• 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. 

Valuation: 

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). 

Source: DBS Research - 27 Jul 2018