• Dairy Farm's share price has retraced closer to YTD trough of US$3.70, at 17.2x forward P/E (close to -1.5 s.d. of historical mean), pricing in the weaker FY20F.
• Medium-term prospects are uncertain, but we think sentiments for the stock will improve, at least to its -1 s.d. levels, once recovery plays are revisited. We view the risk-rewards as favourable for longer-term investors.
• Upgrade our call for Dairy Farm International to ADD, with a lower target price of US$4.50 (on unchanged 20x FY21F P/E).

Better Value Now for Longer-term Investors; Upgrade Dairy Farm to ADD

• We stayed neutral post-Dairy Farm International (SGX:D01)’s last results, on concerns of Hong Kong’s 2H20F prospects. But with Dairy Farm's share price correcting by 7% since our last report on 30 Jul (trending closer to its YTD trough share price of US$3.70) and forward valuations now at 17.2x FY21 P/E (closer to 1.5 s.d. below its historical mean), we believe the near-term uncertainties are priced in.
• With an upside potential of 16.9% to our 12-month Target Price of US$4.50 (still based on 20x FY21F P/E, close to -1 s.d. from its 13-year average mean), we think valuations are favourable for longer-term investors who are looking to revisit recovery plays and willing to ride out the volatilities of the stock (due to Hong Kong uncertainties and uneven recovery in SEA markets).
• We upgrade our call for Dairy Farm International to ADD (from Hold).
• Potential re-rating catalysts are a swifter-than-expected resolution to the Hong Kong protests, better sales growth and margin expansion.
• Downside risks are continued Hong Kong protests, weaker sales/margins in all segments and further dividend payout cuts.

Hong Kong Data Points See Lower M-o-m Growth Declines

• Hong Kong retail sales in Jul 20 was still lower y-o-y (-23.1%), but the rate of decline has been reducing on a m-o-m basis since Mar 20.
• Interestingly, Hong Kong’s medicine and cosmetic sales improved to a 50.9% y-o-y decline (from Jun’s 57.7% y-o-y decline), despite a still negligible number of China visitors to Hong Kong (-99.9% y-o-y).

COVID-19 Cases Declining; Hopes for Cross-border Relaxation Soon

• According to our Hong Kong team, the number of new confirmed cases of COVID-19 in Hong Kong has declined in in the past few weeks, and post the completion of the Universal Community Testing Programme (UCTP) for COVID-19 (scheduled for 11 Sep), they believe there could be a gradual relaxation of cross-border travel within the Greater Bay Area. This bodes well for Hong Kong’s services sector.

Full-on Recovery Slow; But Valuations Are Increasingly Palatable

• We have trimmed our Dairy Farm International's FY20-22F EPS by 2.1-4.6%, as tighter Hong Kong restrictions in mid-Jul to Aug could hit 3Q20F earnings. We forecast FY20F EPS to fall 29% y-o-y, and FY21F to still be below FY19’s EPS despite a 32% y-o-y growth.
• Even post our earnings cuts; forward valuations are still below average 13-year mean of 25.8x and below regional peers’ forward P/E of 21x.
• We have pegged Dairy Farm International's Target Price close to its -1 s.d. from its long-term average (19.5x) to account for the medium-term uncertainties (social unrest, no definite date for border opening in Hong Kong and uneven recovery in SEA markets).

Source: CGS-CIMB Research - 9 Sep 2020