• With most of its main markets slowly easing out of Covid-19 lockdowns, we turn less negative on Dairy Farm’s near-term prospects.
• What is left is a recovery of Chinese tourism to Hong Kong before we turn more positive on the stock. We raise our FY21-22F EPS.
• We upgrade to HOLD and lift our Target Price to US$5.45, now on higher PER of 20x on CY21F EPS (17x previously), close to -1 s.d. from 2007-19 average.

Upgrade to HOLD From Reduce; Negatives Priced in

• We stayed negative on Dairy Farm International (SGX:D01) in Mar (see Dairy Farm International - CGS-CIMB 2020-03-06: Still Cold Up North) as we were concerned about near-term uncertainties for its North Asia convenience stores and restaurants with the onset of Covid-19, and rightly so, as evidenced by its weak 1Q interim update. However, with most of its main markets easing out of Covid-19 lockdowns by Jun, and as HK retail data points bottomed in Feb-Mar 2020, we turn less negative on valuations.
• We raise our PER to 20x FY21F EPS (from 17x), close to -1 s.d. from its 13-year average mean, which lifts our Target Price to US$5.45, and upgrade our call to HOLD.
• Upside risks: a swifter-than-expected resolution to the HK protests, better sales growth and margin expansion.
• Downside risks: continued HK protests, weaker sales/margins in all segments and DPS payout cuts.

Slow FY20F, But Growth Expected in FY21-22F

• We maintain our FY20F EPS as we think 1H and 2H will remain soft (Dairy Farm mentioned that Malaysia and Indonesia’s health and beauty segments could be hit in 2Q) as the world recovers from the lockdowns of 1H.
• We upgrade our FY21-22F EPS by 4.5-5.3% on higher EBIT margins for most of its formats and restaurant business, but left the health and beauty forecasts unchanged as we think the segment still faces medium-term risks from weak near-term Hong Kong tourist visitation, in our view.

Awaiting HK’s Recovery, to be More Bullish

• We would turn more positive on the stock on a meaningful recovery in Hong Kong’s economic conditions (amid sporadic ongoing protests) and tourist arrivals, especially from China (down 54% y-o-y in Jan 20, i.e. pre-Covid-19 outbreak, and 99% y-o-y in Apr 20).
• China visitors are a key driver of Dairy Farm’s Hong Kong health and beauty segment, North Asia sales and EBIT growth, in our view. In 2019, HK stores (ex-restaurants) accounted for 32% of Dairy Farm’s total subsidiary stores (5,219) and 47% of Dairy Farm’s total restaurant count (1,753).

Sustained Financial Position; DPS Likely Intact

• In its 1Q20 interim update, Dairy Farm assured investors about its financial position, citing careful management of its capex and working capital, and said that its facilities was not subject to any cashflow covenants. It also entered into a sales agreement to divest 100% of Wellcome Taiwan to Carrefour in Jun 20. We think all these are steps to preserve its cash position. As such, its FY20F DPS of US$0.21 should be intact, which at today’s close implies a dividend yield of 4.4%.

Valuation and Recommendation

• We had earlier pegged Dairy Farm’s valuation to its Global Financial Crisis (GFC) levels in FY08-09 on the heightened uncertainties that Covid-19 could have on Dairy Farm’s geographies, but with most of the main markets easing out of lockdown by 2H20, we lift our valuations to 20x CY21F P/E (17x previously), closer to -1 s.d. from its long-term average.
• We think valuations close to the -1 s.d. level is fair, given the current medium-term uncertainties (social unrest/no definite date of border opening) in Hong Kong, which contributes a material part of Dairy Farm’s North Asian business (North Asia accounted for 65.4% of 2019 revenue and the majority of 2019 EBIT before support and extraordinary costs), in our view.

Source: CGS-CIMB Research - 9 Jun 2020