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Light at the end of the tunnel?

  • DFI reported a weak set of business updates with profits continuing to be impacted by the ongoing pandemic and losses by key associate Yonghui.
  • We expect the tough operating environment to persist in 4Q21F, but see light at the end of the tunnel with potential HK-China border reopening in 1H22F.
  • We believe more visibility on the HK-China border reopening is needed for sustained multiples re-rating. Maintain Hold with a lower TP of US$3.50.
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Weak set of business updates for 3Q21

In its latest business update, Dairy Farm (DFI) shared that overall results for 3Q21 were lower yoy, due to continued significant impact from the Covid-19 pandemic and losses by key associate Yonghui (601933 CH, Hold, TP: Rmb 4). While Convenience and Health & Beauty (H&B) segments saw yoy revenue growth in 3Q, Grocery Retail and Home Furnishings segments saw declines. Most operating segments saw weaker profitability on a yoy basis due to lower government reliefs, although Convenience and Health & Beauty segments have managed to improve profitability vs. 1H21.

We expect tough operating environment to persist in 4Q21F

We believe DFI’s earnings will remain under pressure in 4Q21F. The H&B segment, which used to be the key profit contributor for DFI pre-pandemic, is likely to remain under significant pressure without the reopening of Mainland China-Hong Kong border. We also expect Grocery Retail segment to be impacted by elevated demand tapering off given loosening of mobility restrictions in most of DFI’s operating geographies in 4Q. Yonghui is also likely to be another big drag; our China Consumer analyst Lei Yang expects margins to remain under pressure for the next 2-3 years as it revamps its store portfolio and adjusts product structure to cater to changes in consumers’ shopping behaviour.

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Light at the end of the tunnel?

News media South China Morning Post reported earlier this week that Hong Kong’s land border with Mainland China could reopen fully to quarantine-free travel by Jun 2022 at the latest. This could be carried out in a three-step plan starting in mid-Dec, with initial trials limited to travel to Guangdong province, using a quota system with priority given to business exchanges and those visiting the elderly or attending funerals. This could be expanded towards an “expanded sizable daily quota” in Feb 2022 before a potential full opening by Jun 2022. We believe the return of Chinese tourists could aid earnings recovery for DFI’s Health and Beauty (H&B) segment in 1H22F, but recovery momentum will be dependent on the pace of border reopening and quota expansion.

Maintain Hold

Maintain Hold in view of the near-term challenging operating environment. We cut our DFI forecasts for FY21-23F by 2.2-23.5%, on the back of lower margin assumptions and higher Yonghui losses. Our TP is lowered to US$3.50, still based on 18.5x CY22F P/E (1 s.d. below DFI’s 5-year historical mean). We will turn more positive on: 1) more clarity on HK-China border reopening plans, or 2) stronger margin expansion.