Dairy Farm International Holdings Limited - 1H15 Result – Weak result ~23% below JPMf

Dairy Farm reported a weak 1H15 result ~23% below JPMf. The result was driven by weak performance in Food with the company attributing the significant decline in earnings to cost pressures, FX headwinds and food deflation. We continue to see limited positive catalysts in the near term and would add the recent weakness in the HK retail environment and strength of the USD as additional headwinds for DFI.

Main points
· 1H15 turnover US$5,593m (JPMf US$5,790m), up 5.6% yoy (JPMf +9.3%).

· 1H15 gross profit US$1,632m (JPMf US$1,729m), implying gross margin of 29.2% (JPMf 29.9%).

· 1H15 EBIT exclusive of non-trading items US$202m (JPMf US$268m), implying EBIT margin of 3.6% (JPMf 4.6%).

· 1H15 EBIT exclusive of non-trading items + equity accounted profit US$234m (JPMf US$302m).

· 1H15 NPAT US$192m (JPMf US$246m), down 18.1% yoy (JPMf +5.1%). We note full year JPMf is currently in line with consensus.

· Interim dividend of US6.5cps declared, below JPMf US7.0cps.

J.P. Morgan comment
· Overall, this was a particularly weak result and we expect DFI’s share price to react negatively. We note the company reported significant earnings decline despite the positive impact from the company’s acquisition of a 20% stake in Yonghui as well as the acquisition of San Miu Supermarket in Macau.

· Food performance was particularly weak with supermarket/hypermarket operating margins down ~130bps and operating profit down ~28% yoy.

The company attributed the weak performance to the following factors:
1) cost pressures and food deflation for certain commodities squeezing margins in Food;

2) Higher rental and labour costs in HK;

3) Significantly lower profits in Singapore due to competitive pressures, higher rents and a weaker SGD;

4) Investments in Malaysia to attract customers;

5) High labour costs and rise in shrinkage costs associated with greater fresh sales, more rigorous stock management and store rationalisation in Indonesia; and

6) Struggling hypermarket sales in the Philippines.

· Health & Beauty sales growth also slowed on a subsidiary level, with operating profit declining ~8% due to ~90bps of operating margin compression.

The company attributed the weaker performance to:
1) Lower tourist arrivals in HK & Macau;

2) Lower profitability in Malaysia following the introduction of the GST on 1st April; and

3) Wage and rent increases in Indonesia.

· Home Furnishings profitability continued to grow strongly with operating profit increasing 32% yoy and operating margins also increasing ~90bps yoy. However, strong performance in Home Furnishings could not offset the weaker performance in Food and Health & Beauty.


Technical Analysis
Daily Chart
· On outlook, the company noted that margin pressure continues to impact financial performance for Food. The Group’s results were also negatively impacted by adverse FX movements.

· We previously highlighted our view that we see limited positive catalysts for DFI in the short term due to:
1) weak sales and margin outlook in SE Asian countries for its key Food division; and

2) a relatively expensive valuation given growth prospects. In addition, we note the following short- to medium-term headwinds: a) A weak HK retail environment likely to impact sales growth negatively and margins for both the Food and Health & Beauty business; and b) FX headwinds for key SE Asian currencies. Nevertheless, we also note a relatively stable shareholder register which may provide some share price support. (Read Report)

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Source : JP Morgan Asia Pacific Equity Research

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