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Tug-Of-Fools: Dairy Farm International Holdings – The Bear Argument
Corporate Digest | 14 November 2014
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By: Choo Hao Xiang
Articles (151) Profile

After reading the bull argument, you would see Dairy Farm as a consistent performer. Backed by the defensive nature of its businesses, the company has been able to generate cash flow to reward its shareholders.

However, as with operating any business, there exists business risks. It can arise due to internal as well as external factors. This kind of risk affects a company regardless of its size and business line.

In the case of Dairy Farm, there are three types of business risks that are currently adversely impacting the company’s business. Firstly, the company is grappling with strategic risk that is present due to its competitive business environment. The second pertains to compliance risks that arose due to policy changes. The third is market risk, more specifically currency risk. Lately, detrimental effects of these risk factors on Dairy Farm’s operations have become more apparent. This prompts investors to rethink if it makes sense to go in at current valuation.

Slowing Revenue Growth
The food segment, which consists of supermarkets, hypermarkets and convenience stores, is the mainstay for Dairy Farm. It accounts for close to 75 percent of total revenue.

Barring FY09 which fell within the Global Financial Crisis period, this segment has seen substantially slower turnover growth for the past few years. For FY13, revenue growth slowed to 3.5 percent compared to 12.5 percent in FY10. This drag continued into 1H14, where growth of a mere 1.5 percent was posted. This dampened sales performance as the company registered a 3.9 percent increase in total revenue for the six-month period, the slowest pace since 1H09.

Revenue Growth (Year-On-Year)

Source: Company Report

Given that majority of food revenue is derived from more established markets, the falling growth rates could suggest that the company is experiencing declining market share. This is not surprising considering how intensely competitive the fast-moving consumer goods (FMCG) retailing space is. Furthermore, demand is highly responsive to price changes because product differentiation is almost non-existent.

Thinning Margins
Dairy Farm has operations spread across 11 Asian markets. Much as the company has a diversified portfolio, it is exposed to regulatory changes in these markets.

In particular, the company has to cope with policy changes that were implemented in Singapore and Indonesia recently. Restriction on foreign labour hire such as tighter foreign worker quotas and higher foreign worker levies in Singapore and mandatory minimum wage in Indonesia have added another burden to performance.

Operating Margin

Source: Company Report

This is on top of increasing costs in terms of rentals. The concern here is that margins might be compressed further. Further deterioration in profitability does not bode well with Dairy Farm’s inherently low-margin business. From FY09 to FY13, operating margin for the supermarkets and hypermarkets segment lost 1.8 percentage points. The five-year average of the profitability measure was 4.9 percent. This paled in comparison to its peer Sheng Siong Group’s average of 6.9 percent.

Currency Translation
Another worry with a diversified portfolio is the exposure to foreign exchange risks. Weakness in regional currencies will translate to lower profits even though performance in local currencies improves.

Dairy Farm’s Indonesian unit is a case in point. Profits from its Indonesian arm saw depressed profits due to a weaker rupiah which has depreciated about 25 percent against the US dollar in 2013.

As the US economic growth continues to gain traction along with the end of the stimulus programme and expectation of an interest rate hike in 2015, the US dollar is expected to strengthen. This might eat into profits, translating to lower profitability in US dollar terms.

The Rise Of E-Commerce
While the latest acquisition of a 20 percent stake in hypermarket operator Yonghui Superstores signals Dairy Farm’s commitment to the Chinese market and could bolster future earnings, the Chinese up-and-coming e-commerce space is an obstacle to traditional retailing.

Though still at an infancy stage, the range of products available online has expanded to include food categories. This might drive up the online shopping population further. Based on findings from Kantar Worldpanel, the global market leader in consumer panels, the base of households shopping online for FMCG goods in the country has been increasing exponentially. Total penetration sits at 28 percent. In less than three years, China’s online penetration is expected to surpass 50 percent.

Therefore, unless the company establishes an online shopping platform, what it might be looking at is limited growth opportunities.

SI Research Takeaway
Coupling the e-commerce concern with the combination of slowing revenue growth and thinning margin in its main business segment might not sit well with the company’s current valuation. Using the latest five-year compounded annual growth rate of earnings per share, the price-earnings to growth (PEG) ratio stands at 3 times. This means that Dairy Farm is trading at a rich valuation.

One certainly do not want to overpay for an investment. At this point with the circumstances highlighted, it might be wiser for an investor to monitor before committing when opportunities arise.

Haoxiang manages and oversees the portfolio of stocks in the consumer goods and hospitality sectors at Shares Investment.

Please click here for more information about this author.

Dairy Farm Int'l Hldgs  5.830 -0.08 -1.35%   
Business: Asian retail co that operates supermarkets, convenience stores & others. [FY18 Turnover] Food (70.3%), health & beauty (14.6%), restaurants (11.8%), home furnishings (3.3%).

Insight: Feb-19, FY18 net profit plunged 77% to US$92m due ... Read More
Sheng Siong Group  1.140 -- --   
Business: Co is a supermarket chain operator.

Insight: Apr-19, 1Q19 revenue rose 10.1% to $251.4m mainly ... Read More

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