coupled with expected improvement in sentiment in 2018;
  2. end of production rationalisation efforts; and
  3. lower raw material costs. 

Where we differ: Worth accumulating.

• We believe Delfi’s operating performance will continue to improve, and the counter is worth a relook. We are already witnessing improvement in its 1Q18 performance, as per our earlier thesis. 
• Our forecasts are c.6-13% above consensus. 

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 25%/20% in FY18F/19F, marking a reverse from profit contraction in FY17. 
• Further upward revisions could re-rate its share price. 

Valuation: 

• Our Target Price is maintained at S$1.80 based on 26x PE average of FY18F/19F forecasts, in line with regional peers. 
• Upside to our Target Price could come from better-than-expected operational results. 

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 Delfi's share price could render our thesis void. 

WHAT’S NEW - Affirmation of turnaround in place

1Q18 results off to a good start; within expectations and affirming our call for turnaround.

• Delfi’s 1Q18 results were within expectations with net profit posting a 33% jump on the back of 15% y-o-y growth in revenue to US$107.3m. This affirms our earlier thesis as indicated in our report on 18 December 2017 (Delfi Ltd: Position for a better year ahead) that operating performance should be turning its corner and 2018 is likely to see a better showing. 
• We retain our BUY recommendation and Target Price of S$1.80. 
• Upside to our Target Price could come from better-than-expected operating performance. 

Sales improvement of 15%.

• 1Q18 saw an improvement in sales revenue to US$107.3m, which is 15.1% y-o-y growth from 1Q17. This was driven by
  1. sales deferred from 4Q17;
  2. benefits of direct shipment initiative to customer;
  3. deliveries in the run-up to Lebaran festivities.
• The top-line growth is within our expectations and our earlier thesis that we should continue to see sequential y-o-y improvements in the quarters ahead. Stripping out the effects of delayed shipments from 4Q17, we estimate top-line growth to still be c.7%. 

Gross margins improved to 34.5%.

• Gross margins registered improvements to reach 34.5% from 33.1%, which was attributed to sales of higher-margin products, coupled with its cost-containment initiatives. 

EBIT margins ticked up despite higher selling & distribution expenses.

• On the back of higher gross margins, EBIT margins also ticked up to 11%, albeit at a slower pace (vs gross margins), from 10% a year ago. 
• Selling and distribution expenses increased by 21% y-o-y to US$21.4m, equating to 19.9% of sales, vs 19% a year ago. This, we believe, can be attributed to the group’s continued focus to invest in strengthening its route-to-market initiatives and develop its distribution network. 

Van Houten brand perpetual rights acquired in April.

• Delfi announced earlier in April that it had acquired the perpetual brand licence of the Van Houten brand from Hershey’s for a total consideration of US$13m. This will provide Delfi the control of the rights to the Van Houten brand name in key Asia markets, save for India, Korea and the territory of the Middle East. 
• Management believes that the acquisition will provide Delfi with an opportunity to strengthen its brand portfolio as well as for growth outside its regional markets. It will also focus on developing and revitalising the Van Houten brand into a premium brand. 

Valuation & Forecasts 

Maintain BUY, Target Price unchanged at S$1.80.

• We maintain our BUY recommendation and Target Price at S$1.80 as we believe financials for the company have bottomed out and turned the corner. 
• The SKU rationalisation efforts have been completed and the group should continue to benefit from an expected recovery in consumer sentiment, particularly in Indonesia. Delfi's share price continues to hover at levels not seen since 2011 (save for a brief period in late 2017). 

Risks: Illiquidity in shares; continued turnaround in operations.

• Our positive thesis is on expectations that we were past the worst for Delfi in 2017, and 2018 will turn out better. So far, as can be seen from 1Q18 results, it is panning out nicely. However, in the event that this fails to materialise arising from a variety of factors, such as a slump in sentiment, rapid weakening of rupiah, among others, its share price could de-rate. 
• Its shares are relatively illiquid and hence there could be days with unexplained significant movements. 

Andy SIM CFA DBS Vickers | Alfie YEO DBS Vickers | https://www.dbsvickers.com/ 2018-05-08

SGX Stock Analyst Report BUY Maintain BUY 1.800 Same 1.800