We recently met up with the management of DLADY and came back feeling more cautious with the surprise shrinkage of the dairy industry. We were introduced to new Chief Financial Officer (CFO), Mirjam Joanna Ghislaine van Thiel, which had officially taken over the duties from former CFO, Ivo Ogink on March. It was the last meeting but an insightful one with Ogink before he relinquishes his position, as he briefed us on the recently concluded FY14, the raw material price movement, as well as the health of the overall industry itself. We were also made known of the price adjustment of DLADY products post-GST. Reiterate UNDERPERFORM with unchanged Target Price of RM43.52, based on FY15E PER of 23.2x, in line with its 3-year mean.

Negative surprise with dairy industry shrinkage. FY14 revenue only recorded growth of 2% despite the Group increasing the prices twice in the year by total quantum of 15% across the product range to pass through the higher raw material prices. Management indicated the overall dairy industry experienced a volume decline in FY14, which explained the flattish revenue growth. The Group attributed the downfall to the persistent weak local consumer sentiments throughout the year, as well as demand switch to other beverages due to the higher pricing of dairy based beverages on the back of higher raw material prices and unfavourable forex as 80%-85% of the milk powders are imported.

Volatile milk powder prices. Milk powder prices spiked up in early 2015, with Whole Milk Powder (WMP) price surging as much as 44% in February 2015 as compared to the prices in end-2014 while Skimmed Milk Powder (SMP) price also spiked as much as 27% comparatively. The spike-up was probably triggered by a forecast downgrade by Fonterra for its milk collections. However, the prices normalized subsequently which we believe led by the market forces in view of the slow demand from China and adequate supply by the exporting countries. Milk powders were sourced through global procurement by its mother company and management guided for continuous volatility on the milk powder prices.

Absorbing the GST. Management informed that the prices of GST standard-rated products under its belt had not been increased, suggesting the extra costs have been absorbed by DLADY itself. Gauging the extent of the extra costs was difficult as the Group refused to reveal the breakdown between dairy based beverages and infant and growing up milk powder, which are zero-rated. However, with price increase of 15% in FY14, we expect the impact from the extra cost arising from GST to be cushioned together with the advantage from the lower raw material prices.

Reiterate UNDERPERFORM with unchanged Target Price of RM43.52. We maintain our cautious stance on DLADY, particularly with the alarming signal of the industry volume decline. However, we think that earnings growth of 9.4% in FY15 can be realized with the full effect recognition from the price increases in FY14, further aided by the lower raw material prices barring any big surge in the USD/MYR rate. Dividend payout of more than 100% can still attract investors with the yield of >5% based on the last closing price. Our TP implies FY15E PER of 23.2x which is in line with its 3-year mean Fwd PER, but we think that current trading valuation of 25.4x is unjustified considering the sustainability of industry growth and the further downside risk from the implementation of GST as well as the weak local consumer sentiments.

Source: Kenanga Research - 6 Apr 2015