Japfa Ltd - DBS Research 2017-07-04: More Stable Outlook From Indonesia Operation

Japfa Ltd - DBS Vickers 2017-07-04: More Stable Outlook From Indonesia Operation JAPFA LTD. UD2.SI

Japfa Ltd - More Stable Outlook From Indonesia Operation

  • A more stable outlook for poultry industry in Indonesia.
  • Swine operation loss to continue next quarter.
  • Share price drop YTD has been excessive.
  • Reiterate BUY with Target Price of S$0.88/share.

More stable poultry outlook from Indonesia offset by swine market in Vietnam. 

  • We believe Indonesia market poultry outlook will be more stable going forward due to government involvement in managing supply and demand. The culling program can be done repetitively by using Ministry of Agriculture Regulation No. 61/2016 as a legal basis. However strong contribution from Japfa Comfeed is partly offset by FY17 weaker outlook in Vietnam`s swine market.

Excessive fear of oversupply in Indonesia 

Better than 2014/2015 oversupply situation. 

  • Although chicken price and therefore earnings have been dragged down by oversupply condition in 1Q17, the situation is nowhere near the condition in 2014/2015. 
  • One factor we would like to highlight is DOC price in West Java (c.50% of Indonesia production) area which stayed above Rp3,000/chick during 1Q17 compared to 2H14 price which fell below Rp2,000/chick.

Weaker-than-expected demand in 1Q17. 

Repeated culling with faster adjustment. 

  • The government needed a year to take action in response to the 2014/2015 oversupply condition which led to the 6-million Parent Stock (PS) culling mandate. In a similar 1Q17 situation, the government took just two months to adjust the supply.
  • However, two months of low prices were enough to drag down earnings and therefore the share price. Nevertheless, two months is still better than twelve.

What could be better? 

  • The government has started another culling programme even before a drop in prices. On 23 May 2017, the government issued a circular letter to adjust DOC FS broiler production by culling 40% of hatching egg production. The culling is to be performed during 5-10 June 2017. 
  • The production cut will take effect a month later, a week after Lebaran holiday. We believe the high culling rate is applied in anticipation of weak demand after Lebaran holiday.

More culling? 

  • Yes, the government announced another culling programme on 21 June 2017. This time, it intends to have a longer-term effect of supply reduction by culling 3 millions PS. The 3-million figure, perhaps, coming from the unfinished 6-million culling programme conducted in late 2015.

Swine market has yet to recover 

Longer breeding time translates to prolonged loss. 

  • Unlike poultry, swine has about a four-month breeding time. The market expected China to open up imports to satisfy its needs during Chinese New Year festival. However, it did not.
  • Therefore, we expect the culling to be done during February 2017 and would only translate to lower supply in June 2017 onwards. Management has indicated that losses in swine operation will be greater in 2Q17 before recovering in 3Q17 after the culling takes effect.

Export ban to China might be lifted? 

  • According to Vietnam News, China expressed interest in opening official channels for Vietnamese pork to enter with a set quota. However, China requested strict controls over hygiene and product quality, especially regarding contaminations such as foot and mouth disease. The procedure will be discussed later during the negotiations of official bilateral trade agreement.

Where we differ. 

  • We are more bullish on the Indonesia industry outlook and earnings delivery on the back of more stability. We believe the drops in share price YTD due to 
    1. fear of oversupply in Indonesia, 
    2. Vietnam`s swine market crash and 
    3. weak performance on 1Q17 result, 
    are not justified.

Potential catalyst. 

  • In this report, we revise our forecasts to reflect higher DOC/live broiler ASP on the back of more stability in supply side and better demand outlook in 2H17. 
  • We believe the disappointing first quarter results were not only caused by of lower broiler ASP but also from high employee compensation on bonus payment from stellar 2016 performance. Therefore we believe the performance to improve from 2Q17 onwards on higher margin and lower operating cost. 


  • Changes to our forecasts upgraded our SOP-based Target Price (pegged to FY17F EV/EBITDA) to S$0.88 – from S$0.84 previously.
  • Further upside is possible if the Vietnam can find a way to export its swine products.

Share price drop has been excessive. 

  • Japfa's share price has dropped significantly from its high of SG$1.06/share in February to SG$0.585/share (45% decline) on 16 June. 
  • While share price has recovered slightly since its low, we believe the overall drop still has more than reflected the current situation and does not justify the potential earnings delivery of the company, in our view.

Key Risks to Our View

  • Predicting demand for chicken consumption has proven to be difficult. Although the Indonesian government has been reactive to adjust the supply, the measurement taken is subject to miscalculation in demand.

Indonesia Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-07-04
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 0.88 Same 0.840