We came away from a recent meeting with DLADY with a conservative view on its outlook. Lower pricing strategies have enabled volume growth amidst tighter competition, with a new UHT line indicating potential to expand further. Still, this may lead to lower margins and higher overheads. While milk prices may see sequential improvements, rising trends raise caution. Downgrade to MP (from OP) with a lower TP of RM62.90 (from RM68.30) on weaker margins outlook.

Affordability at forefront. In the recent 1Q19 results, management attributed the minor decline in sales (<1%) to pricing strategies designed to offer products at affordable levels, in turn leading to a 6% rise in sales volume. We believe that with the rise in milk consumption per capita, this could be to ensure that the group’s market share scales with it. However, management looks to stabilise its pricing in anticipation of value-added taxes and costing pressures in the near future.

Pumping more. The group recently commissioned a new UHT line in 2H18 for its 1L product offerings. The move led to the spike in capex in FY18 to RM34.3m, being a recent high for the group. We believe that products in this space could be in demand, being a more economical choice for consumers. This also reduces the group’s dependency on imported finished goods regionally to meet demand needs. Commenting on the overall utilisation rate, management expressed that production output is at optimum level and may not require any significant injection in the near term.

Qualms on milk trends. Recall that milk powders make up c.50% of the group’s input cost, being a mix of skimmed milk powders (SMP) and anhydrous milk fats (AMF). Though sourced from its global procurement network, which garner better price on higher economies of scale, SMP and AMF trends appear to be seeing constant upticks since the beginning of the year (as of 16 April 2019, SMP traded at USD2,462/mt, +12% YTD and AMF traded at USD6,126/mt, +19% YTD. Source: Global Diary Trade). Still, the group’s 6-month inventory planning could minimise sudden fluctuations in cost exposure. Management also highlighted an initiative to source fresh milk from local farmers as an alternative to sustainable supply, currently making up 6% of total milk sourced, but is more costly at present due to the smaller scale.

Post-meeting, we cut our FY19E/FY20E earnings by 14%/8% on more conservative margin assumptions, mainly from higher milk prices. While we believe market penetration initiatives are crucial for the group, this would dilute sales delivery and earnings potential. Still, DLADY’s market leader position in the RTD and infant formula space, and brand equity could indicate some stickiness in consumer demand, and may be unfazed by higher price adjustments. On the new line, we believe there could be overhead pressures should it not be optimally utilised. Stronger sales volumes should still be complemented by favourable selling prices to generate positive returns.

Downgrade to MARKET PERFORM with a lower TP of RM62.90 (from RM68.30, previously). We roll over our valuation base year to FY20E, on a lowered EPS of 202.8 sen. This is on our unchanged 31.0x Fwd. PER, which is closely in line with the stock’s +1.0SD over its 3-year mean. In the large-cap F&B space, we value DLADY at a premium against our ascribed 30.0x Fwd. PER on F&N, given DLADY’s better dividend yields (3.0-3.1%, vs. 2.1-2.3%) and the highest ROE of c.120% amongst its peers. However, earnings pressures from higher cost may undermine the attractiveness of the stock against other smaller cap players.

Source: Kenanga Research - 30 Apr 2019