Delfi Ltd - DBS Research 2019-10-30: In For A Sweet Treat

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DELFI LIMITED (SGX:P34)

Delfi Ltd - In For A Sweet Treat

• Reinstating coverage with a BUY recommendation and Target Price of S$1.49 offering 49% upside.
• Delfi's Share Price does not fully reflect a recovery in earnings growth momentum.
• Premiumisation strategy to capitalise on consumer trends in Indonesia; Van Houten to aid in regionalisation strategy.
• Excellent distribution model with a moat.

Delfi Company Background

Company History

• DELFI LIMITED (SGX:P34) (formally known as Petra Foods Limited), was established in 1984 by the group’s Chief Executive Officer, Mr. John Chuang, through a series of restructurings and acquisitions, which included PT Perusahaan Industri Ceres (established in 1950) and PT General Food Industries (established in 1969).
• The group was listed on the Main Board of the Singapore Exchange (SGX) on 5 November 2004 at an offering price of S$0.88.

Business operations and operating geography

• Delfi manufactures and distributes chocolate confectionary products ranging from chocolate bars to dragees in Indonesia and its regional markets. It is the market leader for chocolate confectionary products in Indonesia, and Euromonitor estimates its market share in 2018 to be c.44%. While the group began its international expansion drive in 1988, Indonesia continues to be its main market, accounting for 71.6% of its revenue in FY18.
• Delfi classifies its business segments into Own Brands and Agency Brands (third-party brands).
• Delfi manufactures and distributes its Own Brands mainly in Indonesia and the Philippines. It also manufactures and/or distributes more than 40 third-party brands in Indonesia and its regional markets. The distribution channels it uses are the Modern Trade (wholesalers, minimarts, convenience stores) and Traditional Trade (mom-and-pop stores and smaller retailers) channels.
• Its own brands are better received in its home market, accounting for 82.9% of sales from Own Brands in FY18, while its third party brands are almost equally well-received in its home-market and regional market (50.3%/49.7% contribution to Agency Brands revenue in FY18 respectively).
• Examples of Delfi’s own brands include Van Houten, SilverQueen, Ceres, Delfi, Selamat and Goya, and some third party brands it distributes are Fisherman’s Friend, Toblerone, and Tabasco.

Management & Strategy.

• See attached PDF report for details.

Re-instating coverage with BUY and Target Price S$1.49 for 49% upside.

• We re-instate coverage on Delfi with BUY and Target Price of S$1.49. After its efforts to rationalise its product offerings and distribution channel, we believe Delfi’s earnings has reversed to a growth trajectory from FY18 and should accelerate in FY19F/ 20F. In our view, there still seems to be a gap in terms of Delfi's Share Price and valuation, thus offering upside to investors.
• Delfi's Share Price is currently trading at 15.9x FY20F PE, which is c.1.9 S.D. below its 2-year average PE.
• We expect earnings growth to step up to 9%/ 13% in FY19F/20F. Our expectations are premised on its premiumisation strategy, strong distribution channel and regionalisation strategy leveraged on the Van Houten brand.

Leveraging on Van Houten’s brand to grow regionally

Van Houten to lead regional growth strategy.

• Delfi was previously manufacturing and distributing Van Houten chocolates solely in Indonesia. However, on 13 April 2018, Delfi acquired the perpetual and exclusive license to the Van Houten brand name for chocolate and cocoa products in Asia and Oceania (including Australia and New Zealand) for US$13.0m (which is slightly less than c.1x Price/Sales) at the consumer/ retail level.
• Since the acquisition, Delfi began manufacturing and distributing Van Houten products in its regional markets. As a result, sales in its regional markets increased by 9.9% in FY18 and 9.5% in 1H19. We believe its post-acquisition strategy to ramp up Van Houten sales will drive growth going forward, leveraging on the higher disposable income (GDP per capita) of consumers in Singapore and Malaysia, and its distribution network in the Philippines.

Expect higher margins from Van Houten.

• Delfi begun distributing Van Houten chocolates in Indonesia in 1987, and we estimate that Delfi could have been paying royalties of c.7.0% to Hershey. We believe absence of royalty payments will enhance margins further. We believe Delfi now has a greater incentive to promote the Van Houten brand in Indonesia due to its higher margin, and this would help support the Group’s overall margins.

Possible revitalisation of the Van Houten brand; taking a leaf from Knick Knacks and Goya experience.

• After acquiring Knick Knacks and Goya from Nestle in 2006, Delfi re-energised both the Knick Knacks and Goya brands in 2007, increasing their brand awareness. As a result, Goya achieved double digit sales growth and revenue from the Philippines increased by 24.4% to US$40.0m in FY08. We believe that Delfi could adopt a similar strategy for Van Houten to boost its brand awareness among consumers.

Premiumisation supported by millennials

Margin and ASP to increase driven by product rationalisation.

• In 2015, Delfi started on an initiative to increase its sales and profitability through premiumisation. Firstly, it eliminated underperforming SKUs – by c.40% of its total SKU count. Secondly, it focused on growing sales of its own premium brands such as SilverQueen and Delfi by introducing new products (SilverQueen Green Tea, Delfi Take-It Big, etc.) in the premium category. Lastly, it reorganised its distribution model and began distributing to some of its modern trade customers (convenience stores, supermarkets and hypermarkets) directly to ensure high product availability at any time.
• These efforts have lifted ASPs, top-line growth and gross profit margins via higher sales of its premium products. As a result, while revenue in constant currency declined sharply by 9.9% in FY15, it was generally flat in FY16 and FY17, and increased by 16.0% in FY18. Gross profit margins also rose from 29.8% in FY15 to 34.6% in FY18. We believe that continued premiumisation will lead to higher ASPs, top-line growth, and gross profit margins.

Millennials have strong lifestyle consumption habits including spending on chocolates.

• According to World Bank, the consumption of chocolate confectionery in Indonesia increased from IDR 10,543bn to IDR 13,127bn (CAGR of 4.5%) from 2013 to 2018. The increase was largely driven by an increase in the middle-class population, which mostly consisted of millennials, who are equipped with higher spending power, a consumption habit with an emphasis on lifestyle and experience, and relates closely with branding. We believe Delfi’s premiumisation strategy would benefit from this trend given Indonesia’s demographic mix and economic growth.

Excellent distribution model to capture Indonesia’s growth

One of only three key players with exposure to the larger rural mass market segment in Indonesia.

• Rural areas are characterised by less developed infrastructure, low population density and seclusion, making it difficult for foreign brands to tap into the general/traditional trade channels. Delfi, Mayora, and Garudafood are the three key players in the chocolate confectionery space to have access to this market. However, among its competitors, Delfi has the largest market share (c.45.0% according to Euromonitor) in chocolate confectionery in Indonesia in 2019.
• Furthermore, Delfi has excellent reach to the general trade channels (mom-and-pop/warung stores) through its inhouse as well as wide network of distributors. This allows the group to gain access to Indonesia’s mass market segment which accounted for c.65.4% of nationwide packaged food sales in 2018.

Competitive advantage in general trade.

• Its distributors in the traditional channel in Indonesia are largely exclusive to Delfi. These relationships have been established for more than 50 years and consists mostly of family concerns across two or more generations. As such, there is a moat around Delfi’s distribution model in the traditional channel in Indonesia which will allow Delfi to continue capitalising on the growth.

Strong exposure to the faster growing modern trade channels.

• Urbanisation by the Indonesian government has led to the mushrooming of modern trade channel stores across the country. From 2008 to 2018, packaged food sales in modern grocery retailers grew at a CAGR of 14.6%, from IDR 33.7trn to IDR 131.2trn, according to Euromonitor. During this same period, the traditional grocery retailers grew at a slower CAGR of 9.7% from IDR 103.3trn to IDR 260.3trn.
• More recently, the growth in the modern trade channels has slowed due to the backlash the government faced from the locals. As such, we expect sales through traditional channels to continue to remain dominant in the near term, playing to one of Delfi’s strengths. At the same time, as the retail landscape becomes more urbanised in the longer term, Delfi’s complete access to the modern trade channels will allow it to capitalise on the trend.

Potential takeover target – Niche Focus with a Strong Local Brand Association in Indonesia

Delfi could be a potential takeover target.

• The group previously spun-off its upstream cocoa processing business in 2013 when the division was sold to Barry Callebaut AG for US$950m. Delfi now operates a strong branded consumer business in Indonesia, commanding c.44% of the chocolate confectionery market in Indonesia, according to estimates by Euromonitor. It has first-mover advantage and considerable reach into suburban and rural areas which global players have difficulty gaining access to. We believe its strong brands and network could be attractive to strategic investors who are keen to dominate the chocolate confectionery space in Indonesia.

Visibility on raw material prices

Raw material prices hedged up to 18 months in advance.

• Delfi enters into forward contracts with its raw material suppliers, locking in forward costs up to 18 months in advance. This provides the group with adequate time to react and manage costs, ensuring visibility and predictability in margins.

Resistant to short-term fluctuations in cocoa prices.

• Through its forward contracts with its suppliers, Delfi locks in an agreed price for up to 18 months, allowing Delfi to have visibility and stability against short-term raw material price fluctuations, especially as near-term cocoa prices have been volatile on the back of the implementation of a floor price of US$2,600 per ton for cocoa by the Ivory Coast and Ghana governments. Both countries account for more than 60% of the global cocoa supply. It is unclear if both markets can deliver consistently at this price, but we believe this will lead to short term volatility in cocoa prices which Delfi is protected through hedging.

Valuation & Peers Comparison

FY20F forward PE of 23.7x implies a target price of S$1.49, representing an upside of 49%.

• We derived the forward PE multiple based on Delfi’s 2-year historical average forward PE. Delfi is currently trading at 15.9x FY20F PE, which is 1.93 standard deviation (S.D.) below its 2-year average PE multiple.

Conservative estimate.

• We used a more-conservative 2-year average forward PE as this is below its FY20F peer average forward PE of 24.8x. Therefore, Delfi looks attractive relative to its peers and its historical valuation.
• (See Delfi's Share Price; Delfi Target Price; Delfi Dividend History)

Catalysts: Van Houten and Indonesia.

• We believe that potential catalysts could be high regional sales growth led by the sale of Van Houten products and growth in Indonesia from its premiumisation strategy. The acceleration in earnings growth could lead to the resumption of relationship between Delfi's Share Price and its trailing-twelve-month (TTM) earnings.

See attached 25-page PDF report for complete analysis.

Alfie YEO DBS Group Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2019-10-30

SGX Stock Analyst Report BUY INITIATE BUY 1.49 SAME 1.49