Japfa Ltd - DBS Research 2017-04-28: Dragged by Vietnam

JAPFA LTD. UD2.SI

Japfa Ltd - Dragged by Vietnam

1Q17 underlying earnings came in at US$8.6m – below our expectation.
Weak earnings were due to lower contributions from JPFA and Animal Protein outside Indonesia.
FY17F/18F earnings cut by 17%/5% on steeper drop in swine contribution.

Reported 1Q17 earnings came in at US$2m (-91% y-o-y; -24% q-o-q). Excluding gains from changes in fair value of biological assets (net of tax) – but including recurring translation FX gains (losses) – the group posted 1Q17 net earnings of US$8.6m (- 65% y-o-y; -45% q-o-q) – well below the US$11.0-12.6m we had anticipated. This would bring 1Q17 earnings contribution at 9% of our full-year target vs. 14% historical average.
The weak performance was driven by:
1. Weak EBITDA contribution from Japfa Comfeed (JPFA)
2. Negative contribution from Animal Protein outside Indonesia – which booked US$3.6m loss (from EBITDA of US$11.7m in 1Q16 and US$5.8m in 4Q16).
3. These were partly offset by expansion in Dairy segment EBITDA to US$25.2m (39% y-o-y; 38% q-o-q).
Weaknesses in contributions from JPFA and Animal Protein outside Indonesia were steeper than we had anticipated – despite earlier revisions. We understand prices in both live boilers in Indonesia and swine in Vietnam continued to weaken throughout the quarter. While live broiler prices in Indonesia had recovered since as we enter peak season; swine prices in Vietnam have remained weak – due to long fattening lead time (i.e. 6-9 months).

EBITDA contribution from Japfa Comfeed sequentially eased 39% to US$37.2m (-14% y-o-y).
EBITDA margin for the group’s feed business sequentially eased to 10% in 1Q17 – from 12% in 4Q16 – as higher recognised domestic corn prices (i.e. recognition of inventories from end-December 2016) had an adverse impact on feed margins.
Likewise, 1Q17 DOC EBITDA margin slumped to 16% from 28% in 4Q16 (high base), given higher feed cost and weak DOC prices in January-March 2017 (due to c.8% oversupply in the market combined with weak purchasing power). The group’s commercial farm also swung back to losses in 1Q17 due to weak live broiler prices.
All in, JPFA's 1Q17 operating margin of 4.1% (vs. 6.3% in 4Q16 and 6.1% in 1Q16) indicated sequentially lower margins in all three key segments: feed, DOC and broilers.

The group booked negative US$3.6m EBITDA in animal protein ex. Indonesia. The weak performance was driven by falling swine price in Vietnam after the Chinese government started to restrict live pig imports from Vietnam in December 2016. ASP for swine dropped 29% y-o-y, below breakeven cost. We understand prices continue to remain weak in April.
While the group had started to take action, any recovery would depend on culling of piglets and to some extent the parent stocks throughout the country (we understand Japfa commands only c.1% market share in Vietnam).
Given the group’s industrialised farming model, Japfa’s cost of production should be lower than most of the smaller, fragmented breeders – thus indicating widespread culling may have already started.

Dairy EBITDA expanded to US$25.2bn translating to EBITDA margin of 30.6% vs. 26% in 1Q16 and 22% in 4Q16.
Despite low raw milk prices in China (-4% q-o-q), the group booked a 19% y-o-y increase in revenue due to a 38% increase in raw milk sales volume for the quarter. The increase in sales volume was principally attributable to Farm 6 – which had been fully milking in 2016 – and Farm 7 – which started milking in November 2016.
Milk yields continue to expand to 38.6kg/head/day from 37.6kg/head/day.

As at end-March 2017, the group had total borrowings of US$973m (up from US$840m at end-December 2016), which translated to net debt-to-total equity ratio of 80% (rising from 64% at end-December 2016).
The higher net gearing ratio reflects higher debt from a new USD bond issuance from Japfa Comfeed Indonesia.
The group recently issued USD notes of US$150m, equivalent of c.Rp2tr, and second re-tap bonds of Rp1tr (on top of Rp1tr issued in December 2016). The proceeds will be used to call the outstanding US$194.5m USD bonds (due in May 2018) and to improve working capital. Hence, we expect net gearing ratio to drop 56% by end of the year.

Factoring in 1Q17 results, we had cut swine prices to US$1.30/kg in Vietnam; and further reduced feed margins in Indonesia. We expect DOC ASP and live broiler remain relatively flat at -2%/+1% y-o-y.
Although DOC and live broiler ASP were weak during 1Q17; we believe the government's intention to stabilise prices should provide support on price for the remainder of FY17. We have imputed FY17F DOC ASP of Rp5,100/bird, live broiler ASP of Rp17,400/kg and poultry feed price of Rp6,300/kg. Average raw milk price in China is maintained at Rmb3.8/kg this year (- 8% y-o-y).
We expect JAP's EBITDA to ease this year; driven mainly by contribution from animal protein ex. Indonesia due to weak swine price outlook and JPFA to reflect high local corn cost as well as recent weak live broiler ASP. All in, JAP’s FY17F EBITDA is expected to ease 8% this year to US$387m; before recovering 24% next year to US$481m.

We employed SOP valuation based on forward EV/EBITDA multiples of the group’s various segments.
We reiterate our BUY call for 31% upside to our TP. We believe the counter continues to lag its subsidiary’s market value and our assigned value.
We believe the market is also ignoring value contributions from Dairy which continued to expand.
We believe strong subsequent earnings (driven by recovery in purchasing power, potential resumption in PS mass culling post Lebaran, and deleveraging efforts) remain as catalysts for the counter.

Ben SANTOSO DBS Vickers | http://www.dbsvickers.com/ 2017-04-28

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