Japfa Ltd - DBS Research 2020-05-15: Swine & Dairy To Mitigate Weak Poultry

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

Japfa Ltd - Swine & Dairy To Mitigate Weak Poultry

  • Indonesia poultry prices weakened recently on oversupply; demand likely to remain weak in 2Q20.
  • Weakness in Indonesia to be partially mitigated by Vietnam; swine prices remained high at > VND70,000/kg.
  • Benefits of geographical diversification showing.
  • Trim forecasts by 9%/4%, but maintain BUY with revised TP of S$0.86.

Maintain BUY, Target Price revised to S$0.86.

  • We maintain our BUY recommendation for Japfa (SGX:UD2) with a revised Target Price of S$0.86. While we expect its Indonesian operations to face headwinds (Japfa Comfeed Tbk [JPFA]) due to lower broiler and day-old chicks (DOC) prices on weaker demand in 2Q20, we expect this to be partially mitigated by its diversified operations across other geographical areas.
  • Swine prices in Vietnam remained robust as of March, at c.VND70,000-80,000/kg. We trim our forecasts for Japfa by 9%/ 4% on weaker contributions from JPFA, offset by better contribution from Vietnam swine and China dairy operations.
  • Upside could come from higher-than-expected swine prices in Vietnam vs our assumption of VND55,000/kg for FY20, should prices stay alleviated. Despite our earnings cut, Japfa's valuation looks attractive at 5.5x/4.7x FY20F/21F EV/EBITDA.

Japfa's 1Q20 results review

  • Japfa reported its 1Q20 results, which were within expectations.
    • Revenue grew by 4.2% to US$949.9m while PATMI surged 3.5x to US$35.5m, mainly contributed by robust feed margins in its Indonesia operations, Swine business in Vietnam and Dairy in China.
    • Indonesia operations (JPFA) saw revenue increase by 1.5% while PAT improved to US$23.4m (+7.3% y-o-y). The performance was attributed to strong feed operating margins (estimated at 14%), arising from low raw material costs. This was, however, partially offset by its losses in its commercial farm operations amounting to US$10.6m due to lower broiler ASP. As indicated above, we do expect 2Q20 to be weaker on the back of weaker broiler and DOC prices in Indonesia, offset partially by strong feed margins.
    • Animal Protein-Others the star in 1Q20. In this quarter, APO was the star performer with revenue increasing by 12.4% to US$176.7m, while PAT surged 147% to US$16.6m. The increase is mainly due to robust swine prices in Vietnam, which remained high at over c.VND70,000/kg, compared to c.VND40,000/kg during the same period a year ago, based on our market sources. The higher prices helped to more than compensate for the contraction in volumes (-22% y-o-y). In addition, given its industrialised business model, Japfa was able to replenish its swine stocks faster vis-à-vis most competitors.
    • Dairy. Dairy saw decent top-line growth of 7.8% while PAT rose manifold to US$7.6m (+387.1% y-o-y). This was on the back of improvement in raw milk prices in China and higher sales volume of its branded milk in Southeast Asia.
    • Consumer food revenue was flat, but turned in a positive operating profit of US$3.3m from a loss of US$2.9m last year. This is likely attributed to lower costs of raw materials.

Diversified operations bearing fruit.

  • Looking ahead, despite the potential weakness from its Indonesia operations, we do expect this to be partially mitigated by its operations in Vietnam and China. Japfa’s operating profits, while still faced with the industry’s cyclicality, have seen contribution from Animal Protein Others (APO-Vietnam, India and Myanmar) and Dairy, take on an increasing and stable profile. This, in our view, vindicates management’s drive towards diversification.

Indonesia (JPFA operations)

Indonesia operations facing weaker broiler and DOC prices.

  • Tracking prices from the Indonesia Poultry Farmers Association or Pinsar, we note that the average broiler price dropped to Rp12,000/kg in April from Rp17,000/kg in March. While we have seen some recovery in early May, the weak prices for DOC does not bode well for the demand outlook.
  • Based on Arboge website, the average DOC price declined to Rp2,800/chick in April from Rp5,800/chick in March. We believe this was mostly due to oversupply conditions on the back of slower demand. As the months of fasting and Lebaran were approaching, farmers expected demand for chicken to increase, which was the case in the past years.
  • However, the demand turned out to be weak due to social distancing caused by the COVID-19 outbreak.

Looking ahead, we expect demand to be weak in 2Q20.

  • For JPFA, we have imputed lower broiler and DOC price assumptions of Rp16,000/kg (vs. Rp18,000/kg previously) and Rp4,800/chick (vs. Rp6,050/chick previously) respectively in FY20F. This is given our expectations for both prices to remain low in 2Q20 before recovering in the ensuing quarters. This is to factor in weak demand in 2Q20 due to the closure of wet markets, restaurants, and hotels caused by the COVID-19 pandemic in Indonesia.
  • Furthermore, we do not expect higher demand during Lebaran this year given the government’s dissuasion for workers to return to their respective hometowns.

Expecting JPFA’s feed business margins to remain resilient, to mitigate weaker broiler and DOC operations.

  • The lower prices of broiler and DOC would likely pressure JPFA’s EBIT margin this year, as the ASP might not be able to cover the production cost. The biggest contributor of production cost in DOC and commercial farm is feed cost, comprising raw materials of corn and soybean meals. As of end-April 2020, the average domestic corn price was reportedly stable at Rp6,068/kg (+1% y-o-y).
  • In our view, JPFA is most likely to ensure healthy margins for its feed segment and pass on the cost increase to customers. This is due to the fact that feed contributes a bigger percentage of revenue and EBIT to JPFA.

Vietnam swine prices remain high

Swine price still hovered above VND70,000/kg in 1Q20.

  • With the outbreak of African Swine Fever (ASF) since early 2019, this has had an impact on swine population with reports indicating that over 20% to almost 30% were culled (or about 6m pigs). This had an initial impact on swine prices in mid-2019, but that has reversed since then. As of 1Q20, we understand that pork prices remained at above VND70,000/kg.
  • While the Vietnamese authorities expect swine prices to moderate by end-2020, given the current high price and its impact on consumer inflation, there remains a significant buffer to our price assumption (vs current). We have pencilled in VND55,000/kg price in our forecasts for FY20F, vs the average price of VND70,000/kg seen in 1Q20. This should continue to bode well for Japfa.
  • Furthermore, over the longer term, the contraction in swine population should also augur well for larger industrialised that only about 35% of the total hog production are by large industrialised players, and the remaining majority by smaller household farmers. For Japfa, we understand that it has started to import pure line breeders from its partner Hypor to further improve the performance and swine genetics. This should aid in its longer-term growth in this segment.

Dairy – welcoming Meiji as strategic investor in its China Dairy operations.

  • As per Japfa’s earlier announcement on 15 April 2020, 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. We had shared our view on this potential transaction in our earlier note, and continue to opine that this is a positive development (See report: Japfa - DBS Research 2020-06-16: Welcoming Meiji As Its Dairy Partner In China).
  • To recognise gain of US$37m; proceeds to be applied towards loan repayment. As per our earlier note, the proposed transaction should result in an estimated gain of US$37m for the Group. However, with the divestment of its 25% stake, we do expect some dilution in its earnings, mitigated partially from lower interest rates as the proceeds will be used to pare down its debt.

Valuation and forecasts

Trim earnings by 9% for FY20F.

  • We trim our forecasts by 9%/4% for FY20F/21F, on expectations of a weaker contribution from its Indonesian operations arising from lower broiler and DOC prices, weaker IDR, mitigated partially by still elevated Vietnam swine prices.
  • That said, we do expect Indonesia poultry prices to recover progressively towards the end of 2020, as the demand-and-supply imbalances revert to normal. This could be accelerated by culling programmes instituted by the authorities as seen in the past.

Maintain BUY, Target Price: S$0.86.

  • Notwithstanding our earnings revision, we maintain our BUY recommendation on Japfa with a revised Target Price of S$0.86, indicating an attractive 51% potential upside. Our Target Price is based on sum-of-parts of its operations. We have imputed a lower valuation based on our reduced Target Price for JPFA (which was revised to Rp1,400 from Rp1,900), but offset by higher valuation for its Animal Protein and Dairy as we roll our valuations over to the average of FY20F/21F.
  • Our Target Price implies FY20F/21F EV/EBITDA of 6.5x/5.6x and PE of 12.6x/10.6x respectively, as compared to its historical average EV/EBITDA and PE of 5.3x/11x.
  • See Japfa Share Price; Japfa Target Price; Japfa Analyst Reports; Japfa Dividend History; Japfa Announcements; Japfa Latest News.

Andy SIM CFA DBS Group Research | Alfie YEO DBS Research | https://www.dbsvickers.com/ 2020-05-15
SGX Stock Analyst Report BUY MAINTAIN BUY 0.86 UP 0.840