■ Having recovered from day-old-chick (DOC) oversupply, breeding margin is now in an upcycle
■ Stable Rupiah, limited grandparent stock (GPS) supply improving purchasing power and low raw material costs point towards favourable earnings outlook
■ Oligopolistic structure and intense competition are a barrier for new entrants
■ Besides coverage on Japfa Ltd (BUY), we initiate coverage on Charoen Pokphand Indonesia (BUY), Japfa Comfeed Indonesia (BUY), and Malindo Feedmill (HOLD)
Ripe for picking
The valuation in the animal protein sector have largely recovered from Aug-15’s bottom, and are now trading between -1SD and average forward EV/EBITDA multiples. While the depreciation of the Rupiah continued to weigh on 3Q15 earnings, operating profits have bounced from 4Q14/1Q15 lows – driven by both volume and ASP. We expect valuations to move towards their respective historical average multiples (calculated between CY09 and CY13 to remove distortions caused by DOC oversupply in CY14 and CY15).
Favourable supply/demand outlook
A nationwide culling of 6m parent stock (PS) has been underway since end Oct-15, and with lower PS population, poultry breeders should see both lower feed costs and stable DOC prices. These, combined with a more stable Rupiah, reduced USD debt exposure, lower capital expenditure, limited supply of GPS (due to avian flu outbreak in the US and parts of Europe) and – in the case of Malindo Feedmill (MAIN) – additional equity injection, should result in sustained earnings recovery over the next twelve months. With the exception of MAIN, we believe this has not yet been fully priced in, despite the recent recovery in share prices.
Integration and overcapacity are high entry barriers
The sector is dominated by few players, who have in place a vertically integrated model and an efficient distribution network throughout the archipelago. This structure should remain unchallenged until breeding margins pick up significantly; and over-investment in the recent years would remain a deterrent for new entrants for some time, in our view.
JPFA is our IDX-listed pick
We initiate coverage on Charoen Pokphand Indonesia (CPIN), Japfa Comfeed Indonesia (JPFA), and Malindo Feedmill (MAIN), in addition to our existing coverage of Japfa Limited (JAP). Our top IDX-listed pick is JPFA which remains undervalued relative to its FY16F EBITDA, and offers 37% upside potential. We reiterate our BUY rating for SGX-listed JAP, which has 78% potential upside.
Risks to our call
While we believe the likelihood is low, we remain watchful on any steep depreciation of the Rupiah, disease outbreak, another miscalculated over-investment leading to a repeat of the overcapacity situation, as well as spikes in both raw material costs and interest rates. (Read Report)
Source : DBS Group Research