I managed to purchase 1,000 shares of Dairy Farm International at a price of USD 6.05 this morning. I had initially queued for 2,000 shares but it was only partially filled. Oh well, maybe another half the shares for another time perhaps.
This was a company with a very resilient earnings and defensive nature of its business in all economic cycles. As it turns out which I will show you later, the slowdown in the emerging market does play a factor in the plunge in the share price this year.
Dairy Farm is a conglomerate leading pan-Asian retailer which operates in supermarkets, hypermarkets, convenience stores, health and beauty stores and home furnishing stores under some of the world well known brands that most people would have heard of, Cold Storage, 7-eleven, Ikea, Maxims, etc.
Emerging Market Slowdown
The steep plunge in the share price this year can be attributed to the slowdown seen in the emerging markets, specifically the Asian region as we will see later.
In its latest half yearly results, the group reported modest like sales growth year on year in all major markets in all divisions, though margin pressures across the supermarket chains and convenience stores remain a drag on their bottomline.
The key growth in their divisions are clearly the home furnishing area, when they just opened an Ikea stores in Jakarta. Most of the other divisions have seen single digit growth year on year, which indicates that they might find some difficulties in either trying to grow organically because of competition or they might find difficulties in opening up more stores across pan-Asia.
From the below table, we can see immediately why the company is struggling in recent times.
3 out of the 4 divisions are all registering negative growth margins in the EBIT. There are a few mixed reasons for this. While some divisions such as the supermarkets in Malaysia and Hongkong retaining healthy topline margins, EBIT margins were being squeezed due to cost rationalization because of labour cost pressures. The GST implementation in Malaysia also does not help the company in trying to rationalize attracting more consumers in spending more.
The clear growth is in their home furnishing division, Ikea and they are trying to grow this by setting up a few more stores in the Asia region to help lessen the gap left by the other divisions.
The weakening in the exchange rate notably in Malaysia and Indonesia also affected the bottomline as the reporting is done in USD.
Capital Allocator – Leveraging
What I particularly like about the management is they are always on the constant lookout for growth by using internal debt to fund their acquisitions. As we all know, a high return on equity heaped on the faith that one of the factors is to use leverage in boosting their capital return. The management obviously has not failed to use that to their best advantage as and when is necessary.
Recently for instance, the Group completed the purchase of a 19.99% interest in Yonghui Superstores Company in China which deals with end to end supply chain that will boost their earnings under the JV/Associates line in their P&L. The company has also recently started boosting their e-commerce presence, which will bear fruits over time.
This is a company with over 30+% return on equity for the past few years.
The current price has a trailing PER of 17.6x, which is almost 2.5x SD below the 5- year average mean of 27.6x. Forward trailing earnings are expected to modest at about 1 SD below the 5-year average mean, which I thought was still very much reasonable within the margin of safety I am expecting it to be. That is almost a GFC sort of valuation we are seeing here.
I think the more reasonable question to ask is if the squeeze in margins are temporary or permanent. If it is the latter, then the drop in the share price is warranted and valuations will marginalize moving into the next 5 years. However, if the management managed to turn this around, this could be a huge risk reward play as it will marginalized back into its average valuation and the upside could be massive. For the information, Shengsiong is currently trading at a valuation of PER 24x, who has most of their operations in Singapore.
Attractive or not, well it depends on one’s vision to see how the future is going to unfold.
|CIMB Reports back then in Jun 15|