Dutch Lady Milk Industries Bhd
(April 6, RM47.68)
Maintain underperform with a target price (TP) of RM43.52: Dutch Lady Milk Industries’ financial year ended Dec 31, 2014 (FY14) revenue only recorded growth of 2% despite the group  increasing prices twice in the year by a total quantum of 15% across the product range to pass through the higher raw material prices. The 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 foreign exchange as 80% to 85% of the milk powders are imported.

Milk powder prices spiked up in early-2015, with the whole milk powder price surging as much as 44% in February 2015 compared with prices in end-2014, while the skimmed milk powder price also spiked as much as 27% comparatively. The spike was probably triggered by a forecast downgrade by Fonterra Co-operative Group Ltd for its milk collections. However, the prices normalised subsequently which we believe was led by 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 the management guided for continuous volatility in milk powder prices.

The management informed that the prices of goods and services tax (GST) standard-rated products under its belt had not been increased, suggesting that the extra costs have been absorbed by Dutch Lady 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.

We maintain our cautious stance on Dutch Lady, particularly with the alarming signal of the industry volume decline. However, we think that earnings growth of 9.4% in FY15 can be realised with full effect recognition from the price increases in FY14, further aided by lower raw material prices barring any big surge in the US dollar/ringgit rate. The dividend payout of more than 100% can still attract investors with the yield of more than 5% based on the last closing price. Our TP implies FY15 estimated price-earnings ratio of 23.2 times which is in line with its three-year mean forward PER, but we think that the current trading valuation of 25.4 times is unjustified considering the sustainability of industry growth and the further downside risk from the implementation of the GST as well as weak local consumer sentiments.— Kenanga Research, April 6

This article first appeared in The Edge Financial Daily, on April 7, 2015.