Japfa Ltd - DBS Research 2018-10-25: Value In This Animal Protein Play

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JAPFA LTD. (SGX:UD2)

Japfa Ltd - Value In This Animal Protein Play

• Reinstate with BUY, Target Price of S$0.86 on continued earnings recovery.
• Projecting 9.7% EPS CAGR over FY18-20F, driven by its resilient ASP in Indonesia, and swine price recovery (VN).
• Upside earnings surprise would come from dairy segment.
• Ex-Japfa Comfeed value, other segments trade at < 4x FY19F PE.

Indonesia's good performance to continue in 2018F; helped by higher swine price outlook in Vietnam

Reinstate with BUY, Target Price of S$0.86.

• We reinstate coverage on Japfa with a BUY call, and Target Price of S$0.86, implying a 37% upside.
• We believe the challenges seen since late 2016/early 2017 have passed FY18F profit to post a strong turnaround to reach US$8692.2m in FY19F (+6.3%). Our FY19F forecasts are c.12% below consensus, likely due to more conservative estimates from its business segments (ex-Animal Protein Indonesia).
• Upside revision could arise to our thesis are earnings operations, which could be undermined by government outbreak of diseases, consumer impact of raw material prices, among others.
• The projected growth is on the back of
  1. resilient price of day-old Indonesia to continue in 2H18 due to a lack of market,
  2. stability in swine aiding the Vietnam swine operations, and
  3. its China milk yields.
• We detail our views in the following sections:

Undersupply of DOC to benefit poultry players in Indonesia

The tide has turned for the Indonesian poultry industry

• The tide has turned for the Indonesian poultry industry, as it recovers from oversupply conditions which had negatively impacted the poultry players’ profitability in the past. Several regulations have been rolled out by the government to control the situation and such efforts have paid off.
• The government’s intervention in the poultry industry includes:
  • Controlling the supply of DOC via multiple culling programmes to maintain the balance between supply and demand.
  • Implementation of benchmark prices.
  • Reduction of import quota of grandparent stock (GPS).
  • The use of local corn.

1H18 strong performance to continue into 2H18.

• In 2018, we have seen the undersupply situation for DOC and broiler resulting in a better average selling price (ASP). As of end-9M18, the DOC price stood at Rp5,243/chick (+26.8% y-o-y) and broiler price at Rp19,732/kg (+18.5% y-o-y). This has translated into a strong performance from the poultry players in 1H18, and we estimate this strength to continue in 3Q18.

What is behind the undersupply?

• The undersupply of DOC was due to the multiple effects stemming from the past regulations introduced by the government, such as:
  • Lower GPS import quota since 2017
  • Multiple culling programmes rolled out by the government and also control over eggs to be hatched
  • The ban on antibiotic growth promoter (AGP)
• The grandparents stock (GPS) import quota in 2017 was reduced to 650,000 birds (vs 675,000 birds in 2016), resulting in tighter demand and supply conditions. The more balanced supply and demand has led to a stable ASP for DOC and broiler. Besides that, the lower GPS import quota since 2017 and the ban on AGP since the start of the year have also led to a softer DOC supply in the market.
• In our view, the implementation of AGP has led to higher mortality rates in open house farms and we believe that the ban on AGP was the key reason for the steady DOC price in 3Q18. Under normal situations in previous years, DOC and broiler prices had started to decline after the Lebaran season, but this was not the case in 3Q18.

DOC and broiler prices should stay. 

• In our view, since 2017, the GPS import quota has been on a downtrend, which we think would result in an even tighter supply of DOC going forward. Thus, we believe that the high ASP of DOC and broiler will stay at the current level of around Rp18,000- 19,000/kg and Rp5,200-5,300/chick respectively.

Animal Protein Other (APO): Vietnam operation outlook

Share price in 2017 was impacted by its Vietnamese operations, which saw below-cost swine price due to reduction in China demand.

• The decline in swine price since late 2016, and through to 2017 was due to the sharp reduction in China's import of swine from Vietnam. This was mainly due to the Chinese government's concerns over the quality of Vietnam swine. The situation has resulted in a decrease in swine export volume and impacted the domestic swine price in FY17 (which fell below VND30,000/kg).

Recovery in swine price due to less supply in the market.

• The swine price in Vietnam has increased continuously from early 2018; and as of June 2018, the swine price was at VND47,635/kg. At this price, we believe that the farmers are already profitable (estimated breakeven cost at VND40,000- 42,000/kg).
• The improvement in the price of swine was due to the decrease in supply since last year. According to Vietnam Department of Livestock, the swine supply had shrunk by 5.8% y-o-y in FY17.

Swine price recovery looks sustainable at the moment.

• In our view, the recent rebound in swine price in Vietnam is expected to be sustained; as the supply of swine has declined since last year. In our model, we have assumed swine ASP at VND40,000/kg, resulting in a slight profit from this division in FY18F.
• Our assumption is based on higher volume growth due to lower competition from the local farmers,; as some of the farmers had closed down their business due to low swine price environment last year. Nonetheless, we should watch and monitor the potential higher supply of swine, as the price is already above the breakeven cost. There are potential worries that the farmers will increase their supply, thereby causing a decline in swine ASP.

Animal Protein Other (APO): Myanmar operation outlook

Intensifying competition in Myanmar would pressure margins.

• We view Myanmar as a stable business with growing feed volumes. In previous years, Myanmar had been enjoying a good operating margin (mid-teens) due to a lack of competition in the country. However, going forward we foresee a potential operating margin pressure arising from new competition from other players coming into the market.

China dairy operation outlook

Driving for higher milk yield, offsets weak raw milk price.

• The profitability of dairy business is determined by raw milk prices, feed costs, productivity, and overall efficiency. With a growing supply of low-priced imported milk powder, it seems difficult to see an inflection point in the China upstream sector. We have assumed flat raw milk price ASP in FY18F of RMB3.5/kg; mitigated by a higher average milk yield of 39.5kg/head in FY18F. i seeThat said, the group continues to focus on driving its milk yields per cow, which now stands at 37kg/day, significantly higher than China’s average of 21kg/day, and peers.
• Following the completion of its seventh farm in China last year and second farm in Indonesia this year, Japfa will pause its farm expansion in China. Therefore, we believe growth in sales volume will only come from improving milk yields in the near future. However, some volume growth might still be seen as Farm 7 is still running at only half of its milking capacity.

Recovery of raw milk price would be the key catalyst for the share price.

• We are positive on the dairy segment's potential growth going forward as the company has been showing operational excellence, but financial performance and profitability have been hindered by external factors (e.g. weak raw milk price). If we look at the company's sales volume performance, its sales volume posted a 40.2% CAGR between FY13-17. We estimate the sales volume to grow at 21% between FY17-20F. This was impacted by a weak ASP environment. Hence, should there be a recovery in China’s raw milk price and this should drive significant growth for Japfa’s dairy segment.

Key Risks

• The group’s operations are not without risks. Notwithstanding our positive view of the outlook, there remain several noteworthy risks to highlight, as follows:

Keep an eye on potential raw material price hike.

• As of end- 3Q18, the average domestic corn price reportedly increased to Rp4,073/kg (+4.5% q-o-q) due to lower corn production in Indonesia, as the big harvest season is already over (normally such big harvests happen in 1Q). We think that the higher corn price would not have a big impact on the margin of the poultry players, as ASP remains at a high level. In our model, we assume that the corn price would be at Rp4,165/kg for FY18F. Our assumption is based on the fact that the big April harvest is already over, fuelling expectations that domestic corn supply will head lower in 4Q18.
• Soybean meal is an important input for poultry producers, as it comprises 25% of their total raw material cost. The average soybean meal price in 3Q18 stood at US$321.8/ton or declined by -12.3% q-o-q, while the USD/IDR appreciated by 5% q-o-q to Rp14,600 in 3Q18. The weak soybean meal price was due to soybean oversupply in the US due to the ongoing US-China trade war. The weaker-than-expected soybean meal price would bode well for the performance of poultry producers – as the impact of a weakening USD/IDR will be minimal, the lower costs for a key raw materials could help stabilise margins.

Outbreak of livestock diseases, and consumers’ perception of consumption.

• Outbreaks of diseases could have a detrimental effect on the group’s operations. This could lead to regulatory requirement to destroy/cull its livestock, and/or lead to lower demand for such animal proteins. For instance, the previous outbreak of Avian Influenza (H5N1, H7N9 strains) had reduced demand for chickens and had an impact on prices of DOCs and chicken products. Recently, there have been reports of the spread of African Swine Fever in China, and five provinces in China have been affected by the virus (Liaoning, Henan, Anhui, Jiangsu, Zhejiang), according to media reports. While these are largely in the Northeastern and Eastern areas, and a distance from Vietnam, the United Nation’s Food and Agriculture Organisation (FAO) has warned that the movement of pig products could cause the disease to spread across borders.

Valuation

Reinstate BUY, with SOP-based Target Price of S$0.86 for 37% upside.

• We reinstate our coverage on this counter with a BUY call (with also a change of analyst) and a Target Price of S$0.86. This is based on sum of the parts of its various operations, based on FY19F EV/EBITDA. We apply a 10% holding company discount. Our Target Price implies 12.2x FY19F PE.
• Currently, Japfa is trading at 8.8x FY19F PE, at a discount vs regional average valuation PE of 14.3x FY19F and to its subsidiary company, Japfa Comfeed (JPFA) by 26%. We think that investors have not considered a recovery in Japfa's other businesses. If we exclude the stake in JPFA's valuation, the other businesses in Japfa would be trading at only 3.9x FY19F PE which appears to be undervalued (projecting US$17mn of net income in FY19F, based on our estimates).
• 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
  1. Dairy which continued to expand post 100% acquisition last year, and
  2. improvement in APO (Animal Protein Others) segment due to recovery of swine price in Vietnam which could sustain in 2H18.

David Arie Hartono DBS Group Research | Andy SIM CFA DBS Research | https://www.dbsvickers.com/ 2018-10-25

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