Broker's take: CGS-CIMB upgrades Dairy Farm to 'add' on 'palatable valuations'

CGS-CIMB has upgraded its recommendation on Pan-Asian supermarket and convenience-store operator, Dairy Farm International, to "add" from "hold" previously, noting that the counter is now "back at palatable valuations".

The brokerage is of the view that near-term uncertainties are priced in, with the stock correcting by about 7 per cent since CGS-CIMB's last report on July 30 and that the stock is trending closer to its year-to-date trough of US$3.70.

It added that forward valuations are now at about 17.2 times the price-to-earnings (P/E) ratio for fiscal 2021, closer to 1.5 standard deviation below the counter's historical mean.

"With an upside potential of 16.9 per cent to our 12-month target price of US$4.50, we think valuations are favourable for longer-term investors who are looking to revisit recovery plays and willing to ride out the volatilities of the stock," wrote analyst Cezzane See in a research note on Wednesday.

Based on its unchanged estimate of a 20 times P/E ratio for FY2021, CGS-CIMB has lowered its target price on the counter to US$4.50 from US$4.63 previously.

The brokerage has trimmed its earnings per share (EPS) forecast for FY2020 to FY2022 by 2.1 per cent to 4.6 per cent, as it believes that tighter Hong Kong restrictions in mid-July to August could hit Q3 earnings.

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It also forecasts that Dairy Farm's EPS for FY2020 could fall about 29 per cent year on year (y-o-y), and that EPS for FY2021 to be below FY2019's, despite a 32 per cent y-o-y growth.

"Even post our earnings cuts, forward valuations are still below average 13-year mean of 25.8 times and below regional peers' forward P/E of about 21 times," Ms See noted.

That said, according to CGS-CIMB's team in Hong Kong, the number of new confirmed cases of Covid-19 there has declined in the past few weeks. The brokerage believes there could be a gradual relaxation of cross-border travel within the Greater Bay Area, which bodes well for Hong Kong's services sector.

While Hong Kong's retail sales for July was 23.1 per cent lower from a year ago, the rate of decline has been reducing on a month-on-month basis since March, CGS-CIMB said.

"Interestingly, Hong Kong's medicine and cosmetic sales improved to a 50.9 per cent y-o-y decline from June's 57.7 per cent y-o-y decline, despite a still negligible number of China visitors to Hong Kong," the brokerage added.

Potential rerating catalysts include a swifter-than-expected resolution to the Hong Kong protests and better sales growth, while downside risks include weaker margins and further cuts to dividend payout, CGS-CIMB said.

As at 11.37am on Thursday, Dairy Farm shares were trading at US$3.90, up US$0.05 or 1.3 per cent.