• Dairy Farm's FY19 core net profit (-10.4% y-o-y) was in-line at 100.2% of our forecast (US$320.1m), but below at 94% of consensus (US$341.5m).
• HK retail remains weak. Covid-19 outbreak also clouds near-term convenience and restaurant earnings, in our view. We cut FY20-21F EPS.
• We reiterate REDUCE, with a lower Target Price of US$4.38, now at 17x, the Global Financial Crisis (GFC) level in FY08-09, as we roll forward to FY21F EPS.

FY19 Core EBIT Down 13.6% Y-o-y; FY19 Net Profit Down 10.4% Y-o-y

• Dairy Farm (SGX:D01)'s FY19 core group EBIT of US$436.8m was down 13.6% y-o-y as three out of DFI’s four formats weakened.
• We estimate food EBIT grew (+50% y-o-y) on the back of an improvement in profitability for SEA with the ongoing strategic restructuring.
• We estimate convenience store segment EBIT fell 6.2% y-o-y due to pre-opening costs for new 7- Eleven stores in Guangdong.
• We estimate health and beauty (H&B) segment saw protest pressures bring 2H19 EBIT down 29% y-o-y; ultimately resulting in FY19 falling 10.1% y-o-y.
• We estimate home & furnishings (H&F) segment EBIT fell (-33.2% y-o-y) on higher pre-operating costs for upcoming stores. This led to FY19 core net profit falling 10.4% y-o-y.
• The silver lining was an unchanged final DPS of 14.50 US$cts, which took full-year DPS to 21 US$cts – in line with expectations.

Restated Yonghui and RRHI Contributions

• While FY19 associate earnings rose 10% y-o-y, this was below our expectations due to restated food segment contribution (Yonghui and RRHI) - likely due to IFRS 16 adjustments for both entities. Hence, while we expected shrinking restaurant contribution (-21.4% y-o-y), the lower contribution from the food segment was a negative surprise.

Covid-19 Outlook Clouds FY20F Prospects

• Several HK retail-linked datapoints remained weak in Jan-20. The Covid-19 outbreak adds to Dairy Farm’s near-term risk, in our view. In 2003 during the SARS outbreak, restaurant earnings fell 30% y-o-y, while convenience store EBIT shrank 10% y-o-y as footfall fell in both formats.
• We believe Covid-19 will continue to impact DFI's North Asia EBIT and associate earnings (Maxim’s); hence, we cut FY20-21F EPS by 13.1%/10.9% (Fig 8).

Reiterate Reduce, Still Clouded by Near-term Uncertainties

• We are heartened that Dairy Farm’s multi-year transformation programme is bearing fruit in its SEA food business; however, the near-term uncertainties in HK (Dairy Farm’s main earnings contributor over the past three years) are still too large to ignore.
• We think the stock could trade down to GFC levels in FY08-09, hence we ascribe a lower PER of 17x (c. -1.5 s.d. to its 13-year average), now based on FY21F EPS. This lowers our Target Price to US$4.38 (US$5.40 previously).
• Upside risks are swifter-than-expected resolution to HK protests, better sales growth and margin expansion.
• Potential de-rating catalysts include continued HK protests, weaker sales/margins and cuts in dividend payouts.

Source: CGS-CIMB Research - 6 Mar 2020