• Dairy Farm's share price has shrunk 34% YTD but given the persistent uncertainty in HongKong, we think its risk-reward remains lacklustre.
• The HongKong retail situation could likely only improve in 2H20F at best, in our view. Hence, we cut our FY19-21F EPS by 3.8-13.3%.
• Maintain REDUCE, with a lower Target Price of US$5.40, now based on 22x CY20F P/E (23x previously). Wait for better entry points post 4Q19 results.

Hong Kong Retail Market May Remain Weak for the Next 1-2 Years

• In early-Nov, our HongKong consumer analysts turned more bearish on HongKong’s situation. While protests could fade in early or mid 2020F, the negative repercussions on HongKong retail could persist for at least a year as it takes time to regain tourists’ confidence, especially that of mainland Chinese tourists ( > 70% of total visitor arrivals in Hong Kong since 2012).

Dairy Farm Warns of Weak 2H19F

• In Sep, HongKong retail sales declined 18.3% y-o-y and visitor arrivals to Hong Kong fell 35% y-o-y; these were even before the protests escalated into more violence in mid-Nov. Furthermore, Dairy Farm (SGX:D01) in its 3Q19 interim statement highlighted that the softness faced by its HongKong businesses (especially Manning and Maxim's) more than offset any benefits from its ongoing transformation programmes. See Dairy Farm Announcements.

FY19-21F Health & Beauty EBIT Cut by 12-22%

• Dairy Farm's HongKong health and beauty (H&B) segment has a high correlation to China visitors to HongKong. We estimate HongKong accounted for at least 40% of Dairy Farm’s H&B EBIT in FY16-18. We now forecast the H&B division’s FY19F/20F EBIT to shrink 11.3%/3.6% y-o-y (from growth of 1.1-5.3% previously) and only rise 7.6% in FY21F.
• Our overall cuts result in FY19/20F/21F H&B EBIT being reduced by 12%/20.9%/14.3%.

Cutting FY20-21F Restaurant Associate Contributions

• Dairy Farm’s restaurant associate earnings formed 66.9-100% of Dairy Farm’s total associate earnings in FY14-18. According to official stats, total HongKong restaurant receipts plunged 12% y-o-y in 3Q19.
• We had already factored in an 11% y-o-y decrease in Dairy Farm's restaurant earnings for FY19F previously, but we now think such earnings weakness may be extensive we thus cut our FY19-21F restaurant associate contribution forecasts by 8.9-22.1%. See attached PDF report for complete analysis.

Maintain REDUCE – the Coast Is Not Clear Yet!

• We cut FY19-21F EPS by 3.8-13.3%. Given the persistent uncertainties in HongKong (Dairy Farm’s main earnings contributor in the past three years), we think the stock should trade at the average valuation of its downturn year in 2015. Hence we ascribe a P/E of 22x on CY20F EPS (-0.5 s.d. to 12-year average). This lowers our Target Price to US$5.40 (US$7.29 previously). See Dairy Farm Target Price; Dairy Farm Dividend History.
• Upside risks are swifter-than-expected resolution to HongKong protests, better sales growth and margin expansion.
• Potential de-rating catalysts include continued HongKong protests, weaker sales and margins.

Source: CGS-CIMB Research - 28 Nov 2019