Japfa - DBS Research 2020-04-16: Welcoming Meiji As Its Dairy Partner In China

JAPFA LTD. (SGX:UD2)

Japfa - Welcoming Meiji As Its Dairy Partner In China

Meiji to acquire 25% minority stake in Japfa’s China dairy business, along with raw milk supply contract.
Transaction amount of US$254m values the business at c.10x EV/EBITDA, 2x P/BV; gain of US$37m.
Proceeds to be applied towards term loan repayment.
Minor dilution to earnings estimated, but a positive move; maintain BUY.

Japfa (SGX:UD2) announced on 15 April 2020 that it has entered into a conditional Sale and Purchase Agreement (SPA) with Meiji Co., Ltd (Meiji) for the sale of a 25% stake in AustAsia Investment Holdings (AIH). In connection with the transaction, AIH and Meiji will also enter into a contract to supply raw milk to Meiji on a 5-year rolling basis that will be renewed annually.

Based on the company’s announcement, management believes that this transaction will allow it to build a strategic partnership with the Group’s growing dairy customer, with a view to build AIH to be the largest independent raw milk producer in China.
Furthermore, the raw milk supply contract provides a stable revenue stream.
Lastly, the proceeds will be used towards the repayment of its term loan facility that was drawn down for its earlier acquisition of interest it did not already own in AIH back in Dec 2017.

The consideration for the Proposed Transaction amounts to US$254.4m and “was arrived at on a willing-buyer, willing-seller basis”.

The transaction values the restricted AIH at just over US$1.01bn and is estimated to be at c.10x EV/EBITDA, c.2x P/BV and P/NTA of its dairy business in China. This compares relatively favourably to its proforma cost of investment in AIH of US$868m (as at 31 Dec 2019), and hence the company is expected to recognise a gain of c.US$37m.

The company will seek shareholders’ approval at an Extraordinary General Meeting (EGM) to be convened after its AGM on 25 June 2020 or thereabout. Thereafter, management expects the deal to be completed around July 2020.
There are also conditions precedent, including restructuring of its dairy business, satisfactory site visit by Meiji to AIH farms and joint venture dairy factory in China, and no material breach of obligations and warranties.

Management shared that while raw milk prices softened in the past months during the outbreak of COVID-19, its supply chain and farm operations were not affected. It has also seen an increase in enquiries, which is an early indication of demand, particularly as China recovers from the outbreak.
Furthermore, management shared that February and March are traditionally low months within the year.

We see this transaction as a favourable move for Japfa, with the entry of a credible strategic investor coupled with supply contract. This would provide more certainty on the demand for its raw milk and future expansion, and at the same time enable the Group to leverage on Meiji’s growth in China.
In addition, the transaction price also demonstrates the astuteness of its earlier move to acquire the interest it did not already own back in late 2017.

Based on proforma 2019 figures shared in the announcement, the disposal of the 25% minority stake in AIH will lower 2019 EPS by c.5%, we are maintaining our FY20F/21F forecasts for now. Our back-of-the-envelope estimates suggest a similar impact on FY20F forecasts, all else constant.

We maintain our positive stance on the counter. While the current COVID-19 situation could have some impact on its operations, particularly resulting in slower near-term demand for poultry and impacting on broiler prices particularly in the lead-up to Lebaran in Indonesia, we believe this is temporal in nature.
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Given the staple profile of its products, we believe the company should be less impacted. Along with the completion of this transaction and application of proceeds towards its loan, this should allay concerns of refinancing in the current environment.

Andy SIM CFA DBS Group Research | Alfie YEO DBS Research | https://www.dbsvickers.com/ 2020-04-16

SGX Stock Analyst Report BUY MAINTAIN BUY 0.840 SAME 0.840