Japfa - UOB Kay Hian 2018-10-17: An Arbitrage Too Cheap To Ignore

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JAPFA LTD. (SGX:UD2)

Japfa - An Arbitrage Too Cheap To Ignore

• Japfa’s 52.4% stake in the IDX-listed PT Japfa TBK alone is equivalent to 93% market cap of Japfa, stub value of the other segments is only at 1.9x 2018F P/E.
• Japfa’s integrated agri-food business model, backed by more than 40 years of track record, enables it to ride on rising protein consumption among Asia’s growing middle class.
• After a perfect storm in 2017 due to adverse regulations, Japfa is on a strong turnaround path and we expect 2018 net profit to increase by more than 500% y-o-y.
• Initiate coverage with BUY and an SOTP-based target price of S$0.90, which implies 12.2x 2018F P/E, a 10.3% discount to peers’ 13.6x.

Company Background

• Started since 1975, Japfa has grown from a single poultry feed mill in Indonesia to a notable agri-food company with a presence in five countries.
• Continuous expansion into new geographies and other protein-related categories has allowed it to tap new growth opportunities and reduce market and protein risk. Its business is vertically integrated across the value chain from animal feed production to breeding and commercial farming.
• Japfa’s primary animal proteins are poultry, swine and dairy. It is the second-largest feed producer in Indonesia and generates the highest milk yield in China.
• The holding company, listed on the Singapore Exchange, holds a 52.4% stake in the Indonesia-listed PT Japfa TBK.
• Refer to the 33-page PDF report attached for further details on company background and industry overview. 

INVESTMENT HIGHLIGHTS

BUY for a free ride on segments that generate at least US$30m net profit a year.

• Our SOTP-based target price provides 47.5% upside and implies 12.2x 2018F P/E, a 10.3% discount to peers’ 13.6x. Japfa Ltd (Japfa) is deeply undervalued.
• Japfa’s 52.4% stake in the IDX-listed PT Japfa TBK alone is equivalent to 93% market cap of Japfa. It implies that Japfa’s three other business segments, which could generate at least US$30m net profit per year for 2018-20, are trading at 1.9x 2018F P/E.
• Japfa is currently trading at 8.3x 2018F P/E, at a significant discount of 39% to peers in the market and a 17% discount to its 52.4%-owned subsidiary. This valuation gap should narrow as concerns over the earnings drag from other businesses eases.

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Proxy to rising protein consumption from growing middle class.

• Japfa operates in some of the most populous emerging economies in Asia that cumulatively house around three billion people or 40% of the world’s population.
• According to the Organisation for Economic Co-operation and Development (OECD), levels of meat consumption in these markets, while growing fast, are still far below levels in developed markets and global averages. For example, Indonesia’s annual meat consumption in 2016 was at only 11kg/capita vs the global average of 34kg/capita.

On a strong turnaround path from 2018 onwards.

• 2017 saw a perfect storm with a weak poultry performance in Indonesia due to sluggish consumption and China’s ban on pork imports from Vietnam. The likelihood of multiple adverse factors across countries occurring simultaneously again seems remote.
• We expect 2018 to be a mean reversion year with core profit growing > 500% y-o-y, back to 2015-16 levels.

Established and diversified business model not fully appreciated.

• We think the market does not fully understand Japfa’s established business model, as:
  1. the business is complex with multiple proteins and countries;
  2. the stock is “thinly” covered; and
  3. it has a short listing history, since Aug 14.
• To better understand the business, we performed detailed studies on PT Japfa TBK, which contributes 69% of our 2018F profit forecast and has been listed on the IDX since 1989. Its financial performance for the past 15 years shows that the business is resilient.

Valuation: Deeply Undervalued vs Peers And Its Own Subsidiary

Initiate coverage with BUY and SOTP-based target price of S$0.90.

• Japfa’s stub value excluding its 52.4% subsidiary stake in the IDX-listed PT Japfa TBK implies that Japfa’s three other business segments, which could generate at least US$30m net profit for 2018-20F per year are trading at 2.4x 2018F P/E.
• Japfa is currently trading at 8.3x 2018F P/E, a significant discount of 39% to peers and a 17% discount to its 52.4%-owned subsidiary. This valuation gap should narrow as the concerns over the earnings drag from other businesses eases.

Our forecasts and target price are conservative vs 1H18 results and consensus.

• Compared to 1H18’s core net profit of US$67m, our 2018 forecast of US$101m is considered conservative as we provide a wide margin of error for any major swings in animal protein prices. In addition, our net profit forecast and P/E valuation basis for PT Japfa TBK are conservative compared to the street’s.
• Our 2018 and 2019 net profit forecasts for PT Japfa TBK are 8% and 17% below consensus, while our valuation multiple of 12.9x 2018F P/E multiple is also below consensus’ 14.7x. If we were to adopt consensus forecast and valuation multiple, our SOTP target price will increase 9% to S$0.98.
• At this point, we think there could be upside to our net profit forecasts as the prices of three key proteins:
  1. Indonesian poultry;
  2. Chinese milk; and
  3. Vietnamese swine remain stable.
• We value Japfa on a SOTP methodology, based on ascribed P/E multiples for its key business segments, which include:
  1. PT Japfa TBK;
  2. dairy segment; and
  3. animal protein other (APO).
• Our target price after incorporating a 10% holding company discount is at S$0.90, which implies 12.2x 2018F P/E, a 10.3% discount to peers’ 13.6x. We believe the market has yet to fully understand and appreciate Japfa’s diversified business model due to several factors, such as complexity of the business, thin broker coverage, short listing history and short track record of earnings. Refer to the 33-page PDF report attached for complete valuation details. 
• We believe the valuation gap should narrow as the market concerns will be addressed, when losses from smaller segments reverse.
• Details of our SOTP valuation methodology for each business segment:
  • PT Japfa TBK: Based on 12.9x 2018F core net profit. This is pegged to PT Japfa TBK’s 8- year P/E mean, it is also slightly below peers’ average of 13.6x.
  • Dairy: Based on 12.4x 2018F core net profit, this is pegged to the valuation multiple Japfa paid to acquire its remaining minority stake in 2018. This is at a 21.0% discount to China Modern Dairy’s 2018F P/E of 14.0x, which has the smallest market cap among all the China dairy peers, but its milk sales volume in 2017 of 1,149m kg is more than double that of Japfa’s 480m kg in the same year.
  • Animal Protein Others (APO): Based on 12.9x 2018F core net profit. Valued on a similar basis as PT Japfa TBK as the Vietnam swine and overseas poultry business also operate under the same business model as PT Japfa TBK.
  • Consumer food: We do not ascribe any valuation multiple for the consumer business which could hold some potential upside to our valuation. While 2017 recorded losses, the segment has posted small positive EBITDA contributions in prior years 2013-16. We expect EBITDA losses to narrow from 2019 onwards. The reason we ascribe zero value to the business is the much higher level of uncertainty in the timing of the EBITDA turnaround (as that is dependent on the behaviour of competitors).

John Cheong UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-10-17

SGX Stock Analyst Report BUY INITIATE BUY 0.90 SAME 0.90