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Author: UOBKayHian   |   Latest post: Thu, 18 Oct 2018, 01:08 PM

 

DKSH Holdings (Malaysia) - Boring But Rewarding?

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On an absolute and relative valuation basis, DKSH is trading at PE discounts to its Swiss parent unit, five-year mean, and the consumer and pharmaceutical sectors. It has been recording slow and steady growth and has a solid balance sheet with a net cash position. Furthermore, dividend yield is decent at ~3%. In due course, DKSH is expected to issue a large special disbursement to shareholders, like how many listed MNCs have done so in the past in the Malaysian market.

WHAT’S NEW

  • Company background. Over the years, DKSH Holdings Malaysia (DKSH) has transformed from a pure distribution company to a leading market expansion services provider in Malaysia. Its range of tailor-made integrated solutions include: a) sourcing, b) market analysis and research, c) marketing and sales, d) distribution and logistics, along with e) after-sales services. It has more than 180 clients (brand and product owners) and 14,500 customers domestically.
  • Business exposure wise, DKSH has a broad footprint in the consumer goods (CG), healthcare and performance materials (PM) spaces. However, this is segmentalised into: a) marketing and distribution (CG and PM parked here), and b) logistics (healthcare is the primary contributor) in its financial disclosure. From 2010 to 2017, the former booked revenue and EBIT CAGR of 7% and 13%, while the latter booked a revenue and EBIT CAGR of 4% and 3% respectively.

ESSENTIALS

  • Scalable business model. A general investor concern would be the razor thin profits that the company generates; net margin is ~1%. However, this has been improving over the past 10 years (less than 1% in 2009/10), thanks to: a) new customer acquisitions, b) growth of existing clients, which in turn benefits DKSH, and c) a positive operating leverage effect. Hence, DKSH’s business model is highly scalable. The budding middle class in Malaysia and the robust growth profile of Asia are expected to continue to attract and spur market expansion activities.
  • Focus on cost efficiencies. Since DKSH has low margins, there is little to no room for operational error as it can be quite vulnerable to losses. Having realised this, it is perpetually looking at cost optimisation initiatives; currently, there are about 100 ongoing projects to help rein in spending. That said, the company has been profitable in the past decade. Comparing DKSH’s net margin of ~1% to its parent unit in Switzerland of ~2% (which has a wider market exposure to countries like Thailand, Greater China, Singapore), there is scope for improvement. Replicating this kind of productivity and efficiency over to its Malaysian arm should not be an issue in the long run.
  • Moves which may benefit DKSH. DKSH is expected to be a potential winner if the Pakatan Harapan government breaks up the drug supply cartel and scraps Pharmaniaga’s Approved Product Purchase List (APPL) concession agreement. It is already one of the preferred distributors for multinational pharmaceutical companies and fits into the role of being an agent at a lesser fee given their strong competency and vast experience in offering a full suite of market expansion services (click here for full report).
  • Capital management upside. Besides having been able to track slow and steady growth from 2009 to 2017 (top-/bottom-line grew at an 8-year CAGR of 5%/12%), DKSH also has a solid balance sheet with a net cash position. In due course, a large special disbursement to shareholders is expected (via capital management initiatives), on top of its decent dividend yield offering of ~3% (average payout ratio over the past 5 years was 30%). Like many listed MNCs on the Malaysian market (Nestle, Dutch Lady, Heineken), this was the script used to repatriate cash back to their respective parent companies (benefiting minority shareholders in the process).
  • Special dividend payout expected. If DKSH declares a one-time special DPS of RM2.50 (amount based total retained earnings), this is expected to translate to a yield of 70% (which coincidentally equates to the percentage of its book value and formation of net gearing as new debts would be incurred), without affecting physical operations (no brick and mortar assets are needed to carry out a capital management exercise). Postspecial dividend payout, share prices of the above-mentioned locally listed MNCs continued to perform strongly despite functioning with a much lighter balance sheet. To chart similar success, the key is to sustain commendable growth.

EARNINGS REVISION/RISK

  • Based on Bloomberg figures, 2018-20 consensus net profit forecasts are RM56m, RM60m and RM64m respectively.
  • Key downside risks include: a) slower economic activities, b) losing key clients, and c) failure to pass on costs to customers.

VALUATION

  • Over the past five years, DKSH’s Malaysian operations have been trading at a 30% average PE discount to its parent entity. Currently, the discount is at a much wider 51%.
  • DKSH is trading at 10x 2019F PE based on consensus estimates, which is largely in line with peers’ average PE of 11x. However, this is below the stock’s 5-year forward mean PE of 17x. Notably, the consumer and pharmaceutical sectors (average PE of 25x and 14x respectively) have undergone a significant re-rating in valuations since early this year, with many quality names currently trading at +1SD and +2SD above their historical mean.

Source: UOB Kay Hian Research - 27 Jul 2018

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