Japfa Ltd - DBS Research 2019-08-05: Not Time To Breed Yet

JAPFA LTD. (SGX:UD2) | SGinvestors.io JAPFA LTD. (SGX:UD2)

Japfa Ltd - Not Time To Breed Yet

  • JAPFA (SGX:UD2)'s Indonesia and Vietnam operations dragged performance.
  • Continued pressure likely to hit Indonesia and Vietnam operations in 2H.
  • Long-term outlook remains attractive.
  • Maintain HOLD call with lower Target Price of S$0.53.

Maintain our HOLD call with revised Target Price of S$0.53.

  • We maintain our HOLD call on Japfa with a lower Target Price of S$0.53 (from S$0.61) after we rolled forward our valuation to FY20F and adjusted our EV/EBITDA multiple.
  • While Japfa's share price has corrected by c.40% from its peak earlier this year, in the near term, we see continued challenges in its Indonesia operations in 2H19 and uncertainties arising from the outbreak of African Swine Fever (ASF) virus in Vietnam.
  • Japfa’s 2Q19 headline earnings came in at US$5m, down by 83% y-o-y from US$29.6m in 2Q18. Core profit after tax and minority interests (PATMI) without forex was US$16.9m, down 56% y-o-y from US$38.4m.

Where we differ: Lower end of consensus expectations.

  • Our earnings are at the lower end of consensus figures. 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 group’s diversification 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 the group.

WHAT’S NEW - Indonesia and Vietnam operations dragged performance

2Q19 core profit (without forex) fell 56% y-o-y.

  • Japfa’s 2Q19 headline net profit came in at US$5m (down from US$29.6m in 2Q18) which formed only 22.9%/16.7% of our original/consensus estimates respectively. Core PATMI (without forex) came in at US$16.9m, down 56% from US$38.4m. This brought the 1H19 core PATMI to US$35.8m, representing 63%/47% of our and consensus estimates, respectively.
  • The weak performance was driven by lacklustre contribution from Japfa Comfeed Tbk (JPFA). The latter’s EBIT declined by - 27.2% y-o-y to US$65.2m. The weak result was due to the slippage of broiler and day-old-chicks (DOC) prices at the end of 2Q (or at June 2019) and higher corn price which pressured broiler EBIT margin in 2Q19. On the other hand, the group’s Animal Protein Other (APO) segment posted a negative EBIT in 2Q19 of -US$0.10 or down by 101.4% y-o-y on the back of lower swine fattening ASP due to African Swine Fever, largely due to the impact of African Swine Fever outbreak in Vietnam.

Weak contribution from JPFA.

  • JPFA booked 2Q19 PATMI of US$18.6m (-23% y-o-y). JPFA’s core PATMI came in at US$17.4m (-43.9% y-o-y). The weak result was mostly caused by;
    1. higher corn prices which pressured margins in 2Q19, 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 cost.

Indonesia operation revenue improved mostly due to feed business.

  • JPFA’s revenue growth was mainly contributed by higher sales volume for poultry feed and aqua feed which grew approximately by 9%/18% respectively; as well as higher ASP for poultry feed. Furthermore, in 2Q19, operating profit amounted to US$62m (including a US$16m reversal of an overprovision of import costs made in previous years).
  • Excluding the one-off items, feed EBIT margin stood at 11% (vs. 15% reported in 2Q19).
  • Meanwhile, as per our expectations, DOC ASP saw a decline on the back of potential oversupply of DOC in the market. The average DOC price in 2Q19 was Rp4,900 (-23% q-o-q; - 6% y-o-y).

Commercial farm operations recorded an operating loss of US$8.8m in 2Q19, down from an operating profit of US$33.4m in 2Q18.

  • In Indonesia, a weaker-than-expected growth in poultry demand, coupled with an oversupply of broilers in 2Q19, dragged down broiler ASP.

APO reported an operating loss of US$0.1m in 2Q19.

  • APO outside Indonesia contributed 2Q19 earnings before interest, taxes, depreciation and amortisation (EBITDA) of US$6.4m (vs US$12.6m in 2Q18). The group attributed the weak performance mainly to its Vietnamese operations which represented the bulk of its APO business. In 2Q19, the Vietnam operation recorded an operating loss of US$2.2m mainly caused by lower swine fattening ASP due to African Swine Fever.
  • Meanwhile, a biological assets fair value loss of US$4m was recorded in 2Q19 due to lower swine prices.
  • While the poultry sector in Myanmar remains competitive, Japfa’s operations in that country reported profits for the second consecutive quarter.

Dairy segment revenue higher, but profit impacted by higher costs.

  • Japfa’s dairy segment revenue grew by 14.6% y-o-y to US$109 m in 2Q19. This segment recorded a lower operating profit of US$16.2m in 2Q19, compared to an operating profit of US$16.8m in 2Q18. This was due to higher feed costs and imported price of alfalfa. The increase in revenue was largely driven by improved total sales volume in Southeast Asia (SEA) and higher ASP in China by 7% y-o-y.

Consumer food EBIT remained negative.

  • The consumer food segment’s EBIT contribution remained negative at -US$2.6m in 2Q19 due to;
    1. lower ASP of ambient food products on increased 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.


Indonesia operations: Higher costs to weigh on margins.

  • As of June 2019, the average domestic corn price reportedly rose to Rp5,800/kg (+46.8% y-o-y) due to lower corn production in Indonesia. We think that higher corn prices could affect poultry players’ profitability and earnings in FY19F, given the implications on feed EBIT margins, and directly impact the EBIT margin of DOC and broiler segments.

Government proactive measures to stabilise broiler price in 2H.

  • Overall, we noticed some price fluctuations, but they were rather short term in nature. We believe an oversupply situation like the one in 2014-2015 and 1Q17 should not happen again after witnessing the government’s proactive stance in managing supply to reduce price fluctuations. We also believe the recent government regulation should be able to support and stabilise broiler prices in 2H19.
  • But we do not expect broiler prices to be like last year, when the broiler price stood at Rp19,250/kg in 2H18. That was a one-off event arising from the undersupply of DOC in the market which cause the ASP to jump significantly. The cost of broiler production stood at Rp18k-18.5k/kg as of 2Q19; but, with the potential higher corn price in 2H19, we believe that the cost of production could increase as well.

DOC margin would not be as high as last year.

  • Since 1Q16, the DOC EBIT contribution has improved and remained stable with an average EBIT contribution of 27% from FY16-1Y18 (vs -7.3% in FY13-FY15) for Japfa Comfeed (JPFA). The situation is similar to Charoen Pokphand Indonesia (CPIN) where the average DOC EBIT contribution is at 18% from FY16-18 (vs 2.9% from FY13-15). The stable EBIT contribution from the DOC segment was due to the stable price of DOC at above Rp4,200/chick during that high period.
  • With the high corn price – we expect breeding operations (or DOC segment) to be under pressure and we expect to witness softening of 2H EBIT margins, while prices may not increase by much. This is based on the current price of DOC (Rp3,120/chick in June) and we expect DOC price to stay at around Rp3,500-4,000/chick for the remainder of the year given the potentially higher supply of DOC in the market due to higher GPS import quota last year. As of 2Q19, the cost of broiler stood at Rp5,400/chick.

Vietnam operations: ASF update, affected c.10% of total swine population.

  • African swine fever (ASF) continues to spread rapidly throughout Vietnam, despite continuing efforts by the Vietnamese Government (GVN) to limit the impact.
  • According to USDA, as of17 June 2019, the disease had spread to 58 out of 63 municipalities and provinces across the country with 2,637,051 pigs depopulated, equal to nearly 9.4% of the country’s total swine population.

Implications and inflexion point cloudy at current juncture.

  • The African Swine Fever situation could potentially change the purchasing behaviour of the consumers. If we looked at the African Swine Fever case in China, there are several impacts that we could draw from:
    • Production will shift towards large-scale commercial model as potentially some of the small farms would exit the market due to losses.
    • Shift towards other protein (beef, poultry, and seafood) to meet pork deficit and we see poultry benefitting the most.
  • The African Swine Fever situation had lowered the ASP of fattening pork in 2Q19. We understood that the price of pork in South Vietnam is more severe compare to the North Vietnam. As of 2Q19, the South Vietnam, the price of pork was at an average VND30k/kg; while, in North Vietnam stood at VND40k/kg. In our assumption, we have already priced in the potential impact from African Swine Fever by lowering the feed volume assumption of the swine division and assumed soft swine ASP vis-a-vis last year. We have also factored in the potential higher volume of feed and broilers sold in Vietnam. That said, there remains a high level of uncertainty on the outlook to be able to predict the inflexion point at this juncture.

Valuation & Forecasts

Maintain HOLD call with lower Target Price of S$0.53.

  • Our Target Price is based on sum-of-parts (SOP) valuation. We roll our valuation forward to FY20F and adjust our EV/EBITDA multiple, as follows:
    1. APO based on 20% discount to Japfa Comfeed Indonesia’s historical mean;
    2. Dairy segment, 10% discount to regional EV/EBITDA.

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. long-term Vietnam operation outlook, and,
    3. potential upside from the dairy segment with potential improvement in raw milk prices.
  • We expect to see its Indonesian and Vietnam 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 for Indonesia operation. While, we probably will see a pressure in the swine fattening ASP for the remaining year on the back of African Swine Fever case.

David Arie Hartono DBS Group Research | Andy SIM CFA DBS Research | https://www.dbsvickers.com/ 2019-08-05
SGX Stock Analyst Report HOLD MAINTAIN HOLD 0.53 DOWN 0.610