Japfa Ltd - DBS Research 2019-05-02: Near-Term Hiccups

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JAPFA LTD. (SGX:UD2)

Japfa Ltd - Near-Term Hiccups

• JAPFA LTD. (SGX:UD2)'s 1Q19 below our and consensus estimates.
• High corn prices and soft broiler prices hampered its Indonesian operations.
• APO segment continues positive momentum.
• Downgrade from BUY to HOLD.

1Q19 results below expectations; downgrade to HOLD with revised target price (TP) of S$0.61.

• JAPFA LTD. (SGX:UD2)’s 1Q19 headline earnings came in at US$7.8m, down by 53% y-o-y from US$16.7m in 1Q18. Core profit after tax and minority interests (PATMI) (w/o foreign exchange (forex)) was US$18.9m, down 33% y-o-y from US$28.3m.
• We downgrade our call to HOLD to factor in the near-term overhang in its Indonesian operations, Japfa Comfeed (JPFA).
• We estimate a lower contribution from JPFA in FY19F on the back of;
  1. softer earnings before interest and taxes (EBIT) margin arising from higher corn prices and,
  2. potential normalisation of average selling price (ASP) growth of its day-old chicks (DOC) division in Indonesia on the back of expectations of higher supply in 2H19.

Where We Differ: Lower end of consensus.

• After our earnings revision, we are at the lower end of consensus estimate. While we believe in the long term structural growth in animal protein consumption, we believe that Japfa’s Indonesian operations JPFA (currently its largest profit contributor) is undergoing near-term cyclical pressures.
• In the long term, the diversification of the Group across different geographies would help mitigate the fluctuations.

Potential Catalysts:

• A benign raw material environment and higher ASP for DOC and broiler could lead to a better profit outlook for Japfa.

Valuation:

• Our Target Price is based on sum-of-parts valuation.
• Our Target Price, after incorporating a 10% holding company discount, is S$0.61 (which implies 14x FY19F price-earnings (PE)).

Key Risks to Our View:

• The upside catalyst would come from better broiler prices for its Indonesian operations and lower-than-expected corn prices.

WHAT’S NEW - Vietnam improvement not offsetting Indonesian weakness

1Q19 core profit (w/o forex) down by 33%.

• Japfa’s 1Q19 headline net profit came in at US$7.8m (down from US$16.7m in 1Q18) which formed only 8.5%/7.1% of our original/consensus estimates respectively. Core PATMI (without forex) came in at US$18.9m, down 33% from US$28.3m. The weak performance was driven by lackluster contribution from JPFA. The latter’s EBIT declined by -36.9% y-o-y to US$35.6m. The weak result was due to the soft broiler price in 1Q19 and higher corn price which pressured broiler EBIT margin in 1Q19.
• On the other hand, Japfa’s Animal Protein Other (APO) segment posted strong EBIT in 1Q19, back to positive US$10.5m (from negative US$0.1m in 1Q18).

Weak contribution from JPFA.

• JPFA booked 1Q19 earnings of Rp310.7bn (-28% y-o-y; -37.3% q-o-q). The result was below our and consensus expectations, which only formed 12.6%/12.9% of our FY19 estimates respectively. The weaker-than-expected result was mostly driven by;
  1. higher corn prices which pressured margins in 1Q19 and,
  2. soft broiler prices which led to weak EBIT margins in the broiler division; as the cost of goods sold remained high from higher feed and DOC costs.

JPFA: DOC EBIT margin remained strong due to high DOC prices.

• In 1Q19, DOC revenue increased by 34.6% y-o-y to Rp790.9bn (-1.7% q-o-q) on the back of strong ASP in 1Q. The average DOC price in 1Q19 was Rp6,407/chick (+35.1% y-o-y).
• We think that there was still undersupply in 1Q19 which resulted in DOC price remaining high. However, we do not expect the high EBIT margins to sustain into the latter part of this year. This is due to a potentially higher DOC supply in 2H19F which could lower ASP.

JPFA: High corn and DOC prices impacted broiler margins, resulting in negative broiler EBIT margins.

• Broiler revenue declined by -1.5% y-o-y to Rp3.0tr (+5.3%% q-o-q), mostly driven by weak ASP which declined by 11.9% in 1Q19. As a result, DOC EBIT margin slumped to -8.3% in 1Q19 (vs. +7.2% in 1Q18 and +1.4% in 4Q18) due to high cost of raw materials and DOC prices.

APO recovery in Vietnam division continued in 1Q19.

• APO outside Indonesia contributed 1Q19 earnings before interest, taxes, depreciation and amortisation (EBITDA) of US$16.6m (vs US$2.6m in 1Q18). The group attributed the improved performance mainly to its Vietnamese operations which represents the bulk of its APO business. This segment experienced revenue growth driven by higher ASP and sales volume across the board.
• In particular, the sales volumes for poultry and swine feed grew by approximately 20% and 10% respectively. The y-o-y return to profitability for its Vietnamese operations was primarily contributed by higher swine ASP and marked its fourth consecutive quarter of profitability.
• While the poultry sector in Myanmar continues to remain competitive, Japfa’s operations in that country broke even following three consecutive quarters of losses, as a result of improved operational efficiency through cost reduction initiatives. Profit from its feed operations offset the operating losses from DOC and broiler production in the country.
• India is another key growth market in the longer term. Japfa’s current focus is to grow the feed business, which experienced a 39.3% y-o-y volume growth.

Dairy segment revenue continues to rise.

• Japfa’s dairy segment revenue grew by 12.4% y-o-y to US$111.8 m in 1Q2019. This segment recorded a lower operating profit of US$17.7m in 1Q19, compared to an operating profit of US$19.3m in 1Q18. This was due to higher feed costs and imported price of alfalfa.
• The increase in revenue was largely driven by improved raw milk prices as well as milk yields in China. Japfa’s focus is to continue improving milk yields and volumes to mitigate price fluctuations and improve profitability.

EBITDA remained negative in 1Q19, as expected.

• The consumer food segment’s EBITDA contribution remained negative at US$0.6m in 1Q19 due to;
  1. lower ASP of ambient food products due to increase market competition,
  2. inability to pass on the increased production costs arising from higher chicken raw material prices and,
  3. continued investment in advertising and promotion (A&P) to maintain market share.

Outlook

Cut FY19F/20F EBITDA by 24%/16%.

• Adjusting for the weak JPFA results in 1Q19, we made changes to Japfa’s EBIT margins (to take into consideration higher corn prices and lower broiler prices) which resulted in lower earnings and EBITDA margin. The changes in our JPFA estimates are:
  • We lower our gross profit margin to 16.7%/17.2% in FY19F/20F (from 21.3%/20.6% previously) respectively. The new gross profit margin factors in potentially higher corn prices in FY19F.
  • We cut our EBIT growth asssumption by -42%/-33.1% in FY19F/20F respectively. The lower assumption is to factor in the;
    1. slight adjustment in feed EBIT margin to 11.8%/12.3% in FY19F/20F (previously 12.1%/12.7%), respectively; to factor in the higher corn prices,
    2. slashed our broiler EBIT margin to 0.4%/1% in FY19F/20F (previously 3.6%/3.7%) to factor in higher feed prices and,
    3. cut our DOC EBIT margin assumption to 15% in FY19F (from previously 19%) to factor in the potentially higher supply of DOC in 2H19 which should bring down DOC prices.
  • Our FY19F/20F earnings assumption also declines by 49%/38%, respectively.
• Our changes to JPFA forecast have consequential effects on Japfa’s forecast, as follows:
  • We lowered Japfa revenue estimates in FY19F/20F by 4.7%/1.4% respectively to factor in lower JPFA revenue.
  • We cut Japfa EBIT forecast by 33%/22% in FY19F/20F respectively to factor in JPFA’s potentially weaker EBIT margin on the back of;
    1. high corn prices in Indonesia,
    2. soft broiler prices due to weak demand,
    3. potential pressure in broiler EBIT margin performance and,
    4. normalisation of DOC EBIT margin in FY19F due to potentially higher supply into the market in 2H19.
  • Our Japfa FY19F/20F earnings forecast is lowered by 39%/19% respectively.

Valuation & Forecasts

Downgrade Japfa from BUY to HOLD with a new Target Price of S$0.61/share.

• We employed sum-of-parts (SOP) valuation based on enterprise value (EV)/EBITDA multiple on each segment. Our downgrade on JPFA’s share price and adjustments to its EBITDA estimates in FY19F has an impact on its EBITDA contribution to from Japfa. As a result, we downgrade our call to from BUY to HOLD.

Long-term growth but near-term cyclical headwinds in Indonesia.

• We continue to believe in the Group’s long term prospects on;
  1. the structural animal protein consumption story in Indonesia,
  2. Vietnamese operations to continue its good performance on the back of high swine prices and,
  3. potential upside from the dairy segment with potential improvement in raw milk prices.
• Currently, its dairy growth is driven mostly by an improvement in milk yields and benign raw milk prices. However, we expect to see its Indonesian operations face near-term cyclical challenges on the back of normalisation of growth (vs last year), and margin pressure from higher corn prices, soft broiler prices and potentially more DOC supply coming into the market.

David Arie Hartono DBS Group Research | Andy SIM CFA DBS Research | https://www.dbsvickers.com/ 2019-05-02

SGX Stock Analyst Report HOLD DOWNGRADE BUY 0.61 DOWN 0.800