Company Update: Dairy Farm 2021 2Q
The shrinking cruise liner with more holes...
Dairy Farm (DF) is one of the initial companies we had previewed on Weighted.
DF is a business that we had been studying since 2004. It is very uncommon to have a multi-brand retail conglomerate operating at scale and efficiency across multiple countries. Their capability and the knowledge to scale across Asia kept us interested for many years.
We covered DF in our initial article here on 21st August 2020.
The initial thesis is that the loss making Giant (DF’s supermarket arm) is going to turn around. We caution that the health and beauty retail are facing headwinds but the array of brands and their distribution capabilities are really valuable.
Health and beauty used to be a consistent revenue generator for DFI. After the pandemic, we may see a permanent resetting of that business. If their brands continue to provide good range of exclusive brands and low prices, coupled with e-commerce options, we could see that they can hold on to their market share but at vastly reduced margins.
-Report published on 21st August 2020
Coupled with their holdings in their associates like Maxims, Yonghui and Robinsons Philippines, the valuation looks about just about fair.
We published a follow up article for 2020-4Q on 15th March 2021.
In that article, we gushed at their continued opening of convenience stores in Southern China, their continued growth in their Yuu rewards program and then we continue to worry about the beauty business and their reduction in margins.
Suddenly, Dairy Farm looks fairly valued, due mainly to the deterioration of the Health and Beauty segment and the possibly net margin contraction from the grocery businesses. We are still unsure if the net margin contraction is positive or negative for the business but overall an everyday low price strategy is always powerful if any retail company can pull it off.
-Report published on15th March 2021
Since the initial article, DF had dropped from USD 5.7b to USD 4.9b (around 14%).
Prior to the pandemic, there is only one hole in the ship - the loss making Giant in South-East Asia. That hole is easily fixed by closing sub-optimal stores and refurbishing the ones that are doing well.
That thesis technically had played out well.
The problem is that while one hole had been plugged, a few others had emerged.
Health and beauty retail continues to face more problems. Shrinking revenue and decreasing margins are recipe for disaster in retail. A shrinking revenue meant lesser economies of scale in purchase, and the need to maintain low margins meant that cost had to be reset. The bigger problem may be that consumers’ habit had been reset too. The pace of the drop in their revenue is really worrying. It indicates that they are rapidly losing market share to e-commerce and these revenue may no longer be coming back.
Yonghui (YH) is facing some headwinds in China. YH is the third biggest supermarket retailer in China and is the leader in fresh grocery space (pre-pandemic). The pandemic changed quite a bit of the Chineses consumers habits. Online grocery sales had risen, membership-only bulk retailers such as Sam’s Club and Costco are taking off.
With that YH is changing some of their stores to warehouse format and had just changed their CEO… Or to be more correct, the CTO had become the CEO. We do not know what the board of directors have in store for YH but this looks worrying.
Convenience stores operation is the only bright spot where revenue and margins improve sequentially from 20202Q. Maxim’s continue to be one of the best operation for post-pandemic (if it comes…).
Valuation:
The value of the business had decreased substantially.
Health and beauty was once a bright spot in their retail business. The pandemic had totally decimated it. Our belief is that post pandemic, the business will be a shadow of its previous self since revenue and margins are both shrinking. As per any retail operation, shrinking is a painful and multi-year process.
Grocery retail operation will continue to be profitable. The net margin improvement in Malaysia will flow through (due to the closure of the sub-optimal branches) to profitability (the pandemic helped as well). Continued price re-investment meant that gross margins would be kept low. The ability to drive administrative and operating expenses down is the key.
Yonghui need to continue to reinvest in their stores in China to revamp either to a warehouse/membership-only bulk retailer format and also bulk up their e-commerce capability. This meant that Capex is going to stay high at the time their regular business is under stress. The perceived moat on fresh food retail seems looks more like a canal from the assault of the online grocery platform. With fresh funds from Dingdong Maicai’s and MissFresh’s IPO, fiercer competition could be expected.
While 7-Eleven, Ikea and Maxim’s (Starbucks Coffee, Genki Sushi and IPPUDO Ramen, The Cheesecake Factory and Shake Shack) continue to be highly valuable, they only constitute 20% of their revenue.
With 80% of their revenue under stress, things could not be good for DF.
The pandemic had accelerated the pace of deterioration in the health and beauty business. Yonghui’s moat of providing fresh grocery to their customers had been decimated by online delivery. While we continue to hear of improvement in their grocery business in Malaysia and Indonesia, it is still in the midst of a turnaround in revenue and margins.
The decision has been to cut our risk exposure to DF.
Overall, we are almost flat on the trade (after including dividends).
The investment had been a big disappointment since we had been eyeing the DF for a very long time and did once believed in its scalability of their retail platform. But sadly, distribution capabilities are really no longer the moat it used to be.