Animal Protein - DBS Research 2016-09-20: Beware of feed margin compression

Animal Protein - DBS Research 2016-09-20: Beware of feed margin compression JAPFA LTD. UD2.SI

Animal Protein - Beware of feed margin compression

  • Indonesian government sets reference prices for seven food commodities, including corn.
  • Corn currently trades above the set reference prices – due to import restrictions.
  • Ministry of Agriculture facilitates MOU between 29 provincial governments and Feed Millers Association (GPMT) on additional corn cultivation areas.
  • Expect 3Q16 feed margins to sequentially compress on higher raw material costs.

Beware of feed margin compression 

  • We expect Indonesian poultry integrators to book higher feed raw material costs in 3Q16. While these should be passed on through higher feed ASP, we should point out that day-old-chick prices have remained elevated since Lebaran, while live broiler prices have come down. 
  • To avoid steep compression in commercial farm profits, feed margins may need to sequentially narrow.

Corn costs to remain elevated 

  • On 9 September 2016, the Indonesian Trade Ministry established minimum and maximum reference prices for farmers and consumers on seven food commodities – including corn – through Ministerial Regulation. The reference prices are valid every four months and will be periodically reviewed. Poultry feed typically consists of corn (50% of volume) and soybean meal (25% of volume). Hence, corn costs play in important role in determining feed prices.
  • According to Kontan newspaper last week, farm-gate corn prices are currently hovering at Rp3,800-4,000/kg (15% moisture content) and mill-gate prices are hovering at Rp4,100-4,300/kg (same moisture content) – significantly above the respective reference prices of Rp3,150 and Rp3,650. Theoretically, the reference prices serve as levels at 20 Sep 2016 which the state-logistics bureau (Bulog) would buy from farmers and sell to feed millers, respectively. However, the mechanism for which farmers can sell and feed millers can secure at these reference prices was never detailed. We currently employ average domestic corn cost of Rp3,742/kg for 2016 – up from Rp3,515/kg in 2015.
  • The Feed Millers Association (GPMT) was recently quoted as saying that the elevated prices are unavoidable given undersupply due to import restriction since 1 April 2016. Since the restriction, feed millers have substituted 20-30% of the required corn with cheaper feed wheat (approximately 2.5m MT were imported in 1H16 – from only 0.23m MT in the same period last year). The government had since June 2016 also restricted feed wheat imports. We have not imputed feed wheat in our feed cost assumptions.

Better corn supply visibility? 

  • While local corn is generally preferred (due to its freshness) vs. imported corn; higher local corn price (in consequence to import restrictions) would adversely affect feed margins. According to GPMT, Indonesia imported on average 3m MT of corn p.a. over the previous two years.
  • Responding to the corn supply shortfall YTD, Kontan newspaper reported that the Ministry of Agriculture is facilitating and MOU between 29 regional governments and GPMT in an effort to boost local corn production by adding cultivated areas. Under this programme, the government would identify additional land for cultivation to members of GPMT who would have otherwise need to import corn. In lieu of imports, GPMT members would be obliged to purchase corn from the proposed areas. According to the article, the government will also subsidise fertiliser and seed to corn farmers.
  • According to USDA, Indonesia typically has three corn crop cycles (i.e. planting – harvesting) per annum: Nov-Feb (49%), Mar-Jun (37%), and Jul-Sep (14%). We understand the additional land needed under the new programme could reach 724k ha (vs. 3.2m ha currently under cultivation). It is unclear whether the government would be able to identify all required land.

Expect higher 3Q16 realised soybean meal costs 

  • Separately, soybean meal prices at the CBOT had averaged US$387/MT in 2Q16 – up from US$305/MT in 1Q16. With typically a 3-month inventory, we expect the higher 2Q16 soybean meal prices to be realised in 3Q16. Translated into Rupiah landed cost (including freight, taxes and demurrage charges), we estimate realised soybean meal cost would have increased by Rp997/kg. Hence, its impact on feed cost (i.e. based on 25% of volume) should equate to c.Rp250/kg. We expect integrators to increase their 3Q16 feed ASP by up to Rp200/kg. We currently assume spot soybean meal average price of US$364/MT this year.

Animal Protein self-sufficiency programme 

  • In a separate development, Detik.com reported that the government also intends to achieve self-sufficiency in Animal Protein (i.e. chicken, fish, beef, etc.) by 2025 – preceded by self-sufficiency on rice, sugar and corn over the next three years. So far, rice, sugar and corn self-sufficiency programmes have met several problems on the field in areas such as irrigation, fertiliser, and equipment.
  • There is no immediate impact to poultry integrators, given the DOC oversupply in 2014-15. However, 20% share of breeding herd required when importing feeders will come as a challenge for most small feedlotters in Indonesia, due to the difficulties in finding land for grazing.

Neutral view maintained 

  • Following strong 2Q16 earnings results, we expect integrators to book a sequential decline in feed, DOC and commercial farm margins in 3Q16.
  • While we have a Neutral view of the sector, we are currently reviewing our commodity price forecasts and currency assumptions – in light of price movements YTD.
  • We continue to recommend JAPFA (BUY; TP: S$0.97) and MAIN (BUY; TP: Rp2,075) as our picks for the sector.

Ben Santoso DBS Vickers | http://www.dbsvickers.com/ 2016-09-20
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