Japfa Ltd - DBS Research 2020-03-04: Swift Recovery On Strong 4Q19 Showing

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

Japfa Ltd - Swift Recovery On Strong 4Q19 Showing

  • Strong closure to FY19 despite challenging start; 4Q19 saw good performance on volume/margins.
  • Indonesia operations to benefit from feed volume growth and stable prices.
  • Higher swine prices in Vietnam to more than offset volume drop.

Upgrade to BUY, Target Price raised to S$0.84.

  • We raise our recommendation for Japfa (SGX:UD2) to BUY and Target Price to S$0.84 representing 46% upside. Although plagued by broiler oversupply situation in Indonesia and African Swine Fever (ASF) in Vietnam earlier in 1H19, we believe operations are already on a stable platform and on a cyclical upturn with 4Q19 results as testament to the Group’s ability to deliver.
  • Looking ahead, we expect stable growth from its poultry operations in Indonesia, benefitting from poultry/aqua feed volumes, coupled with stable broiler/day old chick (DOC) prices. In Vietnam, concerns of swine volume contraction from ASF are valid, though the Group should benefit from higher pork prices. We believe this is not priced in. Trading at 5.1x FY20F EV/EBITDA and 7.7x core PE, below its historical mean valuation, Japfa looks attractive in our view.

FY19: Slow start, strong end; 4Q19 results above expectations.

  • Japfa (SGX:UD2) reported a strong set of 4Q19 figures with core net profit (without FX) at US$72.1m, a 2.7x surge from 4Q18.
  • Operating profit doubled to US$154.6m from US$77.3m in 4Q18 and a threefold surge from US$48.1m in 3Q19. The surprise came from Animal Protein Indonesia (Japfa Comfeed Tbk), Animal Protein Others, as well as its Dairy operations.
  • Final DPS of 1 Sct was proposed. A final DPS of 1 Sct was proposed, equating to a payout ratio of c.13% (FY18: 27%).
  • Gearing stood at 1x, expected to trend down. As of Dec 2019, the Group’s gearing stood at 1x. With the recent rights issue concluded earlier in Feb 2020, the Group’s proforma net gearing stands at 0.9x. We expect this to trend down further to 0.7x by end-FY20F, based on our current expectations of capex investments.

Animal Protein Indonesia (Japfa Tbk).

  • Japfa Comfeed Indonesia (JPFA) booked 4Q19 profit after tax (PAT) of US$49.2m (+64.5% y-o-y), bringing FY19 earnings to US$127m (-18.6% y-o-y). 4Q19 net profit was way above our estimates. This was driven by better-than-expected operating margin of 13% in 4Q19, bringing FY19 segment margin to 8.7%, above our estimates.
  • Commercial farm’s operating margin surprisingly stood at 12.5% in 4Q19, higher than 1.4% in 4Q18 as well as -5.7% in 3Q19. For the year, commercial farm margins were -0.3%, arising from losses incurred in the first nine months of FY19. The strong showing for 4Q was attributed to lower cost of goods (feed and DOC), coupled with higher broiler selling prices (c.Rp18,500/kg).

Solid performance in animal feed...

  • From JPFA, animal feeds reported EBIT growth of 96.4% y-o-y in 4Q19, with EBIT margin improving to 11.6% in 4Q19 (vs. 6.3% in 4Q18). In our view, this was due to relatively lower corn price at level of Rp5,800/kg in 4Q19 (vs Rp6,000/kg in 4Q18).

…but weak performance in DOC.

  • The strong operational performance in both commercial farm and animal feed segments helped to offset the weakness in the DOC segment that saw EBIT decline by 59.0% y-o-y in 4Q19, with EBIT margin plunging to 10.7% in 4Q19 (vs. 24.1% in 4Q18).
  • However, note that the DOC margin of 0.3% in 4Q19 was better than the previous quarter’s.

Animal Protein Others: Upside surprise from Vietnam.

  • This segment comprises largely of Vietnam, India and Myanmar operations. In FY19, revenue increased by 18.7% y-o-y to US$692m while operating profit also grew by a similar 19.6% to US$39.6m. The strong revenue growth was attributed to increases in Vietnam’s poultry and swine feed volumes (+16%) as well as feed volume in India (+24%). For the year, operating profit also saw a lift from its beef cattle sales in China, arising from robust selling prices. In 4Q19, revenue was US$210.5m, up by 28% y-o-y, from US$164.4m a year ago, while operating profit was US$32.8m (up by almost 3x from 4Q18).

Vietnam: Benefitting from high swine prices.

  • The growth in top line was driven by increases in feed volume in poultry and swine in Vietnam. In addition, despite overall industry contraction in swine fattening volumes, estimated at c.22% based on official statistics, swine fattening sales for the Group registered a surprising 1.1% increase to 65,000 tons.
  • In 4Q19, we understand that the Group also enjoyed strong surge in pork prices in the build-up to Tet, with prices surging to around VND90,000/kg, from around VND30,000-40,000 earlier in 2019 in the immediate aftermath of ASF outbreak.
  • While prices are understood to be currently lower at around VND76,000 (in late Feb), we believe this should continue to bode well for Japfa. In addition, given its swine breeding pyramid, with its own Great Grand Parent (GGP) farms, this could position the company in a better position to replenish its breeding stock. For FY20F, we have assumed Vietnam revenue to moderate down marginally on the back of lower feed and swine fattening volumes, mitigated partially by higher average pork prices.

Myanmar and India: Contribution relatively minor.

  • India sales revenue surged 33.6% y-o-y in FY19, driven largely by feed sales volume growth of 24%. However, given its investment and strategy to drive market share for the longer term, it sank into operating losses of US$1.2m, a reversal from US$3.7m profit a year ago. In Myanmar, revenue was relatively flat at US$81.6m (FY18: US$81.2m) while operating profit was at US$2m, a reversal from loss of US$2m in FY18.

Dairy: Reaping its rewards, though expect milk prices to take a step back on slower demand in near term.

  • Dairy Revenue saw an improvement of 15.3% y-o-y to US$471.5m, while operating profit increased by a larger 24.1% y-o-y to US$89.2m. This was helped by growth in both its China and Southeast Asia dairies business. In China, the Group benefitted from higher raw milk prices, which increased by 5% in 2H19. Operating margins for dairy improved to 26% in 4Q19, from 18.2% in 4Q18 and 18% in 3Q19.

COVID-19 could take some shine off raw milk prices.

  • With the outbreak of COVID-19, there are expectations that this could have some impact on raw milk demand in China. In terms of supply chain, raw milk has not been significantly impacted, while that for feed raw materials could be related to transportation costs. As such, we have imputed an average 3% decline in ASP of raw milk for FY20F, and a lower operating margin arising from higher costs.

Consumer food: Still nursing losses, albeit smaller.

  • Japfa’s Consumer Food (CF) segment continued to register operating losses, albeit lower at -US$5.7m for FY19 (vs FY18: loss of US$16.6m), while revenues dipped by 6.2% to US$190.7m. In 4Q19, operating loss amounted to US$1.5m, an improvement from 4Q18’s -US$3.6m but worse off than 3Q19’s US$1.3m. The full-year improvement arose largely from management’s initiatives in brand rejuvenation, expansion of market position and cost efficiencies.
  • We understand that this segment continues to be a long-term strategic focus for the Group to potentially capture changing consumer preference towards chilled, frozen and convenience products. Thus, investment is likely to continue and we expect operation losses in the near term, although small.

Forecasts and valuation

Raise forecasts by 40%; Target Price raised to S$0.84.

  • The recovery came faster than our expectations, in particular from Vietnam. On the back of a strong 4Q19 performance, coupled with expectations of growth in its poultry/aqua feed volumes in Indonesia and resilience of its Vietnam swine operations, we raised our FY20F forecasts by 40%.
  • We upgrade our recommendation to BUY from HOLD and revised our sum-of-parts-based Target Price to S$0.84, representing 46% upside. Although plagued by broiler oversupply situation in Indonesia and African Swine Fever (ASF) in Vietnam earlier in 1H19, we believe operations are already on a stable platform and on a cyclical upturn with 4Q19 results as testament to the Group’s ability to deliver. Trading at 5.1x FY20F EV/EBITDA and 7.7x core PE, below its historical mean valuation, Japfa looks attractive in our view.
  • Our Target Price is based on enterprise valuation of its segments – Animal Protein Others and Dairy. Given the subdued earnings of its consumer food segment, we peg our valuation to 2x of its estimated book value. We based our valuation of its Animal Protein Indonesia on our Target Price for Japfa Comfeed Tbk of Rp1,900.
  • See Japfa Share Price; Japfa Target Price; Japfa Analyst Reports; Japfa Dividend History; Japfa Announcements; Japfa Latest News.

Risks to our view.

  • Our thesis is premised on stability in its feed margins in Indonesia on the back of our expectations that management would be able to mitigate cost fluctuations with its forward purchases and cost pass-through. Furthermore, we also expect the government’s culling programmes to provide better stability to broiler prices in Indonesia.
  • For Vietnam, our expectations are premised on higher swine prices more than offsetting lower swine fattening volumes, while in China, we expect COVID-19 to only have a temporary impact on raw milk prices.

Andy SIM CFA DBS Group Research | Alfie YEO DBS Research | https://www.dbsvickers.com/ 2020-03-04
SGX Stock Analyst Report BUY UPGRADE HOLD 0.84 UP 0.530