SINGAPORE (July 27): DBS is downgrading its recommendation on Dairy Farm International (DFI), a member of the Jardine Matheson Group, to “hold” from “buy” previously with a lower target price of US$9.35 ($12.73).

In a Friday report, analyst Alfie Yeo says, “We turn neutral on 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.”

This came on the back of the group announcing yesterday that its 1H18 earnings have increased by 6% to US$225 million ($306.2 million), compared to its 1H17 restated earnings of US$212 million, on higher consolidated sales.

The group also declared an unchanged interim dividend of 6.5 US cents.

Combined total sales for 1H18, including 100% of associates and joint ventures (JVs), was US$12.2 billion, a 17% increase from US$10.4 billion a year ago, mainly due to strong growth in its China-based supermarket retailer associate Yonghui as well as its catering associate, Maxim’s.

Revenue for the period by DFI’s subsidiaries were 8% higher than last year at US$5.9 billion compared to US$5.5 billion previously, or 6% higher at constant rates of exchange.

See: Dairy Farm posts 6% growth in 1H earnings to $306.2 mil on higher sales

During the period, the group’s supermarkets segment saw revenue increase by 2.4% y-o-y to US$3.07 billion, but operating profit fall by 53.4% y-o-y to US$33.2m and operating margin falling to 1.1% from 2.4%.

Higher rents and labour costs in Hong Kong, while more store opening in Southeast Asia also led to higher operating costs.

According to Yeo, 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.

The group’s convenience stores saw revenue increase by 5.9% y-o-y to US$1.03 billion on higher same-store sales growth.

The health & beauty business segment recorded a 20.4% increase in revenue to US$1.48 billion, mainly due to the increase in tourist arrivals from Mainland China. Operating profit grew 73.8% y-o-y to US$154 million with operating margin rising to 10.4% from 7.2% on the back of better results from Malaysia, Indonesia and Vietnam.

On the other hand, the group’s associate, Yonghui, reported a 10.7% y-o-y decrease in 1H18 earnings to RMB195 million, due mainly to 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$61 million.

“Although revenue was slightly ahead of expectations with EBIT margins and operating profit growing from 1H17, overall earnings still fell short of our expectations,” says Yeo.

The analyst believes that Yonghui was a key disappointment followed by higher than expected costs in the supermarket/hypermarket business, causing the outlook for the group to be less optimistic.

As at 12.45pm, shares in DFI are trading 8 US cents lower at US$9.15, giving it a FY19 price-to-book value of 5.8 times with a dividend yield of 2.3%.