Deep-dive 2021-1: Dairy Farm International Holdings Ltd

Dairy Farm International Holdings Ltd (DFI SP) is a pan-Asian retailer run by Jardine Matheson, the family holding company of Sir Henry Keswick.

The company was founded as a dairy farm in Hong Kong in 1886 by Scotsman Sir Patrick Mason and a group of five Hong Kong businessmen. It branched out into dairy retail, and later added supermarkets via the acquisition of the Wellcome grocery chain. Henry Keswick's Jardine Matheson acquired Dairy Farm and later relisted it in 1986. Since then, it has acquired retail operations across Taiwan, Malaysia, Singapore, Indonesia as well as China.

Today, the company's primary focus is supermarkets, restaurants and convenience stores, representing almost 50% of operating profit. Another 40% comes from health & beauty stores, or what Westerners would normally consider as pharmacies. The remaining portion of revenues comes from home furnishing stores. North Asia (primarily Mainland China and Hong Kong) represents roughly 2/3 of profits, with Southeast Asian countries such as Singapore, Malaysia, Philippines and Indonesia representing the rest.

There are a few underlying growth drivers. First, modern retail formats are still rare in some Asian countries. Second, demographics are excellent in several Southeast Asian countries. Third, the region has become richer over time and is likely to continue to close the gap with Western countries in terms of income per capita as Asians tend to be well-educated and hard-working. Fourth, health & beauty retail store spend per capita is still very low in countries such as China, Malaysia and the Philippines. Finally, the penetration of private label food products in grocery stores are very low in certain countries, including in China.

The stock has underperformed over the past five years. A strong US Dollar made key Asian currencies drop 4% to 44% since 2014. Since Dairy Farm reports (and trades) in US Dollar, that has a direct impact on perceived growth rates. The Southeast Asian supermarket segment has been particularly weak. Singapore tightened visa restrictions, causing many expats to leave the country. Dairy Farm's Singaporean supermarkets occupy the high-end niche and were hit accordingly. The ban on late-night sales of alcohol in 2015 also hit the city-state's overall retail consumption. Lower-end stores such as Sheng Siong also took market share. Labour cost inflation has been very high in Indonesia due to minimum wage hikes under Jokowi. In Malaysia, we saw a large 2015 hike of GST and much higher cigarette taxes. These factors all played a part.

In addition, Dairy Farm's pharmacies suffered from lower Chinese tourism since the anti-government protests broke out in mid-2019. Local customers in Hong Kong also turned against Maxim's establishments after the founder's daughter criticised the protesters in 2019. And in 2020, foot traffic across the company's pharmacies, restaurants, convenience stores and home furnishing stores dropped to very low levels.

The current CEO "Ian McLeod" took over in 2017. He has a decent track record, recently turning around the Coles supermarket chain from 2008 to 2015. He is now helping Dairy Farm introducing private label food products, closing under-performing stores and connecting grocery stores to digital platforms.

We think there are reasons to be optimistic about the company's fundamentals over the next two years. Tourists are likely to return to Hong Kong now that the protest movement has been dealt a blow via the new National Security Law. Mass inoculation against COVID-19 is likely to lead to a recovery in foot traffic across the region. It remains to be seen whether Ian McLeod is able to turn around the Southeast Asian supermarket segment. But in a worst case scenario, a large portion of Southeast Asian stores are shut down. It would not affect profits materially, given their already-low profitability.

Dairy Farm's valuation is attractive. The 19.9% stake in associate Yonghui Superstores (601933 CH) alone is worth US$2.1 billion at today's market prices and can be compared to Dairy Farm's own market cap of US$5.9 billion. A relatively conservative forecast using a group-wide PE multiple of 20x yields a target price of US$6.6/share, representing upside of +50%.

While some may criticise us for assuming a PE multiple of 20x, let's not forget that Dairy Farm's Asian peer group trades closer to 22x. Dairy Farm itself has historically traded at 23x. It's a rare example of a company with European-style corporate governance and capital allocation and exposure to the best consumer franchises in a fast-growing region. At a minimum, the risk-reward skew is favourable at the current 2024 multiple of 13x. Insider buying further bolsters our conviction.

Thanks to www.globalstockpicking.com for finding this idea. His Twitter account is @GlobalStockPick.

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The above article and PowerPoint presentation constitute the author’s personal views only and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – we do not hold a position in Dairy Farm International Holdings Ltd at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).


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