BUY. Serving up a high-protein diet. Japfa Ltd (JAP SP) Shaken, but not stirred; Initiate BUY. Consumer Staples. Leveraged to a growing middle class

Transcription

1 Consumer Staples Singapore.64 June 21, 218 Japfa Ltd (JAP SP) Serving up a high-protein diet BUY Share Price SGD.61 12m Price Target SGD.86 (+42%) Shaken, but not stirred; Initiate BUY After a forgettable 217 marked by the impact of regulation and other adverse market factors that affected a number of its divisions, we believe Japfa is on a recovery path and see FY18E-2E profit back up to USD89-116m levels from USD16m in FY17. Its integrated industrialised farming model across multiple proteins and geographies in Asia should make it a long-term winner from the secular trend of rising protein consumption in Asia s growing middle class. Around 7% of our FY18E EBIT forecast is derived from the relatively stable animal feed and dairy segments. Japfa currently trades at 9x FY18E P/E while our SOTP based TP of SGD.86 implies 14x FY18E P/E, a 13% discount to peers 16x. Leveraged to a growing middle class OECD estimates per capita meat consumption in some of Japfa s key emerging markets of Indonesia, Vietnam and India at just a fraction of the levels in developed markets. Given the positive correlation between income levels and meat consumption, it estimates 11-13% CAGR in the latter over for these markets. We believe Japfa is well positioned to capitalise on this macro trend. Recovering from a perfect storm Japfa s diversified portfolio somewhat alleviates single market / protein risks. That said, 217 turned out to be a perfect storm with weak poultry performance in Indonesia due to sluggish consumption, China s ban on pork imports from Vietnam and contagion fears of swine flu in Myanmar affecting pork consumption in parts of ASEAN as well. The likelihood of multiple adverse factors across countries occurring simultaneously again seems unlikely in our view. We expect FY18E to be a mean reversion year with core profit growing >4% YoY back to FY15 levels at least. Key risks: high gearing and the currency cocktail Apart from cyclical demand-supply imbalances influencing ASPs, raw material price fluctuation and the wild cards of regulation change, disease, weather inherent to farming, there are two company specific risks that warrant attention. Japfa s net gearing, at c18% for FY18E, is too high in our view as we enter into a rate hike upcycle. Additionally, the cocktail of key operating currencies of IDR, VND, CNY, and INR combined with some USD-linked import cost, USD financial reporting, and an SGD share price, creates an often unpredictable level of realised and translation-related volatility in reported profits. FYE Dec (USD m) FY16A FY17A FY18E FY19E FY2E Revenue 3,33 3,19 3,391 3,561 3,717 EBITDA Core net profit Core EPS (cts) Core EPS growth (%) 47.4 (88.) Net DPS (cts) Core P/E (x) P/BV (x) Net dividend yield (%) ROAE (%) ROAA (%) EV/EBITDA (x) Net gearing (%) (incl perps) Consensus net profit - - na na na MKE vs. Consensus (%) - - na na na John Cheong, CFA johncheong@maybank-ke.com.sg (65) Company Description Produces protein staples, dairy and packaged food. Has presence in five countries with a vertically integrated business model. Statistics 52w high/low (SGD) 3m avg turnover (USDm) Free float (%) Issued shares (m) Market capitalisation Major shareholders: Santosa Family Kolonas Family Santosa Handojo Price Performance Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 FY17 revenue: Diversified protein portfolio.72/ ,86 SGD1.1B USD828M Japfa Ltd - (LHS, SGD) Japfa Ltd / Straits Times Index - (RHS, %) 56.7% 15.2% 4.4% M -3M -12M Absolute (%) Relative to index (%) Source: FactSet India 3% China 9% Vietnam 1% Myanmar 3% Others 1% Indonesia 74% THIS REPORT HAS BEEN PREPARED BY MAYBANK KIM ENG RESEARCH SEE PAGE 47 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS Co. Reg No: E MICA (P) : 99/3/212

2 Value Proposition One of the largest industrialised agri-food companies in a populous region housing 4% of the world s population. No. 1 milk yields in China; No. 2 poultry-feed production capacity in Indonesia & Myanmar; No. 2 DOC production in Indonesia, Vietnam & Myanmar. Diversified geographically and by protein product. Over 7 breeding farms and 3 poultry hatcheries. 15K head of cattle, seven dairy-milking farms and five aqua-feed mills. PT Japfa TBK, a 52% owned subsidiary of Japfa, has 3 years of good financial and listing track record in Indonesia. Price Drivers Historical share price Aug-14 Mar-15 Oct-15 May-16 Dec-16 Jul-17 Feb Leading market positions in multiple protein staples Segment Country Mkt share Mkt position Milk yield China 36 kg/day No. 1 Poultry feed capacity Indonesia 24% No. 2 DOC production Indonesia 29% No. 2 DOC production Vietnam 2% No. 3 Poultry feed capacity Myanmar 31% No. 2 DOC production Myanmar 21% No. 2, Frost and Sullivan Source: FactSet Japfa Ltd - (LHS, SGD) Japfa Ltd / MSCI AC Asia ex JP - (RHS, %) 1. Large earnings miss due to demand supply imbalances of DOC and broiler, which impacted ASP. 2. Earnings beat consensus expectations. Poultry oversupply issue improved in 2H15 after the government coordinated an industry-wide culling program. 3. China s import ban of pork products from Vietnam where the company has swine-farming operations. 4. Profit warning for 2Q17, followed by below-expectation results due to depressed swine price in Vietnam 5. 1Q17 reported a strong recovery in earnings due to better Indonesia poultry and Vietnam swine prices. Financial Metrics FY18E core earnings to grow 467% from a low base after a bad year, revenue growth to be driven by a mix of volume and ASP. Beyond that, volume will drive growth. Expect OCF to improve in tandem with core earnings. FY18E DPS of SGD.7cts to remain the same as FY17. Adjusted core earnings could be viewed as close proxy for staple-consumption growth in ASEAN s emerging markets. Capex for FY18E to slightly increase YoY as PT Japfa TBK s increase will more than offset the decrease in dairy segment. FY19E should normalise to maintenance capex. Core earnings by segment Swing Factors Upside Better-than-expected volume and ASP growth for key Indonesia poultry segment. Turnaround in branded Consumer Food that has struggled due to competition in the ambient products. Improvement in oversupply issue of swine in Vietnam. Improvement in raw milk price in China. Downside (USD m) (5) PT Japfa TBK APO Dairy Consumer food Others* Outbreak of diseases affecting livestock could lead to reduced demand and mandatory culling. Unforeseen import restrictions or regulations on tariffs for protein imports by regional markets. Volatile or prolonged low market prices for its protein and dairy products due to demand and supply imbalances. Execution risks in expansion to new markets and/or facilities. (1) E 219E 22E Source: Company, Maybank Kim Eng johncheong@maybank-ke.com.sg June 21, 218 2

3 Table of Contents 1. Investment summary and risks Focus Charts Company profile Supportive secular protein consumption growth tailwinds A stable foundation from feed and dairy Recovery from a perfect storm Financial analysis Valuation holds upside headroom Investment risks Appendix 1: Management profiles Appendix 2: Overview of APO & Consumer Food Appendix 3: Corporate social responsibility June 21, 218 3

4 1. Investment summary and risks Japfa is one of Asia s largest industrialised agri-food companies vertically integrated across the value chain from animal feed production, breeding, commercial farming to consumer food. Its main animal protein products are in poultry, swine and dairy (with a much smaller presence in beef and aquaculture). Amongst Asia s largest vertically integrated industrialised agri-food companies employing c34, people and operating in six countries It operates in the six countries of Indonesia, China, Vietnam, Myanmar, India and Singapore where the first three account for the lion s share of revenues. It is one of the leading poultry players in Indonesia and is the most efficient milk producer in China. Japfa s operational reporting is by along the four following segments: PT Japfa TBK (JPFA IJ; Not Rated): Indonesian listed subsidiary with c85-9% of profits from poultry farming and the balance from cattle farming and aquaculture. Dairy: Dairy cattle farming for raw milk production in China, Indonesia and branded milk in Indonesia. APO: Other animal protein comprising of swine and poultry farming in Vietnam, Myanmar and India. Consumer food: Branded, ready-to-eat consumer products in Indonesia and Vietnam. Supportive secular protein consumption growth tailwinds Japfa operates in some of the most populous emerging economies in Asia that cumulatively house around three billion people or c4% of the world population. According to Organisation for Economic Co-operation and Development (OECD), levels of meat consumption in these markets, while growing fast, are still far below levels witnessed in developed markets and global averages (for example Indonesia s annual meat consumption in 216 was only 11kg/capita vs. the global average of 34kg/capita). Japfa s operations are concentrated in populous high growth emerging economies in Asia where per capita protein consumption is still low The economies are also growing fast - the International Monetary Fund (IMF) forecasts per capita GDP growth in Japfa s key markets ex-china at % CAGR in E, higher than the global average of 5.1%. OECD expects meat consumption in these markets to continue to grow at a high 11-13% CAGR in as overwhelmingly carbohydrate-based diets characteristically witness protein substitution with rising disposable incomes and a growing pool of middle-income families. FY18E should be a turnaround year We expect FY18E earnings to revert back to 215 levels, in the absence of the various one-off of FY17, such as: The significant USD34m loss for APO was due to a plunge in Vietnam swine prices, which fell below production cost due to China s import ban that came into effect in 4Q16. The market supply has since adjusted to the new norm as evidenced by recovering pork prices in 1Q18 and we expect the segment to post a USD1m profit this year. Indonesian poultry growth is also expected to normalise from an overall weak consumption year in 217 supported by the recovery in coal and crude oil prices and relative stability in CPO, sectors that that employ a material proportion of low to middle income families. The government directed parent-stock culling in mid-217 has also helped adjust supply levels. Also, the Government s minimum wage hike of c8.1% in 218 for the provinces should provide households some incremental spending power (food accounts for over 5% of Indonesian consumer spending). PT Japfa TBK took a one-off charge of USD1m in FY17 for VAT provision adjustments; management indicate this is non-recurring in nature. FY18E profits are expected to grow more than four-fold from a normalisation of demand-supply in Indonesia, Vietnam and the absence of one-offs June 21, 218 4

5 An underappreciated business model We believe the market has yet to fully understand and appreciate Japfa s diversified business model due to a number of factors: 1) The business is quite complex with multiple proteins and countries; 2) The stock is thinly covered by the street (just two Bloomberg consensus estimates); 3) It has a fairly short listing history (since Aug-214) and hence an insufficient track record to demonstrate to the market the ability to recover from downturns; and 4) The short track record of earnings has also been volatile for various reasons (details below). Underlying core business is not as volatile as the market seems to perceive; also the scale and resilience of animal feed operations in the value chain is underappreciated While Japfa has a short listing history and track record, its subsidiary, PT Japfa Tbk, which accounts for 7% and 58% of our FY18E revenue and core profit forecast has been listed since the early 199 s. Looking at its financial performance for the past 15 years, we observe characteristics that suggest the core underlying business is likely a lot less volatile than what the market perceives due to Japfa s relatively short listing history: PT Japfa Tbk s revenue/ebitda/operating profit grew at a 15%/23%/32% CAGR for FY3-FY17. Importantly, in terms of gauging growth consistency, all three metrics posted YoY growth for 12 of these years; Net profits grew at a lower 14% CAGR over the same period with YoY growth delivery for eight of the years. Apart from some small one-off items, the material components responsible for driving profit swings were non-operating and non-cash in nature, such as mark-to-market currency translation gains or losses arising from multi-currency operations and revaluation of biological assets (IFRS13 treatment for agricultural asset valuations in effect from 1 Jan 213). We also highlight the animal feed business (for poultry, cattle, swine) that accounts for over 4% of profits is the backbone of its business model insulating its operating profit from market gyrations in protein ASPs. This is evidenced by relatively stable feed margins with quarterly fluctuations that range largely within +/-2% around the c14% average seen since 21. This is despite significantly higher volatility in feed raw material input prices (corn, soybean meal) and the USD/IDR F/X rates (as some of these inputs are imported) over this period. Management states this is because feed raw materials, principally corn and soybean meal are tradable commodities with long shelf lives, which enables it to price through the cycles as there is no urgency to reduce inventories. Also animal feed production is a much higher entry barrier business requiring technology and capital, and hence does not face supply competition from the unorganised sector of small scale farmers. Valuations should trend towards peers Japfa is currently trading at 9x FY18E P/E, a significant discount of 44% to peers in the market and a 25% discount to its 52% owned subsidiary, PT Japfa TBK. We believe this valuation gap should decrease as the market concerns over the drag of losses of the previous year in smaller businesses of APO and consumer food reverses and narrows, respectively. We value Japfa on a sum-of parts based on ascribed EBITDA multiples for its business units. Our target price after incorporating a 1% holding company discount is SGD.86, which implies a 14x FY18E P/E equal to a modest 12% discount to the peer average. Meanwhile, we estimate that Japfa s stub valuation excluding its stake in PT Japfa Tbk trades at a mere 3.1x FY18E P/E. P/E at a significant discount to peers and subsidiary; stub P/E ex - PT Japfa Tbk at just 3.1x FY18E The key risks Most of Japfa s key investment risks are quite typical for most agri-food businesses, i.e. they pertain to cyclical demand-supply imbalances that affect market ASPs, the price and availability of commodity raw material inputs, market competition factors, and the wild cards of disease, regulatory change June 21, 218 5

6 (import restrictions, tariffs and duties) and weather related operational disruptions. The two key company specific risks in our view are 1) Japfa s high level of gearing that is a result of a period of heavy capex and investments; and 2) the combination of numerous Asian operating currencies, some USD denominated debt and USD reporting that results in an unpredictable F/X rate impact to reported profits from both realised and unrealised translation gains or losses. For more detail, refer to Investment Risks in Section 9. High gearing levels that might require equity raising Net gearing is forecast to significantly increase from.7x in 217 to 1.1x in 218E from a combination of debt taken on to finance a minority buy-out in its dairy segment and higher capex. We forecast net cashflow to be negative for 218E. Discussions with the company suggest that net gearing of x is around the upper threshold of what management is comfortable with and hence we believe some equity capital raising activity is likely over the next couple of years, such as through a placement, rights issue or entry of a strategic investor at the subsidiary level, etc. Forex related risks and sensitivity Japfa s profits would be put at risk from a significant depreciation in the IDR, CNY and the VND against the USD (Indonesia, China and Vietnam are its largest markets), its reporting currency. Japfa s major revenue streams are denominated in IDR, CNY and the VND, while it has debt and associated interest expense denominated in USD. Prices of some of its raw material commodity inputs are USD linked as well. Our sensitivity analysis suggests a 1% depreciation of IDR against USD is estimated to reduce Japfa s earnings by 2%, and vice versa, while a 1% depreciation of CNY against USD will reduce Japfa s earnings by 5.6%, and vice versa. Demand supply imbalances for poultry, swine and milk A sudden drop in market demand or oversupply of Japfa s proteins and milk would adversely affect their ASP and profitability. For instance, Japfa went through the boom and bust cycle of China s dairy industry from (driven by cheap imports flooding the market from Russia banning EU products in retaliation against sanctions) and Vietnam s swine industry from (triggered by growth in stock in 215 followed by China s pork import ban in late- 216). Price and availability of corn and other feed raw materials Raw materials (corn and soybean meal the largest components) make up c.85-9% of cost of goods sold. The prices of these raw materials are determined by the global commodity market and weather conditions. Although Japfa typically can pass on these costs, a sudden spike could impact profitability as pricethrough mechanisms usually have a lag. Japfa imports raw materials, such as corn, soybean meal, feed vitamins, animal protein meal and wheat products from the US, South America, China, India, Europe, Australia and Canada. Competition in the consumer food space The downstream branded consumer food business in Indonesia has many established players and hence competitive intensity is generally moderate to high across various food categories. The market goes through periods of price competition and high levels of promotional activity when there are new entrants, which is what Japfa s ambient food business faced in 217. Disease outbreak Outbreak of diseases affecting livestock is a big risk for Japfa. In the past, disease outbreaks, such as the H5N1 and H7N9 strains of avian influenza in Indonesia and China in 23 and 213 caused significant drops in demand for poultry. In addition, these viruses could trigger the mass culling of livestock, halt production and increase the possibility of incurring significant impairment losses. June 21, 218 6

7 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Consumption/Capita (KG) Japfa Ltd 2. Focus Charts Fig 1: Estimated growth for meat consumption per capita, Japfa s markets have high growth potential Source: OECD Fig 3: 1Q18 core profit shows an encouraging rebound for PT Japfa Tbk and a narrowing of losses in APO (USD m) (1) (2) (3) Est. growth from : +13% +11% +6%, Maybank Kim Eng % +11% +5% +4% +% Fig 5: Feed margins quite stable at +/-2% from average despite high DOC/Broiler ASP, COGS and F/X fluctuations (%) PT Japfa TBK APO Dairy Consumer food Due to low broiler prices. ASP dropped below production cost. Losses in commercial farming in 1Q (8) 4 APO losses in 1Q17-1Q18 due to depressed Vietnam swine prices. Losses narrowed in 1Q18 due to recovery in swine prices, supply adjusted to lower demand. 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 Average: 14% Poultry oversupply in 2H14 after positive government policy earlier. Earnings recovery from lower raw material cost and higher DOC ASPs 3 Fig 2: 218E core profit turnaround mainly driven by APO and PT Japfa TBK segments (USD m) (5) (1) *Financing cost for USD255m corporate debt, to raise stake in the dairy segment., Maybank Kim Eng Fig 4: Poultry feed volumes that account for c4% of profits show fairly stable long-term growth trends ( tonnes) 3,5 3, 2,5 2, 1,5 1, 5 PT Japfa TBK APO Dairy Consumer food Others* Vietnam Swine business lost due to import ban in China, since 4Q16 Loss due to higher chicken prices in 4Q17 and heightened competition in ambient food sector E 219E 22E Fig 6: Vietnam swine price reverting to levels before the import ban from China in 4Q16 (VND/KG) 6, 55, 5, 45, 4, 35, 3, 25, 2, Normalised to 215 level, 216 feed margins were exceptionally high from cost savings of feeds' raw materials. Poultry feed - Indonesia (LHS) Poultry feed - Vietnam, India, Myanmar (LHS) YoY % growth for Indonesia (RHS) Biggest poultry stock oversupply in a decade ,547 48,5 Import ban from China Breakeven price: VND34k/KG 28, 31, 32, 2% 15% 1% 5% % -5% -1% 49, 39, Source: Genesus Global Market Report June 21, 218 7

8 3. Company profile Japfa has grown from a single poultry feed mill in Indonesia started in 1975 to a leading pan-asian agri-food company operating in six countries. A diversification strategy into new geographies and other proteins over the years allowed it to tap new growth opportunities and revenues streams while mitigating single market / protein risk that the company originally faced (for example the proportion of non-indonesia grew from 18% in FY13 to 26% in FY17). Today, Japfa is one of the largest industrialised agri-food companies that produce multi animal proteins. Its business is vertically integrated across the value chain: animal feed production, breeding and commercial farming. Japfa s primary animal proteins are poultry, swine and dairy. It is the second-largest feed producer in Indonesia and the largest milk producer in China. The holding company, listed on the Singapore Exchange, holds a 52% stake in the Indonesiabased PT Japfa TBK and 1% stake in the dairy, APO (Animal Protein Others) and consumer food segments. Fig 7: Vertically integrated / five proteins / geographically diversified Animal Protein PT Japfa TBK (Indonesia) Animal Protein Other (Vietnam, Myanmar, India) Dairy (China, Indonesia) Upstream Animal feed production Poultry feed Cattle feed Aquaculture feed Poultry feed Swine feed Cattle feed Breeding farms Midstream Milking & fattening farms Downstream Processing & Distribution - Branded consumer food Poultry breeding Poultry commercial farming Beef cattle breeding Beef feedlots Aquaculture breeding Aquaculture commercial farming Poultry breeding Poultry commercial farming Swine breeding Swine fattening Consumer Food (Indonesia, Vietnam) So Good So Nice Real Good Santori Beef Tokusen Beef Dairy cattle breeding Dairy milking Greenfields Branded dairy products Source: Maybank Kim Eng, Japfa Fig 8: Revenue breakdown by geography (FY17) China 9% India 3% Myanmar 3% Others 1% Fig 9: Revenue breakdown by geography (FY13) China 3% Vietnam 11% India 3% Others 1% Vietnam 1% Indonesia 74% Indonesia 82% June 21, 218 8

9 Fig 1: Revenue breakdown by segment Fig 11: Core earnings breakdown by segment (USD m) PT Japfa TBK APO Dairy Consumer food (USD m) PT Japfa TBK APO Dairy Consumer food Others* 3,5 3, 2,5 2, 1,5 1, , , , , (5) (5) (4) (15) (5) (6) (34) (2) (1) Fig 12: Japfa s notable market positions Segment Country Mkt share Mkt position Milk yield China 36 kg/day No. 1 A leading player in multiple categories Poultry feed capacity Indonesia 24% No. 2 DOC production Indonesia 29% No. 2 DOC production Vietnam 2% No. 3 Poultry feed capacity Myanmar 31% No. 2, Frost & Sullivan Fig 13: Key success factors for Japfa s industrialised farming business model Factor Strengths and business strategies Scale Leverage on ability to manage mega-scale farming operations; over 34, employees across five countries Japfa s core competencies are its ability to manage scale, technology, maintenance of animal health, and process standardisation Technology Health Standardisation & replication JV with leading genetics companies (Aviagen and Hypor) for superior breeds and genetics; Combine advanced feed technology with best farm management practices Use best-in-class bio-security using stringent operating procedures. Leverage on In-house vaccine production firm PT Vaksindo Replicate the best practices and infrastructure design across the protein groups and countries; replicate the farm design model in dairy farms and DOC breeding farms June 21, 218 9

10 Consumption/Capita (KG) Consumption/Capita Japfa Ltd 4. Supportive secular protein consumption growth tailwinds Japfa is riding on a basic consumption theme the substitution of an overwhelmingly carbohydrate-based diet for the masses to a more protein-rich one in the most populous countries in emerging Asia. 4.1 Southeast Asia has highest multiplier of meat consumption to per capita income growth Consumption habits In Japfa s other key markets of Vietnam and China reflect the plant-based to animal-based swap. As affordability improves, demand for meat increases. From , ASEAN s 2.5% CAGR in meat consumption per capita outpaced the global consumption CAGR of.7%. Despite the higher historical growth rates of meat consumption in ASEAN, the absolute meat consumption in the region is still materially below global consumption. For example, Indonesia s annual meat consumption in 216 was only 11kg/capita vs. the global average of 34kg/capita, according to the Organisation for Economic Co-operation and Development (OECD). We believe the gap will eventually narrow. Japfa s markets are all considered high-growth countries, based on IMF forecasts. Fig 14: Positive correlation between GDP/capita and meat consumption Japfa s markets have more room to grow Vietnam Malaysia China Mexico Philippines Source: OECD, FAO, World Bank Europe USA Australia Singapore 1 Indonesia India - 1, 2, 3, 4, 5, 6, GDP/Capita (USD) Fig 15: Meat consumption per capita growth in Southeast Asia has outpaced other regions from income growth and low base (Rebased) Source: OECD, FAO China World Southeast Asia South Africa Europe Fig 16: Estimated growth for meat consumption per capita Est. growth from : +13% +11% % % +11% % +4% +% Japfa s markets, including Indonesia, Vietnam, China and India have high growth potential Source: OECD June 21, 218 1

11 Fig 17: Estimated 5yr CAGR for GDP per capita from E (5yr CAGR, ) 1% 9.2% 8.7% 9% 8% 7% 6% 5% 4% 3% 2% 1% % 8.3% 8.3% 7.4% 6.5% 6.1% 5.9% 5.1% 4.4% 3.4% Mid-to-high single digit GDP per capita growth expected in E in Japfa s markets should boost consumer spending power Source: IMF 4.2 Consumption is stabilising in key market Indonesia The regulation during 214 requiring the minimum wage to be raised based on a combination of inflation and GDP of the previous year dictates forward wage growth. The development is significant for a somewhat predictable steady growth in low to middle class consumption, as we believe c.5-6% of those employed earn around the minimum wage. After a somewhat lacklustre year for discretionary consumption growth in 217, some macro factors suggest an improvement in 218. The Government s minimum wage hike of c8.1% in 218 for the provinces should provide households with some incremental spending power (food accounts for over 5% of Indonesian consumer spending). Also unemployment has inched downwards in past months, we believe driven by the trade-related and soft commodities sectors given the recovery in coal and crude oil prices and relative stability in CPO these sectors employ a material proportion of low income families. Fig 18: Unemployment (%) Source: Bank of Indonesia, Bloomberg, CEIC Fig 19: Average monthly wage growth 3% 25% 2% 15% 1% 5% % -5% -1% -15% -2% Source: CEIC Monthly wage average YoY Inflation YoY Real wage YoY June 21,

12 Agriculture Industrial Construction Trade Transport & Telco Finance Social services Others Japfa Ltd Fig 2: Employment by sector mn population Source: Statistics Indonesia 4.3 Subsistence living for the emerging masses but they strive for a higher protein diet At the national level, food dominates the household budget at more than 5%. But for those earning less than IDR36m per year, food comprises more than 9% of spending. Despite erratic real income growth, within food categories, at the national level, there has been a palpable migration towards food of higher nutritional value. Families are purchasing higher quality carbohydrates, adding more protein and consuming more prepared foods. Prepared foods are in demand for their convenience and perception of better quality. But tobacco remains a big part of total spending. Fig 21: Breakdown of consumer spending nationwide (%) Fig 22: Food spending per capita Food Housing Goods & svcs Clothing Durables Others 35 3 % % 9% 8% 7% 6% 5% 4% 3% 2% 1% % Cereals Veg & fruits 17. Meat & fish Dairy Oil Tobacco Prepared food Source: Statistics Indonesia * Housing category includes utilities and transportation Source: Indonesia Statistics, Maybank Kim Eng June 21,

13 5. A stable foundation from feed and dairy Despite the volatile earnings for Japfa, which are highly reliant on the ASPs of key proteins, such as Indonesian DOC, broiler and Vietnam swine, one subsegment and another key segment form a stable foundation. They are the Indonesia poultry feed business and dairy segment. We expect both of these segments to form around 7% of FY18E group EBIT and 95% of FY18E group earnings, of which c.4% comes from the Indonesia poultry feed business and 56% for the dairy segment. Feed is the heart of the Indonesia poultry business it is large in terms of profit, are relatively stable and not as exposed to end-product price volatility given the much higher technology and entry barriers to the segment. The success factors lie in the ability to formulate good feeds with research and development, financial strength to fund working capitals and economies of scale. Feed is the largest sub-segment of PT Japfa TBK, which is also the largest group earnings contributor. This sub-segment has demonstrated resilient gross margins despite major swings in raw material prices, currency and poultry ASP. The reason for the stable margins is that feed raw materials, corn and soybean meal, which form around 75% of COGS, are tradable commodities that does not perish quickly, so there is no urgency to deplete inventories. This allows the industry to pass on raw material costs quite efficiently with incremental price adjustments. Our studies of other key competitors indicate they are highly correlated to each other in terms of revenue and operating margin performance (Fig 33 & 34) To tap into new growth opportunities and reduce earnings volatility, Japfa diversified into dairy farming in China in 29 by building its own farm. Today, the dairy segment is one of its most stable segments although not to the same degree as feed, in our view - with consistent operating profit growth in the past three-out-of-four years (214 the exception, Fig 43). The decline in 214 was due to an exceptionally good year in 213 after the milk price spiked, as production fell earlier in 212 due to disease and farmers leaving the industry (Fig 43 & 44). Japfa s acquisition of the remaining 38% stake it did not already own from a minority shareholder in Apr 218 positions it to grow further and tap the full potential of the fast-growing milk industry in China. Fig 23: EBIT proportion by segment and sub-segment Fig 24: Profit proportion by segment and sub-segment (%) PT Japfa TBK APO Dairy Consumer food Others (%) PT Japfa TBK APO Dairy Consumer food Others 22E 1% % 11% 21% 66% 22E -13% -2% 19% 41% 55% 219E 218E -2% % 1% % 11% 11% 22% 24% 66% Stable parts will form around 7% of FY18E EBIT 67% 219E 218E -5% -15% -13% -2% 2% 2% 55% 45% Stable parts will form 95% of FY18E core earnings 58% 56% -1% % 1% 2% 3% 4% 5% 6% 7% 8% baseline historical data, Maybank Kim Eng estimates -4% -2% % 2% 4% 6% 8% baseline historical data, Maybank Kim Eng estimates June 21,

14 5.1 Steady-growth poultry feed driving c.4% of profit We forecast PT Japfa TBK will contribute 6% of group earnings in FY18E, while feeds, its sub-segment, should contribute 65-7% of poultry earnings. Therefore, poultry feed is the most important sub-segment, which should contribute c.4% of the group s earnings. Based on data from Statistics Indonesia, the poultry population has been increasing by around 5-6% YoY over the past 5 years, excluding 217 (4.2%). This is consistent with Indonesia s GDP growth of 5-6% and GDP per capita growth of 3-4% in the past 5 years. Also, we believe the growth could further be driven by the long-term trend of higher protein consumption as Indonesians moves towards the middle income level; Malaysia, which saw its meat consumption rise to the current c55kg/capita levels as its per capita GDP grew over the past decade is a a particularly relevant example in the region. Consistent with the industry, Japfa has also recorded steadily growing sales volume for its poultry feed, although it was impacted by a severe poultry downturn in 215 (Fig 27). We have assumed a long-term growth rate assumption of 5% for feed business revenues. Fig 25: No. of chickens and growth rate in Indonesia (No. 'mil) No. of chickens (LHS) YoY growth (RHS) 2,5 2% 2, 15% 1,5 1% 1, 5% 5 % - -5% Source: Statistics Indonesia Fig 26: Egg production and growth rate in Indonesia (' tons) Tonnes of egg (LHS) YoY growth (RHS) (YoY %) 2, 12% 1,8 1% 1,6 1,4 8% 1,2 1, 6% 8 4% 6 4 2% 2 - % Source: Statistics Indonesia Fig 27: Stable growth for Japfa s poultry feed volumes barring 215 where there was a large oversupply situation in DOC/live poultry ( tonnes) Poultry feed - Indonesia (LHS) Poultry feed - Vietnam, India, Myanmar (LHS) 3,5 2% YoY % growth for Indonesia (RHS) 3, 2,5 2, 1,5 1, 5 15% 1% 5% % -5% Source: Statistics Indonesia, Bloomberg -1% June 21,

15 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Japfa Ltd A resilient business with little margin fluctuation The poultry feed sub-segment has demonstrated resilient gross margins despite major swings in raw material prices, currency and poultry ASP. The reason for the stable margins is that feed raw materials, corn and soybean meal, which form around 75% of COGS, are tradable commodities that does not perish quickly, so there is no urgency to deplete inventories. This allows the industry to pass on raw material costs efficiently. However, it could still be subjected to some volatility if there are big swings in the USD/IDR fx rate and raw material prices, such as soybean and corn. Gross margin has historically fluctuated within a +/-2% range from the average gross margin of 14% since 21. Evidence of the relative stability in the poultry feed business is illustrated by comparison of the fairly small swings in feed gross margins since 21, despite the high level of volatility in the key raw material prices and a weakening currency over this period affecting import costs. Fig 28: Gross margins for Indonesia poultry feed (%) 2 18 Poultry oversupply in 2H14 after the industry expanded too aggressively post government policies aimed at promoting local produce Relatively stable gross margins for poultry feed 16 Average: 14% Fig 29: Corn and soybean meal prices Despite high volatility in input raw material prices for feed, Bloomberg June 21,

16 Fig 3: USD:IDR exchange rate and a sharply weakening currency, Bloomberg Indonesia poultry competitive landscape Japfa is the second largest player in Indonesia's poultry industry behind PT Charoen Pokphand Indonesia Tbk (CPIN IJ; Not Rated) (CP), with around a 25-3% market share. Together, CP and Japfa control more than 5% of the feed and DOC markets. The top 3-4 players in each market also typically control more than two-thirds of the market. Our analysis of 28 years of data for its competitors shows that their revenue growth, operating profit growth and margins have been consistent with each other (Fig 33-35). However, contrasting key trends we observed include: 1) CP' has been growing it revenue at a quicker pace, overtaking PT Japfa TBK in 24, but its operating profit growth trend has been consistent with Japfa; 2) for operating margins, PT Japfa TBK managed to catch up to CP in 217 due to CP s margin decline after venturing into the loss-making commercial farming sector; and 3) during the period of market downturns or oversupply, the larger players have a bigger buffer of operating profit before falling into an operating loss (Fig 34). While CP has grown along with PT Japfa TBK over the past three decades largely avoiding aggressive competitive tactics, there is a risk that it could start a price war to gain market share. There is also a chance that CP could try to acquire PT Japfa TBK if the latter becomes a threat. However, regulators are likely to support healthy market competition, which is in the best interest of consumers and as poultry is an important industry for both farmers and consumers. June 21,

17 Fig 31: Poultry feed production capacity market share Malindo, 4% Fig 32: DOC production capacity market share Malindo, 6% CJ, 6% CJ, 8% Japfa, 22% CP, 31% Japfa, 25% CP, 41%, Frost and Sullivan, Frost and Sullivan Fig 33: Revenue comparison shows steady growth but leader CP outpacing other players (IDR b) 5, 45, 4, 35, 3, 25, 2, 15, 1, 5, Source: Bloomberg CP PT Japfa TBK Malindo Fig 34: Operating profit trend shows larger players outperform in downturns (IDR b) 4, 3,5 3, 2,5 2, 1,5 1, 5-5 Source: Bloomberg CP PT Japfa TBK Malindo Fig 35: Group operating margins show high correlation among peers (PT Japfa TBK caught up with CP in 217) (%) yr correlation CP and PT Japfa TBK: 84% PT Japfa TBK and Malindo: 6% CP and Malindo: 46% CP PT Japfa TBK Malindo 1 5 (5) Source: Bloomberg Backed by a three decade long track record PT Japfa TBK has been listed on the Indonesia Stock Exchange for c.3 years and has established a good long-term financial track record across several business cycles. Its scale started to increase in the early part of last decade. We observe the following from its past 15 years of financials: June 21,

18 Gross profit and operating profit growth, with operating profit 15-yr CAGR of 32% 15-yr average ROIC of 23%, higher than its WACC of 11%. Underwent one significant deleveraging cycle through with net gearing dropping from over 4% to 35%. Has geared up to slightly higher levels since, with net gearing 45% end-217. Fig 36: PT Japfa TBK Healthy gross and operating profit track record (IDR b) 7, 6, 5, 4, 3, 2, 1, -1, Source: Bloomberg Operating income 15-yr CAGR: 32% Gross profit Operating income Fig 37: PT Japfa TBK decent 15-yr ROIC (IDR b) 15-yr ROIC avg: 19% 15-yr ROCE avg: 23% Source: Bloomberg Return on Common Equity Return on Invested Capital Fig 38: PT Japfa TBK net gearing levels modest (x) Source: Bloomberg EBIT to Interest Expense (LHS) Net Debt/Equity (RHS) (x) Fig 39: Continuous reinvestment of operating cash flow to grow the business Cash from Operating Activities (IDR b) Cash from Investing Activities 3, Free Cash Flow 2, 1, -1, -2, Source: Bloomberg Consolidated the stable dairy segment The dairy segment, operated through AustAsia, is a key revenue pillar for Japfa and is expected to contribute 56% of group core earnings in 218E, the second-largest earnings contributor after PT Japfa TBK. More importantly, it is also a resilient segment that has been generating consistent profitability, driven by Japfa s leadership in milk yields and the strength of its market leading Greenfields brand. While the recent acquisition of the entire minority interest is expected to boost FY18E core earnings of the segment by 56%, we expect growth beyond FY18E to be limited as Japfa does not have any immediate plans to add additional dairy farming capacity. Given that the capacity utilisation of the farms are high and Japfa s milk yields are already at industry leading levels, we expect flattish revenue growth beyond 218E of just.2% YoY for 219E-2E. However, in the past, Japfa has added a new farm every 1-2 years, and given its plans to continue growing in this segment, it would likely resume capacity expansion in the not-too-distant future after debt levels are reduced. Growth expectation post 218E is flat until more capacity is added June 21,

19 5.2.1 Growing presence in China and SEA (mainly Indonesia) The dairy segment consists of: Upstream dairy farming to produce premium raw milk in China, where five of the seven dairy farms are in Shandong Province and the remaining two in Inner Mongolia. Customers include Yili, Mengniu and New Hope. Japfa typically adds one new farm per year. In Indonesia, Japfa operates one dairy farm and one processing plant. In Malang, East Java, its dairy farm is the largest in the country by volume of premium fresh milk produced. The plant sells to endconsumers in Southeast Asia with the majority of sales in Indonesia under the Greenfields dairy brand. In 215, the first step towards building a branded consumer goods business in China,, Japfa entered into a JV with Food Union, a European-based dairy and milk processing company to build a premium milk processing plant in Shandong Province. Japfa owns a 19% share in the JV and supplies raw milk to the plant, which in turn manufactures high value-added dairy products for the Food Union, as well as third party international food companies. The plant is targeted for completion in Jun 218. Current revenue split is c.8/2 for China/Southeast Asia. China is the group s main revenue and earnings driver. The company s operations in Southeast Asia are only at the EBITDA breakeven level with cash flows currently being reinvested into building the brand. Fig 4: China raw milk sales volume (Mil KG) China raw milk: sales vol (mil kg) - LHS 6 Milkable cows - China (heads) - RHS 5 (heads) 45, 4, 35, Fig 41: SEA branded milk (Mil litres) 3 25 SE Asia extended shelf life branded milk - LHS Milkable cows - SE Asia (heads) - RHS (heads) 5, 4, , 25, 2, 15, , 2, 1 1, 5, 5 1, Acquisition of minorities provides 218E growth boost After acquiring the remaining 38% stake it did not already own from the minority shareholder in Apr 218, Japfa now owns 1% of a stable business, which it has been running since The deal provides the company with greater exposure to the fast-growing milk industry in the emerging Asia markets. The total consideration of USD263m was mainly funded by a 3-yr bridge loan, recognised at the corporate level (USD223m) and the rest from the issuance of new shares (USD4m from 9m shares issued at a price of SGD.6/sh). Valuation of the deal was about 12.4x FY17 P/E, implying around a 5% discount to China s dairy production peers, which traded at 26x FY17 P/E. We expect core earnings to get a one-time boost of 56% to USD5m from the consolidation of this minority interest during FY18E, before accounting for additional financing costs of USD14.5m for the 3-yr bridge loan (Fig 65). Including financing costs, we expect core earnings to increase by 11% to USD34.5m. June 21,

20 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 Japfa Ltd Fig 42: Dairy segment steady revenue growth Fig 43: Dairy segment steady operating profit growth (USD m) 4 SEA China (USD m) (1) SEA China Key operating metrics of the business, such as sales volumes and milkable cows have been recording healthy growth. Operating profit recorded its first decline in 215 due to a sharp decrease in the raw milk price due to external factors, mainly lower demand from China and cheap imports flooding the market from the EU (supply diverted due to Russia s ban on EU products). However, since the major fall in 215, milk prices have been largely stable. Fig 44: Farm-gate milk price in China the boom and bust cycle (CNY/1kg) Production fell due to disease and farmers leaving the industry. 426 Price boom earlier has led to overproduction. Other reasons include: 1) demand for China fell; and 2) cheaper exported milk flooded the global market, after Russia's ban on EU produce, to retaliate for EU sanctions Source: China National Bureau of Statistics Best in class milk yields Japfa s milk yields are amongst the best in class in the industry, looking at various data points and market aggregates from the past three years. Management cited three key success factors for its high milk yields, which include: 1) understanding and developing localised forage supply in Asia, and scientific development of feed formulation for optimal nutrition; 2) good farm design, with proven Asian 1,-head dairy farm blue-print, infrastructure and standardised systems, which are designed to maximise cattle welfare, operational efficiency and milk quality; and 3) Retention of experienced management over last 2 years, continuous recruitment and training to industry best-practices. It also focuses on genetic improvements and bio-security. June 21, 218 2

21 Fig 45: Japfa delivers the highest milk yield in China (KG/day) Japfa China 216 China ZhongDi Dairy 216 YuanSheng Tai Dairy Farm 216 US 215 China Modern Dairy 216 Japfa SEA 216 China Shengmu Org 216 Canada 215 The Germany France 215 Netherlands Vietnam 215 (intensive) China 216 (avg) Australia 215 New Zealand 215 Vietnam 215 (avg) Indonesia 215 (avg), Nielsen, Rabobank, IFCN, Annual reports of respective listed companies China still has room to grow Dairy consumption in China is still relatively low compared to both Western and neighbouring countries. On a per capita basis, OECD data shows that dairy consumption in China is estimated at 21.1kg in 217, growing at 2% CAGR since 21. OECD expects that the dairy consumption per capita in China will expand to 25. kg by 226E. Globally, China is currently the second-largest dairy market. Euromonitor expects the market in China to grow at a 5-yr CAGR of 11.6% and overtake the US as the largest dairy market by 222, due to China s growing appetite for yogurt and Americans drinking less milk. Yogurt drinks in China are the key growth driver of yogurt consumption. This is largely due to major players expanding their reach with ambient yogurt drinks, which are convenient for consumers and retailers in achieving a wider distribution than chilled yogurts. However, we do note that soy milk and powder based formulas are widely used as a substitute in Asia. Fig 46: Fresh dairy consumption per capita, 217 China is still an underpenetrated market Fig 47: Dairy markets: China expected to overtake US as the largest dairy market in 222 (KG/person) (USD m) Y CAGR USA % China % Brazil % Japan % Russia % Germany % France % India % UK % Mexico % Source: Organisation for Economic Cooperation and Development (OECD) Source: Euromonitor June 21,

22 5.2.5 Local producers getting squeezed by imports China s raw milk production has been declining by 2-4% p.a. since 216 on the back of a surge in imports. Import of dairy products into China increased by 13% YoY in 217 and 21% YoY in 216. The import surge started in early 214 after a series of tainted milk scandals and supply worries that sparked panic buying. In mid-214, cheap exported milk flooded the global market after Russia's ban on EU produce to retaliate against EU sanctions. In 213, a second milk-safety scare forced a number of smaller farms out of the market, and domestic production fell by about 6% from the 212 level. Cheaper imports are forcing a shakeout of smaller, less efficient players in the sector Fig 48: China s raw milk production has been declining (tonne 'm) Cow milk production (LHS) (YoY) 38. YoY growth (RHS) 8% % 37. 4% % 36. % % % % Source: CLAL, China National Bureau of Statistics Fig 49: Imports of dairy products into China Bulk and packed milk Whey powder (tonne '') Whole milk powder Infant milk formula 2,5 Skimmed milk powder Cream +13% Cheese +21% 2, -8% 1,5 1, Source: CLAL June 21,

23 6. Recovery from a perfect storm 217 revenue increased 5.2% YoY but EPS decreased 88%. We argue that most of 217 s woes are unlikely to be repeated. We expect FY18E to be a mean reversion year, where core earnings will revert to FY15 levels, when it didn t have any significant one-off events. We expect Japfa s core earnings to turn around in FY18E to USD89m from USD16m in 217. The key earnings drivers we expect are: 1) turnaround of APO, from a USD34m loss in FY17 to earnings of USD1m; and 2) better growth for PT Japfa TBK due to better sales volume and margin improvement, driven by populist policies from the Indonesian government via various subsidies in 218 ahead of the presidential election in 219. Also, with the recovery in fuel and coal prices, the mining and energy businesses will have greater headroom to raise wages. In addition, the segment was hit by a one-off VAT provision adjustment of USD11m in 4Q17. To recap, the government implemented a new VAT policy in 1Q17, which PT Japfa TBK did not pass on to consumers. The VAT was then abolished in 3Q17. Japfa made a provision in 4Q17, for the VAT it owes the government. Fig 5: Core earnings to record a strong turnaround in 218E driven mainly by APO businesses and growth resumption in PT Japfa TBK (USD m) PT Japfa TBK APO Dairy Consumer food Others* E earnings jump will be a mean reversion to 215 levels in the absence of one-offs: 1) Huge USD34m loss for APO in 217 was due to a plunge in Vietnam s swine prices, which fell below production costs because of China s import ban in 4Q16. We expect the segment to generate USD1m earnings in FY18E, as the market supply has adjusted to the new norm; (5) (1) Vietnam Swine business went into loss Loss was due to higher chicken prices in 4Q17 and heightened competition in the ambient food sector. Normalised to 215 level, the feed business enjoyed exceptional margin in 216, as savings from the substitution of temporarily higherpriced raw materials do not have to be passed on E 219E 22E 2) PT Japfa TBK was hit by a one-off VAT provision adjustment of USD1m in 4Q17. Additional growth should come from normal industry growth and a recovery in coal and crude oil prices, which we expect will lift wages the consumption power of low-middle class Indonesians. * Financing cost for corporate debt of USD255m taken to acquire the minority interest of the dairy segment in FY18., Maybank Kim Eng Fig 51: 1Q18 core earnings recorded a strong turnaround (USD m) PT Japfa TBK APO Dairy Consumer food (8) (1) (2) (3) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 APO losses in 1Q17-1Q18 were due to depressed Vietnam swine prices. Losses narrowed significantly in 1Q18 due to a recovery in swine prices as supply adjusted to lower demand. In addition, demand increased due to Chinese New Year celebrations in Vietnam. 1Q17 weakness for PT Japfa TBK was due to low broiler prices. ASPs dropped below production costs and resulted in losses in commercial farming. 4Q17 loss of USD1m was due to a one-off VAT provision adjustment. In 1Q18, PT Japfa TBK reported good earnings, from better feed margins from lower raw material costs and higher ASPs for DOCs. June 21,

24 6.1 Animal protein other (APO) should see a recovery Reversing the Vietnam drag Japfa has poultry feed manufacturing, breeding and commercial farming in Vietnam, Myanmar and India, and swine feed, breeding and fattening in Vietnam. Vietnam operations were a major drag in 217 with an operating loss of USD34m against an operating profit of USD3m in 216. Performance of the other geographies, Myanmar and India, were positive but too small to offset this big loss. The breakdown by revenue (217), Vietnam was the largest (63%), followed by India (18%) and Myanmar (19%). Vietnam did well in due to the ramping up of its swine business driving growth in operating profit from less than USD1m in FY13 to USD3m in FY16. But the sudden and unexpected import ban on Vietnam pork from China in 4Q16 resulted in a huge oversupply of swine in the market, sending selling prices well below production cost. Fig 52: APO - revenue breakdown by country Fig 53: APO - Operating profit breakdown by country (USD m) 6 India Myanmar Vietnam (USD m) 5 India Myanmar Vietnam Swine recovery is underway We believe the market supply side adjustment to the new lower demand levels is almost complete as prices started to recover in 1Q18 and the farming cycle is around 6-8 months before a swine reaches market weight. Correspondingly, Japfa saw its core PATMI loss from this segment narrow in 1Q18 to a USD2.3m loss from USD9.5m loss in the prior quarter. 217 figures for the Ministry of Agriculture and Rural Development (MARD) indicate that huge losses in swine production led to massive reductions in the Vietnamese sow herd, driving the 11% QoQ lift in prices in 1Q18, which continued to show healthy improvement into May-218. A report dated 18 May 218 by Genesus Global Market Report, a developer of swine genetics, stated that the current average liveweight pig is VND4,/KG (USD1.76) and indicated that most commercial pig producers have turned profitable following the last 15 months following huge losses of up to USD7 per head 217. Japfa has been making incremental improvements in operational efficiency, which has helped lower swine fattening cost, including measures like adjusting the feeding volume and interval to ensure the swine does not grow too quickly until the low price environment is past. While waiting for swine demand-supply to reach equilibrium levels again, the company continues to explore avenues to reduce its cost structure and improve farming efficiency. As one of the most efficient producers in June 21,

25 Vietnam, Japfa believe it is better-positioned to benefit from industry consolidation opportunities in Vietnam, where non-industrialised producers still have more than a 5% market share. Fig 54: Core losses of APO segment diminished in 1Q18 (USD m) Fig 55: Vietnam swine price reverting to pre-import ban levels (VND/KG) 6, 55, 5, 45, 4, 35, 48,5 53,547 Import ban from China Breakeven price: VND35k/KG 49, 39, (5) (1) (15) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 3, 25, 2, 28, 31, 32, Source: Genesus Global Market Report Vietnam poultry feeds provide a stable base Similar to Indonesia s poultry business, feed provides a stable base of profits, while quarterly fluctuations are mostly driven by midstream/downstream prices. Japfa is ranked number three in DOC production in Vietnam with a 2% market share, and is number two in DOC and poultry feed production in Myanmar with around a 2-3% market share. Japfa s market share is behind CP in both Vietnam and Myanmar. Due to the Japfa s early mover status, Myanmar had historically recorded high feed margins. However, with growing competition as the industry developed, feed margins declined to more normalised levels in 217. In India, the business continued to be profitable thanks to the feed business. Fig 56: Sales volume for swine feed Fig 57: Sales volume for swine feed quarterly data (' tonnes) (' tonnes) China banned impport of swine from Vietnam June 21,

26 (Million birds / ' tonnes) Japfa Ltd 6.2 DOCs and broilers: the volatile bit of poultry Aside from feed, the remaining 35-4% of earnings for the poultry business, which translates into c.2% of group earnings, comes from DOCs and broilers. The selling prices of DOCs (recognised under breeding) and broiler (recognised under commercial farming) are subject to market prices, and operating margins are far more volatile than the feed business given the perishable nature of the commodity and the presence of smallscale and non-industrialised farmers in the business who tend to overproduce when market prices are rising and vice versa.. DOCs suffered an operating loss of c.usd4m in FY This was due to weak DOC and broiler prices, and industry oversupply, coupled with cyclically weak domestic demand (Fig 6). However, a turnaround came in 2H15 as the Indonesian government coordinated an industry-wide culling of parent stock, which saw 1-15% of the industry supply culled. This helped to alleviate the demand-supply mismatch and resulted in much improved selling prices of DOCs and broilers. In 1Q17, ASP for broilers again fell below production cost due to a temporary oversupply situation. Since the oversupply in early 217, the government has intervened more frequently in the culling of DOC in managing supply to reduce price volatility. The government s intervention in the poultry industry includes: 1) controlling the supply of DOCs via multiple culling programs to maintain the balance between supply and demand; 2) implementation of benchmark prices; 3) reduction of the import quota of grand-parent stock; and 4) the use of local corn. On the demand side, we note that in 218, the Indonesian government has shifted towards more populist policies and implemented various subsidies ahead of the presidential election in 219. In Mar 218, the Indonesian president decided to keep fuel prices stable over the next two years and will increase the subsidies to keep pump prices unchanged. In addition, with the recovery in fuel and coal prices, the mining and energy businesses may have greater headroom to raise wages. As mentioned, the feed business provides a base level of profits, and margins are stable within a tight 1-14% band. The total operating margins were in the range of % over FY Going forward, we expect a sustainable operating margin for PT Japfa TBK of around 7.9% and its feed margin to stay at 1%. Fig 58: Sales volume for DOC and live birds Fig 59: Operating margin breakdown by segment 9 8 DOC - broiler (million birds) Live birds - commercial farm (' tons) 2% Total Breeding Feed Commercial farms % 1% 5% % 9.7% 8.4% 11.6% 1.9% 6.9% 5.3% 13.4% 1.8% 13.% 9.7% 1.% 1.% 1.% 7.3% 7.9% 7.9% 7.9% 3.% 2-5% 1-1% % E 219E 22E, Maybank Kim Eng June 21,

27 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Japfa Ltd Fig 6: Indonesia broiler and DOC prices (IDR ) Livebirds/broilers (LHS) DOC (RHS) (IDR ) Prices swing on a more short-term cycle as farmers tend to overproduce as market prices rise. Oversupply in 2H14 was severe, due to government policy earlier in reducing import of other meats to boost local production. 1 5 Poultry oversupply in 2H Consumer food small but offers long-term potential In the downstream supply chain, Japfa uses its animal protein products as raw materials for its consumer food segment. In terms of profit contribution, the consumer food segment does not move the needle for the group. We expect it to revert back to EBITDA breakeven level for FY18E. While the consumer food business has historically recorded breakeven EBITDA as Japfa reinvests profits into advertising and promotion, the segment recorded a negative EBITDA in FY17. This was primarily due to higher chicken prices in 4Q17 and heightened competition in the ambient food sector as rivals slashed prices to gain market share. Despite the ongoing challenges, Japfa has laid a good foundation to participate in the Asian consumer markets. Most of this segment s sales are in Indonesia, with some contribution from Vietnam. The products for this segment include processed meats, such as chicken nuggets, meat balls and sausages under the brands So Good, So Good Sozzis and So Nice in Indonesia. Japfa also manufactures and markets small-pack UHT liquid milk under the Real Good brand in Indonesia. In Vietnam, it offers branded sausages under the So Yumm brand. Today, So Good and So Nice have achieved household name status in Indonesia, and have won numerous consumer brand awards. Japfa has also replicated its proven downstream capabilities in Indonesia to Vietnam, where the So Yumm branded shelf-stable sausages are gaining traction. Moving forward, Japfa plans to continue to tap the changing consumer dynamics for downstream consumer food products by investing strategically and focusing on A&P to anchor its consumer brands in Indonesia and Vietnam. Japfa has embarked on a few strategic initiatives to enhance its brand value: 1) increasing ASPs for frozen food; 2) brand rejuvenation; 3) improving the taste and quality of products to meet the changing taste buds; and 4) widening its ambient product positioning from the existing snacks category to a broader general grocery market. June 21,

28 Fig 61: Consumer food segment EBITDA Fig 62: Consumer food segment core earnings (USD m) (2) (4) (6) (8) (1) (USD m) (5) (1) (15) (2) (25) Fig 63: Frozen products sales volume Fig 64: Ambient products sales volume (tonnes) 12, (tonnes) 45, 1, 4, 35, 8, 3, 6, 25, 2, 4, 15, 2, 1, 5, June 21,

29 7. Financial analysis A key financial highlight is the earnings turnaround for FY18E, driven by PT Japfa TBK and APO, as their proteins ASPs have recovered from the trough and are currently near their two-year high. From a low base, we expect FY18E to grow 462% to SGD88m. Already in 1Q18, PT Japfa TBK and APO recorded a strong turnaround, where core earnings for Japfa grew 288% YoY. Without any ASP shock, our FY18E core earnings should be achievable, given that 1Q18 has already met 32% of our FY18E. ASP aside, Japfa has been able to grow its sales volume across three main segments over time and this is consistent with its testament to create long-term value regardless of the market cycle. A potential concern for its balance sheet could arise from a significant increase in net gearing from.7x in 217 to 1. 1x in 218E, which could lead to equity capital fund raising. This is mainly due to the USD255m bank loan drawn down for the full acquisition of the minority stake in the dairy segment and an additional 1.3% stake in PT Japfa TBK. On the other hand, since KKR took a 12% stake in Japfa in mid-216, Japfa has shown good progress in improving access to funding and lowering financing cost. 7.1 P&L overview We expect FY18E/19E/2E core earnings to grow by 467%/18%/1%, supported by revenue growth of 6%/5%/4%. On top of that, the core earnings turnaround of APO segment and margin recovery for PT Japfa TBK is expected to drive operating margin expansion. For FY18E, we expect the revenue growth to be driven by a mix of volume and ASP. Beyond that, we expect stable ASPs and volume will be the main growth driver. The operating margin for APO could continue to expand as it regains operating leverage from an ASP recovery. For the dairy segment, core earnings for FY18E will increase by 56% from the acquisition of the remaining minority stake. Beyond that, we expect growth to be marginal as Japfa does not have any plans to add additional farms. For the consumer segment, we expect losses to gradually diminish on the back of fading competition, the timelier pass on of increases in chicken prices, and additional measures taken by Japfa. The segment other is comprised of the existing corporate level borrowings of USD1m and USD255m for the 3-yr bridge loan to fund the acquisition of a minority interest in the dairy segment and additional 1.3% stake in PT Japfa TBK. Total financing costs are estimated to be USD15m in FY18E, excluding a one-off USD3m transaction cost for the 3-yr bridge loan. June 21,

30 Fig 65: P&L forecasts and key assumptions FYE Dec (USD'm) FY14 FY15 FY16 FY17 FY18E FY19E FY2E Revenue 2,947 2,787 3,33 3,19 3,391 3,561 3,717 Growth, YoY -5.4% 8.8% 5.2% 6.3% 5.% 4.4% COS (2,441) (2,267) (2,368) (2,616) (2,696) (2,826) (2,949) Gross Profit Marketing & dist. costs (17) (19) (121) (137) (148) (153) (16) Admin expense (28) (195) (233) (248) (271) (279) (291) Income from operations / EBIT Financial Income Finance costs (82) (7) (6) (67) (93) (89) (83) Other (losses)/gains Gain on disposal of asset held for sale Share of results of joint ventures () (1) () () Profit before FX & changes in FV of bio assets FX adjustments losses/profit (8) (42) (8) Changes in FV of bio assets (4) (6) (19) (22) Profit Before Tax Taxation (15) (2) (57) (51) (5) (59) (62) Net Profit Minority earnings (28) (27) (79) (55) (47) (53) (59) Profit attributable to shareholders Adjustments (26) (24) (11) Core PATMI w/o forex Growth, YoY 55.5% 47.5% -87.9% 467.2% 18.2% 1.% Breakdown of key segments: PT Japfa Tbk (52% owned, 12% KKR) Animal feed - poultry sales volume (' tons) 2,72 2,641 2,782 3,111 3,298 3,496 3,671 Growth, YoY 6.4% -2.3% 5.4% 11.8% 6.% 6.% 5.% ASP (USD per ton) Growth, YoY -4.8% -7.7% 3.8% -2.8% 2.%.%.% Revenue 2,56 1,855 2,29 2,26 2,382 2,525 2,652 Growth, YoY 1.3% -9.8% 9.4% 8.7% 8.% 6.% 5.% Operating profit Operating margin 5.1% 6.8% 1.7% 7.1% 7.8% 7.9% 7.9% Depreciation (43) (45) (51) (57) (64) (7) (69) EBITDA Core PATMI Animal Protein other (1% owned) Animal feed - swine (' tons) Growth, YoY 13.% 39.7% -2.3% 3.2% 5.% 5.% 5.% ASP (USD per ton) 1,87 1,41 1,519 1,245 1,245 1,245 1,245 Growth, YoY 22.1% -24.6% 7.7% -18.%.%.%.% Revenue Growth, YoY 38.% 5.4% 5.2% -15.4% 5.% 5.% 5.% Operating profit (27) Operating margin 7.2% 6.7% 7.6% -5.7% 6.% 6.5% 6.6% Depreciation (5) (7) (8) (9) (11) (13) (13) EBITDA (19) Core PATMI (34) Dairy (1% owned) China raw milk: sales vol (mil kg) Growth, YoY 61.3% 47.% 26.3% 28.9%.2%.2%.2% ASP (USD per kg) Growth, YoY -4.7% -22.5% -13.% -5.4%.%.%.% Revenue Growth, YoY 53.7% 13.9% 9.8% 21.9%.2%.2%.2% Operating profit Operating margin 23.2% 17.4% 18.% 19.3% 19.3% 19.3% 19.3% Depreciation (1) (16) (2) (24) (25) (25) (25) EBITDA Core PATMI (cont d) Source: Company, Maybank Kim Eng June 21, 218 3

31 Fig 65: P&L forecasts and key assumptions (cont d) FYE Dec (USD'm) FY14 FY15 FY16 FY17 FY18E FY19E FY2E Consumer Food (1% owned) Consumer - Frozen and ambient products (tons) 44,247 45,682 45,227 42,7 42,7 42,427 42,851 Growth, YoY 6.% 3.2% -1.% -7.1%.% 1.% 1.% ASP (USD per tons) 4,723 4,78 4,422 4,792 4,792 4,792 4,792 Growth, YoY -18.4% -13.7% 8.4% 8.4%.%.%.% Revenue Growth, YoY -13.5% -1.9% 7.4%.6%.% 1.% 1.% Operating profit (16) (6) - 3 Operating margin 2.% 2.3% 1.5% -7.9% -3.%.% 1.5% Depreciation (5) (5) (7) (7) (8) (8) (8) EBITDA (8) Core PATMI (5) (4) (5) (2) (12) (6) (3) Others (mainly financing costs for USD255m corp debt, to raise stake in the dairy segment) Core PATMI (15) 5 (6) 3 (18) (15) (15) Source: Company, Maybank Kim Eng June 21,

32 7.2 Balance sheet A potential concern could be the risk from a significant increase in net gearing from.7x in 217 to 1.1x in 218E, which could lead to equity capital fund raising in the form of a placement or rights issue, etc. This is mainly due to the USD25m 3-yr bridge loan drawn down for the full acquisition of the minority stake in the dairy segment. However, we note that the additional earnings from the minority stake of USD16m a year is sufficient to service the financing cost of c.usd13m a year. In addition, Japfa has locked in the interest rate and fully hedged the currency risk for the next 3 years. Since KKR acquired a 12% stake in mid-216, PT Japfa TBK has benefited from an improved profile among institutional investors and credit rating agencies. We understand that KKR has actively engaged institutional investors and credit rating agencies to share their research and views on PT Japfa TBK. The most apparent financial benefit is a reduced cost of financing. PT Japfa TBK has been able to reduce the effective interest rate from refinancing of its three major bonds from 216 to 217, as shown below. Effective interest rates pa. (%) Bonds payable A Bonds payable B Bonds payable C Source: Company, Maybank Kim Eng Another positive for Japfa was the new IDR3t (USD215m) committed loan facility, signed in 3Q17 with favourable terms. Three key highlights of this deal include: 1) this loan consolidates the previous secured facilities into an unsecured facility under one agreement; 2) this is a landmark loan as committed and unsecured bank term loans of this size are not common in Indonesia; and 3) this attests to the creditworthiness of PT Japfa Tbk and the strong relationships built up over the years with its major banks; this transaction was a Club deal with 3 of PT Japfa Tbk s existing major banks (BCA, Bank Mandiri and Maybank). The terms of the facility include: 1) An unsecured basis; 2) Three years with an option to extend for another two years; 3) Use of funds for working capital and general corporate purposes. As of FY17, about half of Japfa s USD79m net debt (USD944m total debt USD235m net cash) came from PT Japfa TBK and most, amounting to USD389m, are in the form of bonds with a long-term maturity period; PT Japfa TBK currently has three bonds, as shown below. Bonds payable Amount Currency Maturity date Interest rate pa. (%) Bonds payable A USD73.8m IDR Terms of 5 years until April 21, Bonds payable B USD25.m USD Senior Notes due Bonds payable C USD73.8m IDR December Source: Company For its USD25m USD denominated bond, it is protected from USD/IDR fx fluctuations as the principal and interest have been hedged for the full duration of the bond up to the all-time high level of the USD/IDR exchange rate equal to 14,693. Breakdown of Japfa s debt and cash profile by segment as of FY17 (USDm): Business segments Total debt Total cash Net debt PT Japfa TBK Dairy APO Consumer food Others Total Source: Company June 21,

33 Fig 66: Balance-sheet forecasts FYE Dec (USD'm) FY14 FY15 FY16 FY17 FY18E FY19E FY2E Current assets 1,184 1,47 1,261 1,236 1,236 1,314 1,387 Cash & cash equivalent Inventories Biological assets Trade Receivables Other financial assets Other assets Assets held for sale Non-current assets 1,143 1,166 1,264 1,57 1,676 1,699 1,718 Property, plant and equipment ,11 1,145 1,129 1,15 Investment properties Intangible assets Biological assets Investments in subsidiaries Investment in joint ventures Deferred tax assets Trade and other receivables, non-current Other financial assets Other assets Total assets 2,327 2,213 2,525 2,743 2,912 3,14 3,15 Current liabilities ,22 1,51 Income tax payable Trade Payables and accruals Other financial liabilities Other liabilities Non-current liabilities Put option financial liabilities Provisions Deferred tax liabilities Trade and other payables, non-current Long-term Loans Other financial liabilities Total liabilities 1,499 1,385 1,436 1,72 1,988 1,944 1,874 Net assets (or total equity) ,89 1, ,69 1,231 Shareholders' equity ,89 1, ,69 1,231 Share capital Treasury shares (5) (5) (5) (5) Retained Earnings Other reserves (399) (396) (375) (481) (744) (744) (744) Translation reserve (115) (172) (18) (168) (168) (168) (168) Shareholders Funds Non-controlling interest Put option reserve (167) (181) (17) Total liabilities and owner equity 2,327 2,213 2,525 2,743 2,912 3,14 3,15 Source: Company, Maybank Kim Eng June 21,

34 7.3 Cash flow Japfa has demonstrated a good track record in generating healthy operating cash flow, even during the major downturn in 217, thanks to its resilient feed business. Its key segment, PT Japfa TBK has shown a healthy track record of positive operating cash flow in the past decade (Fig 36-39). From its historical cash flow analysis, we note that although its spending on capex is heavy in some years, its operating cash flow did subsequently catch up. This is consistent with its strategy of investing to meet the growth in demand. We expect FY18E capex to increase by c.2% from FY17. PT Japfa TBK s expansion will more than offset the reduced capex for the dairy segment. After seeing healthy sales volume growth for PT Japfa TBK, we expect more capex to be directed to expand capacity, based on management guidance. On the other hand, no new dairy farm will be built in FY18E. Beyond FY18E, we expect capex to be above Japfa s maintenance capex of USD7m as it plans to further expand PT Japfa TBK in anticipation of higher poultry demand. Capex breakdown by segments (USDm) E 219E 22E PT Japfa TBK Dairy APO Consumer food Total Source: Company, Maybank Kim Eng June 21,

35 Fig 67: Cash flow forecasts FYE Dec (USD'm) FY14 FY15 FY16 FY17 FY18E FY19E FY2E Profit before tax Depreciation & amortisation Loss / gain from changes in fv of bio assets Increase in provision for retirement benefits Interest income (3) (3) (4) (4) (3) (3) (3) Interest expense Net effect of exchange rate changes (6) 8 8 (5) Other non-cash adjustments (8) (8) (1) (17) Operating profit before WC changes Changes in working capital: (Increase)/ decrease in inventories (55) (11) (2) (59) (18) (35) (32) Bio assets (55) (18) (27) (45) (47) (52) (58) (Increase)/decrease in receivables (16) 18 (3) (3) (9) (9) (9) Other assets 6 (11) (1) (8) Increase/ (decrease) in payables Provisions (2) (7) (5) (12) Other liabilities () Cash generated from operations Interest paid (93) (89) (83) Income Tax Paid (39) (18) (41) (8) (5) (59) (62) Net cash generated from op activities Acquisition of subsidiaries (51) - - (223) - - Purchase of PPE (25) (153) (168) (212) (24) (1) (9) Purchase of intangible assets (2) (1) (1) (3) Purchase of land use rights - (1) (5) (3) Purchase of other financial assets () (5) (3) (5) Purchase of biological assets (17) (32) (27) (27) Proceeds from disposal of PPE Proceeds from disposal of subsidiaries Capital expenditure on investment properties Proceeds from disposal of investment in other FA Addition of investment in joint venture (3) (1) (1) (2) Interest Received Net cash used in investing activities (299) (188) (175) (237) (46) (97) (87) Increase / decrease in working capital loans (99) (211) (155) Increase / decrease in cash restricted in use (2) (2) Buy back of bonds payable - (15) (5) (315) Proceeds from new bank loans (75) (1) Net proceeds from issue of bonds Proceeds from issue of new shares to NCI Proceeds from disposal of shares in subsidiary Acquisition of NCI (19) (8) (5) Dividends paid - - (6) (13) (13) (13) (13) Dividends paid by subsidiary to NCI (4) - (11) (25) Proceeds from issue of shares Issue of new shares by combining entities Others (6) Net cash generated from financing activities 233 (23) 3 (1) 236 (88) (113) Net increase/(decrease) in cash & cash eq. 6 (135) 191 (98) (38) Cash at beginning Net Effect of Exchange Rate Changes () (5) () (3) Cash at end Source: Company, Maybank Kim Eng June 21,

36 8. Valuation holds upside headroom We value Japfa on a sum-of parts based on ascribed EBITDA multiples for its business segments of: 1) PT Japfa TBK; 2) Dairy; and 3) APO and Consumer. Our target price after incorporating a 1% holding company discount is SGD.86 which implies 14x FY18E P/E, a modest 12% discount to the peer average. Japfa is currently trading at 9x FY18E P/E, a significant discount of 44% to peers in the market and a 25% discount to its 52% owned subsidiary, PT Japfa TBK. We believe the market has yet to fully understand and appreciate Japfa s diversified business model due to a number of factors, such as complexity of the business, thin broker coverage, fairly short listing history and short track record of earnings that we discussed in detail earlier in this report. We believe this valuation gap should narrow with the market concerns over the drag of losses of the previous year in smaller business APO and consumer food reversing and narrowing, respectively. Overview of our SOTP methodology: PT Japfa TBK: Based on 6x FY19E EBITDA. This is pegged to a 33% discount to CP s consensus FY19E EBITDA, on par with PT Japfa TBK s 5-year P/E mean discount to CP (Fig 71). APO: based on 6x FY19E EBITDA. Similar basis as PT Japfa TBK as the Vietnam swine and other overseas poultry business also operate under the same business model as PT Japfa TBK. Dairy: Based on 5x FY19E EBITDA, this is pegged to China Modern Dairy s FY19E EBITDA. It has the smallest market cap among all the dairy peers, but its milk sales volume in FY17 of 1,149m kg is more than double that of Japfa s 48m kg. Consumer food: We do not ascribe any EBITDA valuation multiple for the consumer business which could hold some potential upside to our valuation. While FY17 had EBITDA losses, the segment has posted small positive EBITDA contributions in prior years FY We also do expect it to turn back into positive EBITDA in 218E. The reason we ascribe zero value to the business is the much higher level of uncertainty in the timing of the EBITDA turnaround (as that is dependent on the behaviour of competitors). Fig 68: SOTP valuation for Japfa FY19E EBITDA (USDm) EBITDA multiple (x) Value (USDm) Valuation basis PT Japfa TBK ,658 Based on 33% discount to CP, on par with PT Japfa TBK s 5- year P/E mean discount to CP (Fig 71). Dairy Based on the valuation multiple Japfa paid to acquire its APO remaining minority stake of 38% in FY Similar basis with PT Japfa TBK as both segments operate under the same business model. Consumer food 8. - Ascribed zero value. Net debt for FY18E (996) Total 1,346 After 1% conglomerate discount 1,211 Shares outstanding 1,847 Value per share (USD).66 USD/SGD conversion rate 1.31 Value per share (SGD).86 Source: Maybank Kim Eng June 21,

37 Fig 69: Valuations of animal protein and dairy peers Japfa is trading at a discount vs peers on P/E basis. Share Target Market P/E 3Y EPS Market cap/ EBITDA EV/ EBITDA P/BV ROE Div yield Rating Curr. price price cap (x) CAGR (x) (x) (x) (%) (%) (lccy) (lccy) (USD m) FY18E FY19E FY2E (%) FY18E FY19E FY2E FY18E FY18E FY18E FY19E FY18E Japfa BUY SGD Animal protein peers PT Japfa Tbk NR IDR 1,63 n/a 1, Charoen Pokphand NR IDR 3,46 n/a 4, Malindo Feedmill NR IDR 74 n/a n/a n/a Market cap weighted average Dairy peers Inner Mongolia Yili NR CNY n/a 27, China Mengniu Dairy BUY HKD , China Modern Dairy NR HKD 1.51 n/a 1, Yashili International HOLD HKD , n/a Market cap weighted average excluding Yashili Source: Bloomberg, Maybank Kim Eng. Share prices as of 18 Jun 218 Japfa is also trading at a stub value of just 3.1x FY18E P/E, after excluding Japfa s 52% stake in PT Japfa s TBK. We believe the rest of the segments are deeply undervalued as dairy and APO are both profitable segments. Fig 7: Japfa is trading at a stub value of 3.5x FY18E P/E Details Value (USDm) Japfa market cap 828 Market cap of IDR-listed PT Japfa TBK 1,358 Value of 52.4% stake of PT Japfa TBK 712 Japfa s residual market cap ex-pt Japfa TBK 116 Japfa s FY18E core profit ex-pt Japfa TBK s contribution 37.7 Stub 218E P/E of Japfa ex-pt Japfa TBK 3.1x, Maybank Kim Eng Fig 71: 5-yr P/E mean of animal protein and dairy peers Company 5-year P/E mean (x) Japfa 15 Fig 72: Japfa 4-yr forward P/E band (x) 3 +1SD = 28.3x Animal protein peers PT Japfa Tbk 12 Charoen Pokphand 18 Malindo Feedmill 13 Market cap weighted average Mean = 14.7x Dairy peers Inner Mongolia Yili 2 China Mengniu Dairy 21 China Modern Dairy 14 Market cap weighted average 2 Source: Bloomberg, FactSet, Maybank Kim Eng 1 5-1SD = 1x Aug-14 Aug-15 Aug-16 Aug-17 Source: Bloomberg, Maybank Kim Eng 8.2x June 21,

38 Fig 73: PT Japfa TBK 5-yr forward P/E band (x) Fig 74: PT Charoen Pokphand Indonesia TBK 5yr fwd P/E band (x) SD: 8.9x +1SD: 15.x Mean: 12.x 11.6x SD: 15.4x +1SD: 19.7x Mean: 17.5x 17.1x 5 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Source: FactSet 1. Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Source: FactSet Fig 75: PT Malindo Feedmill Tbk 5-yr forward P/E band Fig 76: Inner Mongolia Yili 5-yr forward P/E band (x) 25. (x) SD: 16.5x Mean: 13.1x 12.8x SD: 23.2x Mean: 19.6x 23.8x SD: 9.6x SD: 16.x 5. Jun-13 Jun-14 Jun-15 Jun-16 Jun Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Source: FactSet Source: FactSet Fig 77: China Mengniu Dairy 5-yr forward P/E band Fig 78: China Modern Dairy 5-yr forward P/E band (x) 28 (x) SD: 24.1x 25.7x Mean: 2.7x SD: 18.4x Mean: 14.x 19.5x 16-1SD: 17.2x Jun-13 Jun-14 Jun-15 Jun-16 Jun SD: 9.6x 5 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Source: FactSet Source: FactSet June 21,

39 9. Investment risks 9.1 High gearing levels that might require equity raising Japfa s net gearing should increase significantly from.7x in 217 to 1.1x in 218E, due to the USD25m 3-yr bridge loan drawn down for the full acquisition of the minority stake in its dairy operations. Along with its increased capex plans of 19% YoY higher levels this year, we expect cashflows will be stretched in FY18E. Discussions with the company suggest that net gearing of 1.1x is around the maximum level that management is comfortable with. Hence we would not rule out the likelihood of some equity capital raising activity through placement, rights issue, entry of a strategic investor at subsidiary level, etc. over the next couple of years. We do note that the additional earnings accretion of cusd16m a year from the acquisition of the minority stake is sufficient to service the financing cost of c.usd13m a year and that the bridge loan terms have a locked-in interest rate for the next three years with allowance for early repayment without penalty. 9.2 Forex related risks and sensitivity Japfa s profits would be at risk from a significant depreciation in the IDR, CNY and the VND (Indonesia, China and Vietnam are its largest markets) against the USD, its reporting currency. Japfa s major revenue streams are denominated in IDR, CNY and the VND, while it has debt and associated interest expense denominated in USD. Prices of some of its raw material commodity inputs are USD linked as well. While Japfa attempts to pass through currency impact with adjustments to selling prices, there are constraints to the extent this can be done in certain parts of the business due to consumer affordability and market competition factors. IDR sensitivity: Indonesia is the largest profit contributor with c.6% of FY18E earnings from PT Japfa TBK. Also, we expect the feed business to be able to largely pass through the currency impact (as past performance indicates); USD/IDR rate movements will largely affect DOC and broiler profits that make up c2% of Japfa s profits. We estimate a 1% depreciation of the IDR against USD will reduce Japfa s earnings by 2%, and vice versa. However, this is translational as Japfa reports its financial results in USD. CNY sensitivity: The reporting currency for Japfa s dairy business is CNY and this segment contributed 56% of FY18E group profit. We estimate a 1% depreciation of the CNY against USD will reduce Japfa s earnings by 5.6%, and vice versa. USD debt exposure: Japfa s exposure to USD denominated debt was USD426m as of end-217, around USD4m was attributable to PT Japfa TBK. We understand that a substantial portion of this is working capital loans for its poultry feed business, which has USD denominated raw material costs. Japfa will face higher financing and principal repayment costs if the USD strengthens against its local operating currency. The company subsequently raised another USD25m 3-yr bridge loan for which we understand it has hedged the principal and interest, and hence exchange rates should have minimal impact. June 21,

40 9.3 Demand supply imbalances for poultry, swine and milk A sudden drop in the market demand or oversupply of Japfa s proteins and milk will adversely affect their ASP and Japfa s profitability. For instance, Japfa went through the boom and bust cycle of China s dairy industry from and Vietnam s swine industry from The dairy industry in China enjoyed a period of high milk ASP in 213 and 214 as production fell in 212 due to disease and attrition in the farming industry. But in 215, milk ASP collapsed, as: 1) earlier price boom led to capacity increases and overproduction; 2) demand from China fell; and 3) cheaper EU exported milk flooded the global market after Russia's ban on EU produce in retaliation against EU sanctions. Vietnam s swine industry faced a massive oversupply issue in 4Q16 after China banned the imports of swine from the country. Vietnamese farmers were forced to sell their swine at ASPs below production cost of around VND34,/kg. 9.4 Price and availability of feed raw materials Raw materials make up c.85-9% of the cost of goods sold. The main raw materials are corn and soybean meal, which make up c.5% and c.25% of COS, respectively. Although Japfa typically passes on these costs, any sudden spike could impact profitability. Japfa imports a portion of its raw materials, such as corn, soybean meal, feed vitamins, animal protein meal and wheat products from the US, South America, China, India, Europe, Australia and Canada. It also purchases a substantial amount of corn from domestic farmers. Market prices for corn and soybean meal may be subject to fluctuations resulting from weather, harvest size, transportation and storage costs, governmental agricultural policies, currency exchange rates and other factors. 9.5 Competition in the consumer food space The downstream branded consumer food space is a competitive segment in Indonesia with many established players, and hence competitive intensity is moderate to high across various food categories. Japfa s ambient food sector in Indonesia started to face competition in 4Q17 as rivals slashed prices to gain market share. Japfa has reacted by providing more direct discounts to suppliers and also created a fighter brand. Although price wars typically do not last longer-term and are typically adopted by newcomers to encourage brand switching, this would impact short-term profitability. 9.6 Disease outbreak Outbreak of diseases affecting livestock is a big risk for Japfa. In the past, disease outbreaks, such as the H5N1 and H7N9 strains of avian influenza in Indonesia and China in 23 and 213 caused significant drops in the demand for poultry. In addition, these viruses could trigger the mass culling of livestock, halt production and increase the possibility of incurring significant impairment losses. Japfa mitigates this risk by having an in-house laboratory with vaccination and research capabilities. Although its in-house research laboratory allows for quicker response time to combat livestock diseases, it does not offer total insurance against the threat of diseases affecting Japfa s livestock and businesses. June 21, 218 4

41 Appendix 1: Management profiles Mr. Tan Yong Nang, Executive Director and CEO Appointed as an Executive Director on 1 Jun 29. Joined Japfa in 27 as an assistant to the CEO and COO of Corporate Services before taking on the position of COO of the Group in 211. Involved in the growth of Japfa s operations in the region, such as the expansion of swine and dairy business segments and had oversight of the management functions across businesses. Management of Group s financial liabilities and has assisted in diversifying financial relationships to include international banks. In 23, Mr Tan joined Delifrance Asia Ltd as its CEO, and in 25 he joined Li & Fung Group in 25 as its Project Director and COO. Graduated with an Economics degree from the University of Cambridge, UK in Chartered Financial Analyst in Mr. Kevin Monteiro, Executive Director and CFO Appointed as an Executive Director on 16 April 214. Currently also the Head of Corporate Finance of PT Japfa Tbk. Previously the head of corporate finance and has over 14 years of experience working in the agri-food industry, having joined PT Japfa Tbk in Obtained a Bachelor of Economics degree from Monash University, Australia in 1979 and has been a member of the Institute of Chartered Accountants in Australia since Mr. Bambang Budi Hendarto, COO, Poultry Indonesia Oversees the entire poultry operations, including the feed, breeding and commercial aspects. Joined Japfa in 1978 as a Nutrition Manager in the Production Planning Control Department where he was involved in supervising and coordinating the activities for the production of formula feed. Became Deputy Director of PT Comfeed Indonesia in 1981 and led the Feed Division. Graduated from Brawijaya University in 1972 with an Engineering degree in Animal Husbandry. Mr. Edgar Dowse Collins, COO, Head of Dairy Responsible for operations of Dairy division and is in charge of strategic and long-term business plans for the Dairy operations. Involved in beef and cattle operations throughout his career. Been with AustAsia Food since Manager for 2 years at BxE Commodities, which engaged in the import and trading of cattle feed commodities in Australia s and New Zealand s dairy industries. Established a system for the importation, trading and distribution of feed products, such as copra meal and palm kernel extract to commercial farmers and feedmills. Ms. Christina Chua Sook Ping, Head of Legal and Compliance Joined in 21. Oversees all legal, compliance and secretarial functions. Has more than 2 years of experience in legal practice. She joined Drew & Napier LLC in 199 and later joined Rajah & Tann LLP in 27. She was a partner in the corporate and tax departments of both firms and was recommended as a leading tax practitioner in Singapore by various bodies. Graduated with a Bachelor of Laws (Honors) degree from the National University of Singapore in 1989 and was admitted as an advocate and solicitor of the Supreme Court of the Republic of Singapore in June 21,

42 Appendix 2: Overview of APO & Consumer Food Fig 79: APO operations overview Fig 8: Consumer food operations overview June 21,

43 Appendix 3: Corporate social responsibility Growing with stakeholders Japfa recognises the importance of growing together with its stakeholders. As an agri-food producer, Japfa contributes to the lives of the people in the countries it operates in by providing nutritious and affordable animal protein staples to consumers, partnering and empowering farmers, creating jobs, and contributing to national economic development. It has over 34, employees across its network of industrialised farms, mostly located in Indonesia. Its strategic partnerships with local farmer partners provide employment opportunities beyond the farms, as they form the basis for the economic development programmes. Through these programmes, its local farmers contribute to the economic growth in their operating regions via the provision of food protein, job creation and local tax contributions Efficiency in Animal Protein Production Achieving efficiency in animal protein production is important so as to keep costs low, enabling Japfa to offer affordable protein to consumers. It continuously strives to enhance efficiency by improving the performance of its livestock, through: 1. Selecting the right animal genetics with superior feed conversion ratios in the tropical climate where it operates its livestock farms; 2. Producing animal feed that provides optimal nutritional value for the animal to reach its best potential; and 3. Minimising the incidence of diseases through stringent biosecurity practices to protect the health of its animals. Animal health (statement from Japfa corporate) The health of our chickens is our main priority in every step of our production cycle, and we ensure their well-being by preventing flock infection from external sources. We are focused on identifying, evaluating, and resolving issues relating to animal well-being, both within our farms and with our local farmers. Our approaches include: 1) formulating balanced feed; 2) housing of its chickens as a sustainable approach to poultry farming; 3) safe transport; 4) vaccines; 5) preventing virus from spreading; and 6) slaughterhouse practice. Developing farmer partners Japfa runs partnership programmes with farmers, where it carries out knowledge transfer to improve their technical skillsets and raise their farming capabilities in producing healthy and affordable protein. These efforts will ultimately help them become better farmers and improve their economic well-being. In 217, Japfa established partnerships with more than 9, poultry partners in Indonesia. Started in 1998 when the financial crisis hit Indonesia, the programme aims to create job opportunities through the development of local farming and raise farmers ability to increase production efficiency. Under the programme, Japfa supplies its farmer partner with DOC, feed, medicine, vaccines and chemicals, as well as veterinary service and technical assistance. The model follows the principle of being transparent. At early stages, farmer partners will receive crucial information, such as their share of sales and how Japfa manages the sales and marketing. In situations when broiler market prices are low or when losses are incurred, the farmer partners will still be given a basic living cost compensation. When the broiler market prices are high, the farmers will enjoy the upside accordingly. This partnership programme with small local farmers is in line with Japfa s Number 1 goal of Sustainable Development, which is to reduce poverty. June 21,