We attended a meeting with the management of DLADY and came out feeling neutral on the group’s prospects. While top-line growth is supported by higher selling prices and volume, rising cost of sales is putting earnings under pressure. We believe demand for its products is sustainable by their strong brand equity and market leading position for milk products despite low consumer sentiment. Maintain MARKET PERFORM with a higher TP of RM58.25 (from RM54.15) as we relook at the ascribed average PER.

1H17 results better improved from higher ASPs and product demand. To recap, the group’s 1H17 sales of RM513.6m grew by c.4% YoY. While we had suspected that the earlier Hari Raya seasonality had boosted sales, management explained that the 3-5% price increases in selected products also contributed to the higher top-line. However, we do not discount that effective promotional activities (i.e. re-launching of the premium Friso brand in 4Q16) had a stimulated a stronger brand awareness to keep demand intact).

Ongoing cost concerns. The group’s input costs primarily consist of milk products and packaging materials. Although skimmed milk prices have been trailing at lower levels (i.e. Oct 2017 6-mth average at USD1,999/mt vs Apr 2017 6-mth average at USD2,380/mt. Source: Global Dairy Trade), this is offset by the group’s exposure to rising Anhydrous Milk Fat (AMF) prices (i.e. Oct 2017 6-mth average at USD6,571/mt vs Apr 2017 6-mth average at USD5,448/mth. Source: Bloomberg). Further, the absence of commodity hedging denies the group from taking strategic price positions. Higher packaging costs are also due to supply shortages which we believe could be due to the closure of prominent paper mill companies in China. To recap, the group saw a 6M17 PBT of RM84.8m (-13% YoY) with lower margins of 16.5% (-3.0pts YoY).

Sideways from here? Management describes the market as challenging given the abovementioned cost pressures and increasing competitiveness with a shrinking market size. This reaffirms our view on the consumer sector; in line with the low consumer sentiment readings that macroeconomic factors (i.e. unfavorable forex, post-GST price hikes) have led to consumers adopting more price-conscious spending habits. However, we believe that the group’s longstanding brand equity is able to keep its offerings relevant to the market. Further, we view milk products as relatively inelastic in demand to consumers as they are essential for the physical development of infants and toddlers. Operationally, while production costs may continue to linger at unfavorable levels in the short-term, various operational enhancements by the group may support profit margins. Such initiatives include the integration of the group’s working software towards the global Frieslandcampina template in addition to utilising a shared finance service center to rationalise costs.

Post meeting, we leave our assumptions unchanged as we believe the abovementioned points are adequately factored into our estimates.

Maintain MARKET PERFORM but with a higher TP of RM58.25 (from RM54.15, previously). This is based on an unchanged FY18E EPS of 242.9 sen against higher ascribed valuation of 24.0x PER from 22.3x PER as we relook into the group’s historical average mean. We move towards a 5-year average from a 3-year average to be in line with the range ascribed to the valuation of the group’s larger cap peers, such as NESTLE and F&N, given their status as market leaders.

Source: Kenanga Research - 7 Nov 2017