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Should Investors Be Worried About Dairy Farm International Holdings Ltd’s Shares?

In a previous article I wrote, I shared three questions investors can ask to determine how risky a share is. I would like to apply the questions to Dairy Farm International Holdings Ltd  (SGX: D01), so that investors can have a better idea on how risky Dairy Farm’s shares may be.

Given that the company is set to become a blue chip soon by joining the Straits Times Index (SGX: ^STI) on 24 September 2018, I thought many investors may be interested to learn more about Dairy Farm.

Here are my three aforementioned questions on risk:

1. Is there any form of concentration in the company’s business model?

2. Is the company’s valuation high?

3. Is the company’s balance sheet weak?

It’s worth noting that my trio of questions are not the only important things investors should ask when determining how risky a share is. But, they can still lead to valuable insights on the crucial subject of risk.

The business

Dairy Farm is a pan-Asian retailer with a wide variety of retail store formats under its banner. The company has interests in hypermarkets, supermarkets, convenience stores, pharmacies, furniture stores, and restaurants. Some of the retail store brands that are related to Dairy Farm include Cold Storage, Giant, Guardian, IKEA, and 7-Eleven.

As of 30 June 2018, Dairy Farm, together with its associates and joint ventures, operated over 7,400 outlets across Asia. The countries and territories that Dairy Farm is in include Hong Kong, China, Singapore, Malaysia, Indonesia, the Philippines, and more.

The questions on risk

On the first risk question, it’s highly likely that Dairy Farm does not have any customer-concentration risk given the nature of its business: The company runs retail stores, and so its customers are individual consumers. But, the company does have some form of geographical concentration risk. North Asia, which includes Hong Kong, China, Macau, and Taiwan, accounted for 78.6% of Dairy Farm’s total revenue ( including revenues from its associates and joint ventures) in 2017. The geographical concentration risk is mitigated to some extent by China’s fast-growing economy.

Coming to the second question, Dairy Farm currently has a price-to-earnings (PE) ratio of 30.2. Not only is this higher than the market’s PE of around 11, it is also at the higher end of the historical trading range as shown in the chart below. Notably, Dairy Farm’s earnings per share in the first half of 2018 had inched up by just 1.6% compared to the first half of 2017 after non-recurring items are stripped away.

Source: S&P Global Market Intelligence

Lastly, on the third risk question, Dairy Farm has a net debt position of US$670.3 million (total debt minus cash) as of 30 June 2018, which gives rise to a net debt to equity ratio of 40.4%. Although I would prefer a company to have more cash than debt, Dairy Farm’s net debt to equity ratio looks reasonable. Moreover, Dairy Farm has been adept at generating free cash flow – from 2015 to 2017, the retailer’s annual free cash flow had averaged US$407.1 million.

A Foolish conclusion

To sum up, Dairy Farm is a share that carries valuation risk. But, do note that this study of Dairy Farm’s fundamentals should not be taken as the final word on whether the company is a good or bad investment opportunity. See the information here simply as a good starting point for further research.

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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 owns shares in Dairy Farm International Holdings.