This Seemingly Pricey Share Might Yet Turn Out To Be a Bargain

At their current price of US$9.34, Dairy Farm International Holdings Ltd’s (SGX: D01) shares can easily be considered as pricey. That’s because it carries a high price/earnings (PE) ratio of 25.

In comparison, the SPDR STI ETF (SGX: ES3) is valued at around 13.5 times its trailing earnings. The exchange-traded fund tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI).

But, there’s more to Dairy Farm’s story if we take a closer look behind the numbers.

An ‘expensive’ cheap share?

From the chart below, we can see that Dairy Farm’s current PE is actually right in-line with its long-term average PE of 25 going back to the start of 2004. This might actually mean that Dairy Farm isn’t that expensive.

Dairy Farm Price Earnings Ratio

Source: S&P Capital IQ

But, it should be noted that looking at PE ratios without thinking about the future of the company’s business can’t give us a holistic picture. As investor Ric Dillon once mentioned:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say, just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be [emphasis mine].”

To frame Dillon’s words another way, a share’s high valuation can still be justified if its business future actually looks bright.

The future of retail

With Dairy Farm, which runs close to 6,000 retail stores (there are hypermarkets, supermarkets, convenience stores, restaurants, and home furnishing stores) throughout Asia, there seems to be a genuine case for optimism about its business. Here’s what my colleague Chin Hui Leong had recently written about some of the opportunities that Dairy Farm has to grow its business:

“Singapore and Hong Kong currently houses more than half of the 5,889 retail outlets for Dairy Farm. At the same time, China alone has at least nine cities which are larger than Hong Kong in terms of population size. In 2013, Dairy Farm had only 972 retail outlets in China, so there is space for the company to grow further in the country.

Furthermore, according to Euromonitor International, China and Indonesia are each expected to generate more than a trillion U.S. dollars in additional sales through convenience stores in 2014. Dairy Farm has a strong convenience store presence in both countries.

Another report from the Economist suggests that rapid urbanisation and a growing middle class is expected to drive sales for the overall retail environment in Asia. The research outfit estimates that Asia will be the home to 1.7 billion middle class citizens by the year 2020.”

In particular, the China angle is intriguing given that Dairy Farm had bought a 20% stake in Yonghui Superstores, a Shanghai-listed Chinese hypermarket and supermarket operator, in August this year. As part of the deal, Dairy Farm and Yonghui would also be collaborating closely in the Chinese hypermarket and supermarket space.

A Fool’s take

There’re plenty of things to like about Dairy Farm’s future. But as always, there’re also risks to consider.

In my opinion, one of the most pertinent ones would be the rise of online retail. The bulk of Dairy Farm’s business lies with its supermarkets and hypermarkets. In that type of business, price competition is key and if a retail outfit can’t provide a differentiated shopping experience, it might find it hard to compete against the convenience and lower prices that online retail can bring. If Dairy Farm can’t find a suitable strategy to thrive while e-commerce grows, then all the growth opportunities the company has might be for naught.

All told, investors would have to weigh the risks and rewards with Dairy Farm International in order to come up with an intelligent investing decision.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.