Japfa Ltd - Maybank Kim Eng 2018-07-31: Appetite Should Improve

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JAPFA LTD. SGX:UD2

Japfa Ltd - Appetite Should Improve

2Q much better than expected

• Japfa’s 2Q18 profit recovery was stronger than expected, propelled by topline growth in PT Japfa TBK, APO and Dairy divisions combined with margin improvement from cost and yield efficiencies. Only Consumer Food continued to struggle in a very competitive Indonesia market. 
• 2Q18 reported PATMI of USD29.6m turned around from the loss in the prior year and was up 77% q-o-q with 1H18 accounting for c52% of our full year forecast. 
• Maintain BUY with SOTP-based target price of SGD0.86 (unchanged).

PT Japfa TBK boosted mainly by ASP and margins

• Subsidiary PT Japfa TBK’s contribution saw c12% y-o-y revenue, 70% EBIT and 74% PATMI growth in 2Q18 from a combination of c15% average y-o-y growth in DOC, broiler market prices, 8% growth in poultry feed volume as well as margin expansion from better poultry feed margin which benefited from lower local corn prices. 
• Management also indicate that post-Ramadan poultry sales volumes appear to be holding up better than prior years, suggesting a broader improvement in consumer sentiment in the Indonesian market. 
• We do expect some growth moderation in coming quarters as current high DOC, broiler prices will likely normalise and the bonus of feed margin gains may be transient.

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APO back to black while Dairy saw volume growth

• Animal Protein Other (APO) posted profits after five quarters of losses mainly from the recovery in swine prices in Vietnam as the market supply seems to have finally adjusted to China’s ban on pork imports since 4Q16. 
• Other APO areas saw poultry feed volume growth in Vietnam (+20%), Myanmar (+9%) and India (+10%). 
• Dairy saw c20% y-o-y revenue, 15% EBIT and 63% profit growth principally from a combination of raw milk sales volumes (+11%) and improvement in milk yields (+1%) in China.

Consumer Food - the fly in the ointment

• Losses from Consumer Food in 2Q18 widened to -USD6.8m from - USD4.9m the year before. Management indicate that the quarter witnessed another round of intense price competition due to Ramadan. Japfa has embarked on a number of initiatives in brand rejuvenation, differentiation to turn around the business over the next couple of years.

Investment thesis:

• Japfa’s vertically integrated industrialised farming business model leverages on scale and technology for competitive advantages. It stands to benefit from long term secular consumption growth trends with operations concentrated in highly populous and high-growth emerging economies in Asia where per capita protein consumption is still low.
• Japfa’s operations appear well on its way to recovery from the perfect storm it faced in 2017 when its Indonesian poultry operations faced an oversupply situation (resulting in a government-led culling program), the Vietnam market was hit by China’s unforeseen ban on pork imports and, both Vietnam & Myanmar poultry operations witnessed depressed demand due to H1N1 avian flu concerns in the region.
• Valuations appear undemanding at 11.1x FY18E P/E relative to its listing history (14.9x mean), its regional peer basket average (19.2x) and our SOTP-based target price estimate of SGD0.86 after factoring a 10% holding company discount.
• Moreover, after excluding Japfa’s 52% stake in subsidiary PT Japfa TBK, its stub valuation is c8x FY18E P/E which suggests the other divisions to be potentially undervalued as both Dairy and APO are profitable businesses and accounted for around half of 1H18 Group PATMI ex-forex and fair value adjustments for biological assets. Note that Chinese dairy companies trade at an average 2018 P/E of 25.2x, according to Bloomberg consensus estimates.
• See Japfa initiation report: Japfa - Serving up a high-protein diet, June 21, 2018

Valuation and risks

• We value Japfa on a sum-of–parts based on ascribed EBITDA multiples for its business segments of:
  1. PT Japfa TBK;
  2. Dairy; and
  3. APO and Consumer. 
• Our target price after incorporating a 10% holding company discount is SGD0.86, which implies 14x FY18E P/E.
• Japfa is trading at 11.1x FY18E P/E, at a material 42% discount to a regional peer basket average of similar industrialised protein companies i.e. CP Food (CPF TB), PT Japfa TBK (JPFA IJ), PT CP Food Indonesia (CPIN IJ) and Malindo Feedmill (MAIN IJ) and a 29% discount to its subsidiary, PT Japfa TBK.
• We believe the market has yet to fully appreciate Japfa’s diversified business model due to a number of factors, such as complexity of the business, thin broker coverage, fairly short listing history and short track record of earnings.
• We also believe this valuation gap should narrow with the market concerns over the drag of losses of the previous year in smaller business APO and consumer food reversing and narrowing, respectively.

Investment risks

• The key risks in Japfa’s business, in our view, are as follows:
  • Forex-related risks and sensitivity to currency movements as revenues are largely local currency denominated (IDR, CNY, VND, INR, MMK) while cost of goods include some USD priced commodities and a significant proportion of debt (although largely hedged) is in USD terms as well.
  • Sudden demand-supply imbalances for poultry, swine and milk due to regulations or imports.
  • Price and availability of feed raw materials, which make up c85-90% of cost of sales.
  • Competition in the consumer food space leading to sustained losses for the division.
  • Disease outbreak affecting livestock in its operating markets.
  • High gearing levels combined with debt repayment schedules that might require equity raising in some form over the next 2-3 years.

Neel Sinha Maybank Kim Eng Research | John Cheong CFA Maybank Kim Eng | https://www.maybank-ke.com.sg/ 2018-07-31

SGX Stock Analyst Report BUY Maintain BUY 0.860 Same 0.860