Japfa Ltd - Maybank Kim Eng 2019-09-13: 2H19 More To Do With Oink, Not Cluck

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Japfa Ltd - 2H19 More To Do With Oink, Not Cluck

Receding ASF impact is the key catalyst to watch for

  • Indonesian soft poultry prices remains a focus area for some investors but the y-o-y drop from the exceptionally high price environment of 2018 has been tracking our expectations so far. The real wild card for Japfa (SGX:UD2)’s 2H19 performance lies with the near-term unpredictability of ASF on Vietnam hog volumes and prices.
  • Valuations, while attractive, will stay in the back seat for now, but current risk-reward may be interesting for long term investors.
  • Our estimates and SOTP-based Target Price are unchanged. BUY.

The chickens are alright

  • July/Aug PT Japfa farm-gate broiler prices were higher than the seasonal lows of 1H19. While this still appears to be the main concern in the market, the y-o-y monthly price declines are to be expected with the unusually high base of 2018.
  • The YTD average of IDR17.1k has so far been tracking in line with our full-year outlook of cIDR17k and we think there may be some incremental upside to these levels in 2H19 with the government mandated culling in the past couple of months.

It’s uncertainty in Vietnam African Swine Flu timeline that concerns us

  • African Swine Flu (ASF) spread rapidly across China’s farms for 10-12 months before some provinces saw a deceleration in the number of new monthly outbreaks. In Vietnam there is still limited clarity on this front; ASF broke out in North Vietnam in early-2019.
  • New outbreaks are reportedly slowing there and pork prices inched up m-o-m for July. But South Vietnam, where ASF broke out a few months after the North is not seeing any such slowdown or signs of pork price inflexion yet.
  • Moreover, the heavy rains in the South could possibly fuel its spread across farms in coming months.

2018 star to YTD 2019 flop – what’s next?

  • Japfa was one of the best performing stocks in our coverage in 2018 (+44% abs; +55% rel) but may close 2019 as amongst the worst (YTD -32% abs; -37% rel). Stock price is at the lows seen in 1Q18 in the aftermath of the China pork ban that resulted in a c20% industry oversupply.
  • Japfa’s evaluation of a worst-case ASF scenario patterned on some of China’s worst affected provinces is a c25% stock cull. In a sense, markets appear to have already largely priced in such a worst case.
  • Price catalysts may take time to materialise but forward valuations are attractive and the risk-reward may be interesting for long-term investors.

Vietnam ASF update

  • ASF has spread rapidly throughout Vietnam since the first reported outbreak in Feb-2019. The country’s Ministry of Agriculture and Rural Development (MARD) reported that the disease had spread to all 63 of its provinces. There is no vaccine treatment for ASF and stringent biosecurity practices are the only way to control its spread at the moment.
  • MARD also reported that around 4.7m hogs had been culled since the outbreak (we estimate this is c16% of its pre-outbreak hog population).
  • While the spread of ASF was initially across backyard and small farms, industrial farming companies, including Japfa, have also been affected in recent months.
  • Japfa management have estimated a couple of impact scenarios based on the Chinese experience where the disease has been widespread for almost two years. Some of China’s worst affected provinces have seen around 25-28% of stocks get culled from pre-outbreak levels.
    • Worst case: Japfa management estimates that if 25% of its commercial stock were to be culled, the negative impact to operating profit could be to the tune of USD30m if pork ASP stays low throughout the year.
    • Moderate case: In a more moderate impact scenario that involved 25% of stock getting culled but an ASP recovery in the 2H19, the estimated operating profit impact would be cUSD15m.
  • There are three potential offsets to these ASF impact scenarios above:
    • Firstly, as an industrialised farming company, the risk to Japfa’s stock is arguably lower due to wide site diversification and higher biosecurity measures than posed to hybrid and backyard operations; we estimate Japfa to be amongst the three largest industrialised farmers in the country. Its hog operations have one Great Grandparent, six Grandparent farms, 22 Parent farms and over 300 company and contract fattening farms diversified geographically across the country.
    • Secondly, pork prices could rise much sharper than assumed and potentially offset the loss of stock, like in China where shortages have resulted in pork prices skyrocketing in some provinces and even at a national level with increases of as much as 30-50% y-o-y in recent months (Aug 2019 prices up 47% y-o-y);
    • Thirdly, Japfa’s poultry operations in Vietnam would possibly benefit from some consumption substitution from pork to poultry.
  • In the medium term, the impact of ASF would be to shift the percentage share of industry production towards industrialised farming from backyard and hybrid farms. The estimated share in hog farming for industrialised farms at end-2018 was estimated at c35%.

Valuation and risks

  • Our forecasts, Target Price and valuation methodology are unchanged.
  • Japfa is trading at 7.1x FY20 P/E, half the levels of its APAC protein peer average of 20.6x.

Neel Sinha Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2019-09-13
SGX Stock Analyst Report BUY MAINTAIN BUY 0.730 SAME 0.730