• Keep NEUTRAL and USD3.09 TP, 9% upside. We maintain our rating on Dairy Farm as we await a better outlook (currently appears mixed) before turning positive on the stock. China tourists to Hong Kong are still lagging pre-COVID-19 levels, and grocery consumption in Singapore, China, and Hong Kong remains unexciting for DFI. We stay cautious on a more aggressive recovery until DFI’s key markets’ domestic supermarket consumption and China outbound tourist numbers pick up. This report marks the transfer of coverage to Alfie Yeo.

• 1Q23’s mixed performance within expectations. Better performance from the health & beauty (owing to the reopening of the Hong Kong-China border) and convenience store (from improved footfall and promotions) segments were offset by relatively poor grocery retail (due to last year’s high base) and home furnishing divisions (on weaker demand for furniture in Hong Kong and Taiwan), leading to a modest hike in operating profit. Associate income rose significantly, driven by improvement from Maxim’s (as COVID-19 restrictions eased). Grocery retail showed higher profitability vs 2019, while the profitability of the convenience stores and health & beauty segments remained below 2019’s levels.

• Gradual recovery going forward. We anticipate a gradual rather than a firm earnings recovery towards 2019’s levels. Hong Kong supermarket retail sales have been subdued so far this year, and the 2.8m Chinese visitors to Hong Kong in May remains far from pre-COVID-19 levels of 4-5m a month. There should also be a lag effect to China’s recent rate cuts before consumption improves. Our economics desk does not see a 2023 V-shaped recovery for China either. Finally, we see risks of downtrading from higher- end grocery segments in Singapore, due to downside risks to the GDP growth outlook. We therefore believe that earnings recovery will be gradual. We have kept our earnings forecasts largely unchanged, given our stance of a gradual earnings recovery outlook.

• Leadership transition. DFI’s current CEO since 2017, Ian Macleod will be stepping down from 1 Aug 2023, paving the way for Scott Price who was formerly Walmart Asia’s CEO, and subsequently EVP, Global Leverage. He has also been Coles Group Australia’s independent non-executive director since Sep 2022. We believe there will be tweaks to DFI’s business focus and strategy after the new CEO’s appointment, and the benefits of the new plans could take time to realise.

• ESG. As DFI’s ESG score is 3.0 out of 4 – in line with our country median – we have a 0% ESG premium/discount to DFI’s intrinsic value in deriving our final TP.

• Risks to our recommendation include slower-than-expected recovery in consumption spending, and higher-than-expected costs, which should ultimately lead to lower margins and earnings. There will be upside earnings risks should the opposite of the above scenario play out.

Source: RHB Research - 11 Jul 2023