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1 Reason Why I’m Staying Away From Dairy Farm International Holdings Ltd For Now

Dairy Farm International Holdings Ltd (SGX: D01) is a pan-Asian retail group with more than 7,400 outlets (including associates and joint ventures) across many Asian countries and territories. It operates supermarkets, hypermarkets, convenience stores, health and beauty stores, and home furnishings stores under famous brands such as Cold Storage7-ElevenGuardian and IKEA.

I like Dairy Farm due to the following reasons:

1) It offers daily essentials through its vast network of stores;

2) It generates copious amounts of free cash flow; and

3) With a rising Asian middle class, the company should do well for the long-term.

However, I’m staying away from Dairy Farm for now for one main reason.

High valuation

Even though there are some great things going on for the company, I’m staying on the sidelines due to its high valuation.

Yesterday, Dairy Farm shares closed at US$8.88 apiece, giving a price-to-earnings (PE) ratio of 28.9 and a dividend yield of 2.3%. The PE ratio is at the higher end of the historical trading range over the past five years.

For further perspective, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the fundamentals of the Straits Times Index (SGX: ^STI), was going at a PE ratio of 11.0 and had a distribution yield of 3.5%.

The pan-Asian retailer’s higher-than-average valuation could be substantiated if its net profit was growing at a double-digit growth rate. However, that is not the case.

Since 2013, its profit attributable to shareholders had fallen from US$500.9 million to US$403.5 million in 2017. The underlying earnings per share had declined over the same time frame as well, as seen from the chart below:Source: Dairy Farm International Holdings Ltd 2017 annual report

What the future holds in store?

In Dairy Farm’s 2018 first-half earnings announcement, the company’s chairman, Ben Keswick, said (emphases are mine):

“The first half of the year saw strong results from North Asia, driven by the Health and Beauty business in Hong Kong and Macau, but the Southeast Asian Food businesses continued to face challenges producing a weaker overall performance.

While the outlook for the remainder of the year is expected to remain challenging for the Food businesses, particularly in Southeast Asia, the Group’s other businesses should continue to make steady progress. Significant management and structural changes have been made to address the issues the Group faces in a number of areas, but time will be needed to deliver sustainable improvement.”

Dairy Farm needs time for the improvements it is undertaking to bear fruit. Till then, I’ll be watching the business from the sidelines to see if its valuation comes to a more palatable level for me to bite.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Dairy Farm International Holdings Ltd. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.