I initiated a position in Dairy Farm International a couple months back which I have written here.
Today, I added to the position further by accumulating them at a price of $5.83 and then $5.79.
The overall investment thesis remains the same as what I’ve written before and valuations remain more compelling in terms of purchasing, so it’s a straightforward decision to add more.
Like I mentioned in the previous article, the company seems to be facing headwinds both on the internal and external front and the share price dropped accordingly to reflect that. On the external factors, we have the global slowdown particularly in China and a few emerging market, and the currency fluctuations against the strong USD did not help the cause. On the internal factors, we see margins compression in 3 out of the 4 divisions and this can be attributed to global slowdown, stronger e-commerce competition and cost rationalization. Being a global market leader in the Asian region, I do expect them to follow the path of Walmart in the US and Tesco in the UK where operating margin dropped in the late 1990s before rebounding back to the high 6-7% from then on. Dairy Farm was also registering the same year on year growth in the early 2000s before settling down across the 4-5% until recently where it dropped to about 3%.
I think the experience of the management to go strategically organic and inorganic through vertical integration will help them to push the margins back up again when the whole economy recovers. It is also good that during this time, the smaller players can be weed out to prevent further competition. The company has also embarked on an intensive productivity cost cutting measures by using self check counters for instance to replace man hours labors which is highly more expensive in the long run. Since these falls under fixed assets, they can also capitalize the assets instead of expensing them all at one go. I think this will be the future of cashier in what we've already seen in many places.
Dairy Farm has recently increased their leverage on their strategic acquisition of 19.99% interest in Yonghui Superstores company in China and also the acquisition of San Miu stores before that. Even though balance sheet has weakened slightly due to higher leverage, their interest coverage ratio is still a respectable high of 11x (from 21x before the acquisitions). I don’t think there’s any cause of concern yet for this as they are comfortable paying them through their operating cashflow.
The company has been paying out a consistent growing dividends to their shareholders for as long as I can remember. The last dividends paid over the past 3 years is standing at US$23 cents at around 65% payout and I expect the dividends to remain the same this year, even if earnings have gone down this year. Their ability to pay dividends through their operating cashflow is what that makes them an attractive company to have in the portfolio. Based on the last closing price of US$ 5.79, this represents a dividend yield of 4% and I think it is attractive enough to hold for the dividends while waiting for the market to recover. I don’t think it’s common that you can get such a high yield out of Dairy Farm, so I think it’s an opportunity, at least for me.
In terms of valuation, they are currently trading at a rather compelling situations based on the price to earnings, even as the earnings have dropped this year. Based on the current price, they are trading at a -2.5 SD away from the mean based on the last 10 years data and if you are a believer of mean reversion, then the potential return could be massive. I actually doubt they'll fall a lot more than what they are already now unless they face specific execution or strategic issue which was not apparent to me.
As always, please do your own due diligence before taking a position in the above.
Vested with 2,200 shares as of writing.