• FY17 Revenue was in line with our expectation; FY17 Adjusted PATMI missed our estimation by 6.6% on higher than expected operating expenses and tax rate
• Strong trading performances from Convenience Stores, Health and Beauty, IKEA, Maxim’s and Yonghui
• PATMI weighed by poor operating results from Southeast Asia Food and US$64.5mn of business change costs; excluding the business change costs, PATMI +1.5%
• Declared final dividend of US14.50 cents (Full year dividend of US21.00 cents, unchanged from last year)
• Maintained BUY and slightly lower SOTP-derived TP at US$9.83 (previously US$9.89)

The Positives

+ Positive performances in most of the segments. Notably, operating profit from Convenience Stores and Health and Beauty divisions grew 15.5% and 19.6% YoY, respectively. Both divisions saw margin improvement of 0.4 and 0.9 percentage points, respectively, reflecting its successful store rationalization and beauty care range enhancements initiatives.

+ Strong results from its key associates. Its Associates and JVs contributed 28.2% of FY17 EBIT, compared to last year’s 20.5%. Maxim’s saw strong performances from its branded products, particularly mooncakes, and its restaurant businesses in China; while Yonghui Superstores were underpinned by net addition of 292 stores in 2017 and margin gains.

 The Negatives

– Persistent weakness in the Supermarket and Hypermarket businesses, mainly in SE Asia (Southeast Asia). Notwithstanding the soft consumer sentiment in Singapore, Malaysia and Indonesia, competition in these markets intensified in terms of pricing and store format (e-commerce in Singapore and smaller format stores in Indonesia).

– Higher operating costs, gestation costs and business change costs hurt its core operating profit. FY17 recorded two huge one-offs in FY17: US$9mn pre-opening expenses from the new 4th store in Hong Kong (opened in Oct-17); and US$72.8mn of business change costs arising from the closure of underperforming stores, stock clearance and restructuring costs in the Food division in SE Asia.

Outlook

Positive outlook on brighter economic prospect. We expect recovery in SE Asia consumer sentiment as well as higher Chinese tourist arrivals to Hong Kong and Macau to gain momentum in 2018.

A new Group Chief Executive, Ian McLeod, joined the Group in 18 Sep-17. The former Coles Group’s Chief Executive, who brings with him, over 30 years of international retailing experience, and an impressive track record of resuscitating the ailing retail giant in Australia. He has initiated a strategic review since he took helm.

Maintained BUY with slightly lower TP of US$9.83 (previously US$9.89)

We trimmed our FY18e Core EBITDA by 10.6% on higher operating costs, leading to a 12.2% lower FY18e EPS of US36.4 cent. However, due to the increased market value from Yonghui, our SOTP-derived TP is broadly unchanged from US$9.89 to US$9.83.

We continue to like Dairy Farm on its:

• Well-established regional presence with long track record. The Group, including associates and joint ventures, added a net 633 stores in 2017. At 31 Dec-17, the Group had 7,181 stores in operation in 11 countries and territories, including its interest in 779 Yonghui stores in China and 1,210 Maxim’s stores.
• Strong cash generation and solid balance sheet to support its expansion plan. It generated higher net cash flow from operating activities of US$671mn in FY17, +23.7% YoY. Net gearing ratio also improved to 0.34x as at end-FY17 from 0.41x a year ago.

Successful execution and materialization from its continuous growth initiatives could be re-rating catalysts

• Increases accessibility via online and offline

1. Ramping up its e-commerce. For its Food division, the Group is partnering Meituan (China), Happy Fresh (Malaysia) and Go-Jek (Indonesia) to enhance last-mile delivery capabilities. On the other hand, its IKEA business now has nationwide delivery capability in all its franchise markets, and is developing new online platforms and tap onto selective marketplace sites.
2. Expanding store network. In particular, two new stores in Taiwan (scheduled to open one store each in 2019 and 2021), and a 2^nd IKEA store in Indonesia (secured site and pending licensing approval).
3. Moving towards smaller store format. Smaller store typically has shorter breakeven period and higher profitability per retail area.

• Improve profitability via better sales mix and efficiency gains

1. New distribution centres to drive economies of scale and provide capacity for wider range of product offerings. A new dry distribution centre in Macau (opened in 2017); a new purpose-built fresh distribution centre in Malaysia (slated to open in the 1H18); and a new purpose-built fresh distribution centre (opened in 2017) and a new dry distribution centre (target to open in 2019) in the Philippines.
2. Push for higher margin products. These include Fresh, Own Brand (i.e. private label), Upscale brand, and Ready-to-Eat food. The better results from Convenience Stores and Health and Beauty divisions are testament to the strategy and execution. The Group has also acquired the remaining 34% of minority investment in Rustan (in 3Q17), which now it is a wholly-owned subsidiary of the Group.