Dairy Farm - DBS Research 2018-07-27: Take A Pause, For Now 

Dairy Farm - DBS Group Research Research 2018-07-27: Take A Pause, For Now  DAIRY FARM INT'L HOLDINGS LTD SGX:D01

Dairy Farm - Take A Pause, For Now 

  • Dairy Farm's 1H18 earnings below expectations on lower than expected margins and associates contribution. 
  • Interim DPS of 6.5 UScts declared. 
  • Cut FY18F-19F earnings by 5-7%. 
  • Downgrade to HOLD with lower SOTP Target Price of US$9.35. 

Downgrade to HOLD, lower Target Price to US$9.35.

  • We turn neutral on Dairy Farm (DFI) on a slower growth outlook coupled with strong total share price (including dividends) performance (+20%) in the past year. We project earnings growth at a slower pace in FY18F, dragged by lower contribution from associate income especially Yonghui, and higher operating costs.
  • The turnaround of the Supermarket/Hypermarket business now requires more time given current cost challenges as seen in 1H18 numbers, competition, and effort needed to implement infrastructure, product range and competitive pricing strategies going forward. 

Where we differ:

  • We believe Dairy Farm’s outlook will be relatively slower on
    1. higher operating costs;
    2. more time needed to turnaround supermarket/hypermarket business;
    3. lower contribution from Yonghui going forward. 

Potential catalyst:

  • Faster than expected earnings turnaround from Yonghui and Dairy Farm’s core business are catalysts. This will depend on the successful implementation of strategies by new CEO Ian McLeod to deliver sustained earnings recovery. 


SOTP valuation methodology. 

  • Our target price of US$9.35 is derived from sum-of-parts valuation methodology. 
  • We value Dairy Farm’s core business at US$7.43 based on DCF, 20% and 18% stakes in Yonghui and RRHI based on the market values at US$2.13 and US$0.29 respectively; and higher net debt at US$0.50 per share (post financing of its 6.1% stake in RRHI). 

~ SGinvestors.io ~ Where SG investors share

Key Risks to Our View: 

  • Significant near-term earnings improvement. We believe any share price upside will be driven by earnings recovery over the longer term.
    Upside risk on the stock is based on DFI’s ability to turn in more efficient operations going forward that will drive earnings growth. We believe that earnings would have to improve significantly to derail our neutral bias on the stock. 

WHAT’S NEW - 1H18 results

1H18 earnings below on lower operating margins and associate income:

  • Dairy Farm’s 1H18 earnings came in at US$215m (+1.6% y-o-y), below our estimate despite revenue growth of 7.7% y-o-y (US$5,929m). The lower than expected earnings was mainly led by higher operating and net interest costs, as well as lower associate contribution. 
  • SGinvestors.io ~ Where SG investors share
  • Interim DPS of 6.5 UScts was declared, in line with our expectations.

Revenue ahead led by Health & Beauty.

  • Revenue growth at 8% y-o-y was slightly ahead, forming 53% of our full year forecast with sales growing at 6% y-o-y in local currency terms as more stores were added in FY17. 
  • Supermarkets grew 2.4% y-o-y (US$3,072m), Convenience stores expanded 5.9% (US$1,029m) on higher SSSG, Health & Beauty at 20.4% (US$1,480m), attributed to the increase in tourist arrivals from Mainland China, and Home Furnishing at 14.1% (US$347m) due to new outlets in Hong Kong.

Higher than expected operating costs.

  • Gross margin was in line at 30%. However, EBIT (US$218m, +8.7% y-o-y) margin at 3.7% was below estimate.
  • 1H18 saw Supermarkets’ operating profit fall by 53.4% y-o-y to US$33.2m and operating margin falling to 1.1% from 2.4%. There were higher rents and labour costs in Hong Kong while more store openings in South East Asia led to higher operating costs. 
  • Convenience stores operating margin was flat at 3.5% with operating profit growing by 5.8% y-o-y to US$36.4m. 
  • SGinvestors.io ~ Where SG investors share
  • Heath & Beauty’s operating profit grew 73.8% y-o-y to US$154m with operating margin rising to 10.4% from 7.2% on the back of better results from Malaysia, Indonesia and Vietnam. 
  • Home Furnishing’s operating profit rose 1.5% y-o-y to US$34m, with operating margin lower at 9.8% from 11% on higher opex. 
  • Support office costs went up by 44.6% y-o-y to US$40m.

Lower associates contribution on lower Yonghui earnings.

  • Yonghui reported 1H18 earnings of RMB943m, 10.7% y-o-y lower, with 2Q18 net profit falling by 37.5% y-o-y to RMB195m on losses from new format Yun Chuang stores, higher stock award expenses, and lower investment and financial income. This caused associates contribution to be flat at US$61m, below our estimates. 
  • There was also higher net debt at US$670m vs US$599m as of 2H17 due to continual investments that led to higher net interest costs.

Results a mixed bag, less positive outlook:

  • Although revenue was slightly ahead of expectations with EBIT margins and operating profit growing from 1H17, overall earnings still fell short of our expectations. 
  • Yonghui was a key disappointment followed by higher than expected costs in the Supermarket/Hypermarket business across Hong Kong and Singapore. Outlook is now less optimistic, as plans to turnaround the Supermarket/Hypermarket segment requires more time.

Cut earnings by 5-7% for FY18F-19F:

  • Based on 1H18’s current run rate, we are cutting our FY18-19F earnings by 5- 7%. We have raised our revenue estimates on higher store count, but have also lowered EBIT forecast by 1-3% on higher costs. 
  • Associates income is reduced by 10% due to decline in Yonghui’s 1H18 earnings.

Downgrade to HOLD with lower SOTP based Target Price of US$9.35.

  • In line with our earnings revision, our Target Price is now reduced to US$9.35, with core business based on DCF at US$7.43, net debt at US$0.50, 20% stake Yonghui at US$2.13 and 18% stake in RRHI at US$0.29. 
  • Dairy Farm’s share price has done well and is up by c.20%, including dividends, outperforming the overall market. We advocate a breather at this juncture and reassess should growth is projected to be stronger than our current thesis and/or additional catalysts.

Alfie YEO DBS Group Research Research | Andy SIM CFA DBS Research | https://www.dbsvickers.com/ 2018-07-27
SGX Stock Analyst Report HOLD Downgrade BUY 9.35 Down 9.770