KEY HIGHLIGHTS

Duty-Free International (DFI) whom successfully transfer from Catalist to the mainboard of SGX on 5 Oct 16, is the largest dutyfree retailer in Malaysia currently operates over 40 retail outlets nationwide in duty-free zones, border towns, international airports, ports and island duty-free shops. The stock has attracted investors’ interest recently, seeing its share price rallied c.50% YTD after the announcement of its partnership with Heinemann. With the synergistic benefit arising from the Heinemann tie-up, DFIL is expected to experience margin expansion, improved product mix and growth via possible M&A activities in the dutyfree segment. Consensus call for a BUY with a TP of SGD0.57.

Benefiting from Heinemann’s operational synergies. Early this year, DFI entered into a strategic partnership with Heinemann Asia Pacific (HAP), one of the world’s prominent travel retail players and locally known under its retail brand “Be Duty Free” operating in KLIA2. The partnership will allow DFI to leverage on HAP’s global purchasing power and vast supply chain that could see DFI improve on its product mix, operational efficiency and ultimately its bottom-line margin.

DFI to increase product offerings and SKUs. It was reported that with c.50k stock keeping units (SKUs) under Heinemann’s product range belt (Heinemann commands c.30% of European airport duty-free market), the duty-free giant would be able to help bring in new products to Malaysian shore through DFI. With Heinemann’s extensive relationships with various suppliers (including big names such as “Hermes”, “Ferragamo”, “Boss” & etc.), DFI could look to expand its product offering in underserved categories such as fashion, jewelleries and electronic goods, apart from their stronghold in perfume & cosmetic segment. The improved product offerings would help to cater a wider consumer targets, translating to future sales growth.

Stronger bargaining power, better operational efficiency. Historically, DFI would load up on stocks ahead of peak seasons to enjoy bulk discounts from its suppliers, which saw its cash conversion cycle expanded from c.51 days in FY11 to c.192 days (or c.RM300.0m in value) in FY16. However, with HAP partnership, it is believed that DFI could see improvement on its cash conversion cycle days by disposing off its old higher cost inventories and taking advantage of Heinemann’s bargain power on procurement. It is also forecasted that its cash conversion cycle may shorten to c.80-c.130 days across FY18E-FY19E (or lower to RM260.0m-RM180.0m in value). This would translate to lower working capital requirement and higher cash pile in hand. Putting this into perspective, the improved cash management arising from lower working capital requirement would free up cash for higher yielding opportunities. Assuming additional RM100.0m cash earns 2%, this will translate to an additional RM2.0m in additional interest income that could improve its bottom line (c.1.8% to FY17E PBT).

Margin expansion expected. With greater economies of scale through Heinemann’s procurement power to purchase lower priced stocks, it is forecasted to see DFI’s bottom-line margin to improve. Based on consensus estimates, a 1% enhancement in gross profit margin could lead to a 6-8% improvement in profit after tax. Consensus is expecting DFI’s gross margins to expand +0.4ppts/+1.0ppts in FY17E/FY18E, which will translate into net profit growth rates of +21.9%/+24.5% or translating into net profit margins of 10.5%/11.9% respectively (from an average of c.10.6% 2012-2016).

M&A catalyst? With (i) expected total cash (c.239.1m) proceeds from 25% equity sale in DFZ Capital to Heinemann, (ii) new placement of DFIL’s shares (c.RM60-100m) and (iii) reduction in working capital (C.RM80-100m based on forecast), the company would have a sizeable war chest (c.RM380-439m) to venture into M&A activities to expand its footprint domestically and regionally to take advantage of the current favourable tourism trends in South-East Asia and Greater Asia.

Or more dividends? While it is still an open question whether any M&A opportunities are available, the additional war chest proceeds that the company receives could potentially translate into more dividends for shareholders. To note, the group had a record of paying out at least 50% of its net profits as dividends (since 2012 till date) despite not having a dividend policy in place. Consensus is currently forecasting RM0.056 DPS for FY17E, translating to a dividend yield of 4.2%.

Source: Kenanga Research - 17 Oct 2016