Period  2Q14/1H14

Actual vs. Expectations Dutch Lady’s (DLADY) 1H14 net profit came up to RM47.3m which was down 25.6% YoY. The result is below both our forecast and consensus expectation by accounting for only 34% of the full-year forecasts. The negative deviation can be attributed to higher-than-expected dairy raw material price and higher-than-expected operating costs as a result of the increase in fuel price and electricity tariff hike.

Dividends  No dividend was declared for the quarter, as expected.

Key Results Highlights YTD, revenue inched up by 8.8% thanks to the volume growth from existing product, additional sales from new products as well as the ASP adjustments to account for the higher raw material prices. However, higher raw material costs (+39%) and operating costs (+16.7%) narrowed the PBT margin by 6 ppt to 12.9%, resulting in a 25.6% drop in PBT to RM64m.

 YoY, 2Q14 net profit declined by 29.8% to RM34.6m despite a 7.4% growth in its top line due to the same reasons mentioned above. Whole milk powder (WMP), one of its main raw materials saw a surge in average price by 26% in 1Q14; which can be used as reference assuming the Group lags behind by 3 months in recognizing raw material prices changes.

 QoQ, PBT margin was comparatively lower at 12.2% vs 13.7%, but the net earnings was lifted by 5.2% to RM24.3m owing to the strong growth of 17.8% in its top line, which we reckon is more driven by the ASP adjustments rather than volume growth.

Outlook  Raw material prices continued to have a big impact over the Group’s earnings. With the WMP prices declining c.20% to average of USD3846.8/MT in 2Q14 vs USD4837.1/MT in 1Q14, we expect the cost pressure to ease starting 3Q14. However, the increase in operating costs, which is higher than we had initially expected could offset the lower raw material price and continue to erode the earnings margin.

 Moving forward, we do not think that DLADY can grow its top line at a faster pace to offset the high operating costs as the overall consumer sector remained subdued on the back of lower consumer spending due to the subsidy rationalization measures by the government.

 Near-term outlook remained challenging for DLADY on softened consumer spending on the back of weak sentiment. The imminent implementation of GST could put a further dent on consumer confidence.

Change to Forecasts We impute higher operating costs into our earnings forecasts as we had previously underestimated its operating costs. As a result, FY14E-FY15E net profits are slashed by 16.4%-21.3%, with FY14E showing a negative EPS growth of 21%.

Rating Downgrade to UNDERPERFORM from MARKET PERFORM

Valuation  Our Target Price is nudged down to RM42.32 (from RM48.00) following the earnings cut. We roll over our valuation to FY15 and peg our TP with unchanged 22.1x PER against a revised EPS of 191.5 sen. Our TP translates into a downside of 9.6% from its last closing price as DLADY is currently trading at 24.4x FY15 PER, above its +1.5 SD 5-year mean PER which we deem lofty.

Risks to Our Call Lower-than-expected operating costs.

 Lower-than-expected raw material prices.

Source: Kenanga