SINGAPORE (Apr 29): Despite an 18-19% cut in FY20-21 earnings owing to poorer health and beauty, as well as convenience store earnings, DBS Group Research has maintained its “buy” rating on Dairy Farm (DFI) based on promising valuations in light of ongoing transformation of its Southeast Asian supermarket business.
“DFI remains a multi-bagger re-rating play on its transformation strategy. Earnings may be derailed by the COVID-19 outbreak in the current quarter, but positives in the transformation process continue to come through in key areas such as South East Asia supermarkets showing improving operational efficiency,” reported analysts Alfie Yeo and Andy Sim on Thursday.
The Covid-19 outbreak has resulted in strong supermarket and hypermarket performance in Southeast Asia. With more people staying at home, demand for groceries has risen as household’s increase their consumption of home-cooked meals, resulting in strong Same Store Sales Growth. Ongoing transformation plans have moreover improved efficiency in supermarket and hypermarket operations, promising sustained strong performance in this business arm.
These gains have been offset, however, by poor performance in the health and beauty and convenience store sectors in North Asia due to both declining tourist numbers to Hong Kong and lower footfall across mainland China, Hong Kong, and Singapore. DBS believes that 1QFY20 earnings will be lower y-o-y following a business update from DFI reporting a deterioration of North Asia Health & Beauty, Maxim’s and the convenience store segments.
“We now assume that sales in the Convenience Stores and Health & Beauty segments will each fall by close to 30% y-o-y. Operating profit for both segments in aggregate is projected to fall by 12% to US$419m (S$592.6m),” noted Yeo and Sim. They forecast a potential 18-19% cut in DFI’s FY20-21 earnings on the back of weak performance in 1QFY20.
DFI has seen stronger performances in its IKEA business arm, however, with sales and margins of its Home Furnishing segment improving on the back of new stores absent last year and increasing e-commerce growth. Costs have also fallen due to the elimination of start-up costs going forward, allowing for a potential improvement in profit margin going forward.
In spite of these headwinds, DBS considers Dairy Farm’s valuations to be favourable at half a standard deviation (-0.5 SD) below its historical mean. The counter offers a strong dividend yield of 4.4% at time of publication with a low risk of dividend cuts, with Yeo and Sim calculating that parent company Jardin would prefer to maintain distribution per share (DPS) payout for now. Return on equity on the counter stood at an excellent 25% at time of report publication.
More importantly, supermarket transformation remains undamaged by the pandemic. Improvements in long-term efficiency means that the bluechip counter is likely to be re-rated in the longer-term once the pandemic has lifted. A strong and sustained earnings recovery led by the effective and successful implementation of its multi-year transformation plan, could prove a catalyst for this favourable outcome.
DBS has maintained a “buy” rating on this undervalued blue chip for close to 12% upside including dividends. Yet the anticipated fall in FY20-21 earnings has also prompted DBS to lower its target price to US$5.10 from $5.59 (7% upside). DFI’s core business is valued at US$3.03 from a discounted cash flow model and its 20% and 18% stakes in Yonghui and RRHI based on market values of US$2.42 and US$0.26 respectively with net debt per share at US$0.61.
“A significant earnings decline led by other segments and drop in valuation of Yonghui and RRHI [business arms] would pose downside risks to our earnings forecast and TP,” warned Yeo and Sim.
As of 2.30pm today, Dairy Farm stocks were trading at US$4.72 (S$ 6.56) with a dividend yield of 4.45% and a price-to-earnings (P/E) ratio of 15.83