• Dutch Lady’s 1H17 net earnings of RM64.2m were below our full year estimates to make up only 42%.

• 1H17 earnings declined by 9.1% YTD due to high input cost despite higher revenue.

• 2Q17 earnings improved marginally by 1% qoq due to higher revenue (+5.4%) possibly because of Hari Raya sales.

• We pared down our FY17 and FY18 earnings by 11% and 10% respectively to reflect the higher input costs. Downgrade to SELL with new target price RM 53.00 based on DCF methodology with WACC of 8%.

Overall performance below expectation

Dutch Lady’s 1H17 earnings were below our full year expectation making up only 42%. The weak earnings performance of RM64.2m (-9.1%) was due to increase in commodity prices and advertisement and promotions (A&P) expense.

YoY earnings impacted higher commodity prices

On yoy basis, earnings declined 12.2% to RM32.2m despite revenue increase of 6.8% mainly from higher commodity prices. Average milk power price have increased c.8% between 2Q17 and 2Q16. As a result, COGS made up 61% of revenue (2Q16: 57%) and EBIT margin fell 4ppts to 16.2%.

QoQ earnings improved slightly on the back of higher revenue

As for qoq, 2Q17 posted a slight improvement in earnings by 1% supported by revenue increase of 5.4%. We believe the improvement was attributed to higher spending trend for the month of Ramadhan and Hari Raya festivities.

Outlook challenging exacerbated by higher commodity prices

Average milk powder prices had risen c.12% in 1H17 from 1H16. The price is expected to increase further in 2H17 and into 2018. Fonterra, one of the largest players in the dairy industry, cited that global demands for dairy milk are strengthening especially from Latin America. It also notes that key exporters such as EU, Australia and New Zealand are seeing flat to declining milk production growth, pointing to tightening supply. Additionally, we expect Dutch Lady’s input cost to increase on higher A&P cost and product innovation to sustain sales and market share. We pare down FY17 and FY18 earnings forecast by 11% and 10% respectively to factor in higher raw material and A&P costs.

Downgrade to SELL with new TP of RM53.00

We downgrade the stock to SELL with a lower DCF-derived TP of RM53.00 from RM56.00 (WACC: 8%) which implies FY17F PE of 25x.

Source: BIMB Securities Research - 23 Aug 2017