SINGAPORE (Mar 27): Dairy Farm International is turning to its new CEO Ian McLeod to save the day.
With more than 30 years of experience in the retail sector under his belt, McLeod is best known for breathing life back into Australia’s ailing supermarket giant Coles.
Last year, DFI saw its full-year earnings tumble 14% to US$404 million ($529 million) on the back of weakness across the group’s supermarket and hypermarket businesses in Southeast Asia.
Its food division, in particular, recognised business change costs amounting to US$64 million in the FY17 ended December, largely due to stock clearance and the closure of underperforming stores.
See: Dairy Farm's FY17 earnings fall 14% to US$404 mil on business change costs
“The food division has been challenging for Dairy Farm since 2015,” says RHB Research analyst Juliana Cai in a report on Tuesday.
Since taking over as group CEO in September last year, the Scottish businessman has been working tirelessly to help turn the supermarket operator around.
“Ian brings with him extensive strategic and operational retail experience with a strong track record of driving profitable growth,” Dairy Farm chairman Bes Keswick said in statement last year announcing McLeod’s appointment.
“Ian became managing director of Coles in Australia in 2008, where he oversaw a significant improvement of the business which outperformed the market during his tenure,” the statement added.
Already, McLeod’s operational changes “could lead to near-term margin upside in 2018,” according to Cai.
“[McLeod] pointed out operational changes that needed to be made, which could take a longer time to materialise,” she says. “However, he mentioned that major store closures and stock clearances have been implemented in 2017.”
In Singapore, where the group runs the Cold Storage and Giant supermarket chains, DFI has seen its market share dip with the net closure of nine stores in its store rationalisation exercise in 2015-2016, even as rivals such as NTUC Fairprice and SGX-listed Sheng Siong Group ramped up on store openings.
With supermarkets typically taking two to three years to reach optimum sales levels, Cai says the impact became apparent in 2017.
To make matters worse, Cai opines that the bulk of the industry’s 3.6% growth came from new residential estates such as Punggol, where NTUC Fairprice and Sheng Siong had most of their new store openings.
“The lack of new store openings meant Dairy Farm lost out in terms of growth,” she adds.
At the same time, she adds that DFI also faced direct competition from the entry of Amazon Prime into Singapore in July last year.
But now, Cai believes that DFI could be coming back into the game.
“Based on our observations of HDB’s commercial leasing website, Dairy Farm resumed its bid for new stores in 2017. This should put the group back in the game to fight for new stores in new, growing residential estates this year,” she says.
In addition, Cai says that McLeod has pointed out “operational inefficiencies” that need to be rectified, including making changes to storefront displays and product ranges to make them more customer-driven instead of supplier-driven.
“We believe such initiatives would need to be closely monitored, and if well executed, would yield positive results to sales,” she says.
Meanwhile, in Malaysia, where a slowdown in consumer spending has intensifying pricing pressure among retailers, Cai believes the closure of five Giant supermarkets in Nov 2017 could help to improve overall efficiency and productivity.
“The distribution centre, which was supposed to commence operations in 2H17, is now expected to open in Apr 2018,” says Cai. “The commencement of the distribution centre in 1H18 could also bring about improved operational efficiencies to offset some of the losses in sales.”
However, DFI has also underperformed in Indonesia, where Cai says the group has been slow in responding to the changing needs of consumers.
“With a rising middle class, [hypermarkets] are no longer popular in Indonesia, as consumers prefer to shop in specialty stores,” says Cai. “We deem the rise of the mini-marts as a structural issue that would continue to erode the market share of the larger format hypermarkets and supermarkets.”
According to Cai, DFI has indicated that it would be opening smaller stores moving forward, which the analyst believes would lower the group’s cost-to-income ratio in Indonesia.
“The group is also likely to focus more on its upscale brand, Hero Supermarket, which is likely to sell more higher-margin products such as fresh food, to differentiate itself from mini-mart operators,” Cai says.
In the short-term, Cai believes that DFI’s operating margins should improve on the back of the clearance of slow-moving stocks. “According to Mr McLeod, the bulk of slow-moving stocks has been cleared and there seems to be no more ‘large skeletons in the closet’,” she adds.
Finally, in the Philippines, Cai is upbeat on DFI’s acquisition of an 18.25% stake in Robinsons Retail Holdings Inc (RRHI) in a deal worth close to US$520 million.
The deal will see DFI trade its 100% stake in Rustans Supercenters (RSCI) for a 12.15% stake in RRHI, and fork out an additional US$174 million for another 6.1% stake in Philippines Stock Exchange-listed group.
See: Dairy Farm partners Robinsons to build food retail business in The Philippines
“This implies an FY18F P/E of around 26x,” says Cai. “We view this deal positively as we expect RRHI to contribute approximately US$20 million (annualised) to Dairy Farm’s pretax profit.”
“The Philippines was the only country that demonstrated higher sales amongst the Asean supermarkets in 2017. Nevertheless, its bottomline contributions remained negligible,” she adds.
RHB is keeping its “buy” call on Dairy Farm with a lower target price of US$9.16, from US$9.53 previously.
As at 2.22pm, shares of Dairy Farm are trading 5 US cents up at US$7.93 or 20.2 times FY18 earnings with a dividend yield of 3.1%.
