CP Indo. Cautious outlook. Rp1,910 - SELL. Indonesia Materials. Jessica Irene (62)

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1 CP Indo Rp1,910 - SELL Jessica Irene jessica.irene@clsa.com (62) May 2011 Indonesia Materials Reuters Bloomberg CPIN.JK CPIN IJ Priced on 16 May 2011 Jakarta 3, M hi/lo Rp2,050/465 12M price target Rp1,750 ±% potential -8% Target set on 28 Apr 11 Shares in issue 16,422.8m Free float (est.) 44.5% Market cap US$3,660m 3M average daily volume Rp40.8bn (US$4.7m) Major shareholders Central Agromina 55.5% Stock performance (%) 1M 3M 12M Absolute Relative (1.8) Abs (US$) ,495 2,020 1,54 5 1, (Rp) 12 0 M ay-09 Nov-09 M ay-10 Nov-10 Source: Bloomberg (%) CP Indo (LHS) Rel to Comp (RHS) Cautious outlook Excellent 1Q11 results proved us to be too conservative on our gross margins this year. Hence, we are revising up our earnings by 18% this year based on higher ASP assumptions. Despite the strong start, we remain cautious on the company s ability to continue increasing ASP going forward, given relatively weak chicken prices YTD. CP Indo currently trades at 15x 11CL earnings. Our new TP suggests 8% downside. Maintain SELL. Supernormal 1Q11 We proved to be too conservative on our gross margin assumption this year. 1Q11 gross profit make up 31% of our FY assumption whereas in the past, 1Q gross profit usually make up less than 20% of the FY number. Gross margins however dropped from its peak in 3Q-4Q10 to 23% in 1Q11. Operating profit and bottom line grew nearing 50% YoY, both making up 37% of our FY previous forecasts. Weakness in chicken prices Despite the strong start, we remain cautious on the company s ability to continue increasing ASP going forward given relatively weak chicken meat prices YTD. Chicken prices are down 11% YTD. Low chicken meat price may limit CP Indo s ability to continue passing on costs going forward as further feed price appreciation could push farmers margin too low and consequence greater volume loss. Earnings upgrade We upgrade our earnings forecast by 18% this year to adjust for the supernormal 1Q11. Our new assumptions are based on 28% revenue growth this year, primarily driven by price increases in feed and DOC, and capacity expansion in processed chicken. Future growth driver will partly come from processed chicken segment with an estimated Cagr of 20% over the next five years. Maintain sell We upgrade our target price by 9% to Rp1,750 per share following our earnings upgrade for the year but maintain our SELL call on the stock. Our new target price is derived from 14x 11CL earnings, in line with JCI Index PE, suggesting an 8% downside to current share price. CP Indo currently trades at 15x 11CL earnings, expensive compared to its regional peers who are trading at 13x. Financials Year to 31 Dec 09A 10A 11CL 12CL 13CL Revenue (Rpbn) 14,559 15,078 19,357 19,954 22,190 Rev forecast change (%) Net profit (Rpbn) 1,613 2,210 2,067 2,593 3,038 NP forecast change (%) EPS (Rp) CL/consensus (0) (EPS%) EPS growth (% YoY) (6.5) PE (x) Dividend yield (%) ROE (%) Net debt/equity (%) 18.2 (19.0) (4.5) (12.0) (15.3) Upgrade earnings & recommendation Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com

2 1Q11 gross profit makes up 31% of our FY number Supernormal 1Q11 We proved to be too conservative on our gross margin assumption this year. 1Q11 gross profit make up 31% of our FY assumption whereas in the past, 1Q gross profit usually make up less than 20% of the FY number. Gross margins however dropped from its peak in 3Q-4Q10 to 23% in 1Q11. Operating profit and bottom line grew nearing 50% YoY, both making up 37% of our FY previous forecasts. Figure 1 1Q11 results (Rpbn) 1Q11 1Q10 % YoY 4Q10 % QoQ Sales 4,380 3,458 27% 4,221 4% COGS 3,374 2,749 3,063 Gross profit 1, % 1,158-13% Selling exp G&A exp Total opex Operating profit % % Other income (charges) Interest expenses (9) (16) (9) Forex gain (loss) - net (3) Interest income Others Total EBT % % Taxes Minority interest (3) (0) (4) Net profit % % Margins Gross margin 23% 21% 27% Op margin 19% 16% 17% Net margin 15% 13% 14% Opex/Sales 4% 5% 11% Segment breakdown Feed sales 3,248 2,948 10% 2,984 9% Feed EBIT % % DOC sales % % DOC EBIT 184 (1) n/a % Processed chicken sales % % Processed chicken EBIT % % EBIT margin per segment Feed 17% 17% 15% DOC 28% 0% 28% Processed chicken 17% 21% 32% 18 May 2011 jessica.irene@clsa.com 2

3 Figure 2 Figure 3 Quarterly feed sales Quarterly gross margins 4, , , % 28.0% 26.0% Peak gross margin at 27% 3, % 2, , , , % 20.0% 18.0% 16.0% 14.0% 12.0% - 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q % 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 Stronger growth seen from feed and processed chicken The strongest revenue growth drivers are poultry feed and value added food products from the processed chicken segment. Revenue and profit growth breakdown for each categories are as follows: Feed sales grew 10% YoY and 9% QoQ due to a series price increases since beginning of the year. YTD, CPIN has already increase prices by almost 30%. DOC sales grew by 49% YoY due coming from low base, but down 22% QoQ due to seasonality on volumes. DOC production is disrupted across the industry last year given disease breakout and unfavourable weather conditions. Prices skyrocketed in 4Q10 and were maintained throughout 1Q11. Processed chicken sales grew by 46% YoY and 24% QoQ given both higher prices and volume expansion. CP Indo plans to double capacity within next two to three years. Despite the strong start, we remain cautious on the company s ability to continue increasing ASP going forward given relatively weak chicken meat prices YTD. National chicken prices are down 11% YTD Weakness in chicken prices We continue to see weakness in domestic chicken prices, down 11% YTD. Chicken meat prices are driven primarily by demand, given that chicken farming is largely fragmented across the nation. Weak chicken meat price is indicating that consumer demand for chicken meat is declining, while on the other hand, farmers costs to grow chicken have increased. The imbalance could drive chicken farmers to slow down their chicken production, causing lower demand for both feed and DOC. The chart below shows the movement of chicken meat price versus corn price since Inflection point 1 shows corn prices collapse while chicken meat prices sustained. The two opposite price movements expand feed producers margins as they managed to hold selling prices while raw material prices collapse. The reverse happened in inflection point 2 this year where corn prices sky-rocketed while chicken meat prices plummet. 18 May 2011 jessica.irene@clsa.com 3

4 Figure 4 Chicken meat and corn price movement Broiler chicken meat prices (Rp/kg) Corn prices (USc/bushel) RHS 28,000 Inflection point ,000 24,000 22,000 20,000 18,000 16,000 14,000 Inflection point , Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Source: Bloomberg, Disperindag Feed prices appreciated more than 25% YTD CP Indo has increased prices by more than 25% YTD to partially offset higher corn and soybean meal prices. Theoretically, chicken meat prices should follow as farmers pass on their feed cost inflation, but it failed to happen. Demand for chicken meat is not strong enough to absorb the price increases given that mass market buying power is eroded by other basic food inflation. Low chicken meat price may limit CP Indo s ability to continue passing on costs going forward as further feed price appreciation could push farmers margin too low and consequence greater volume loss. As an illustration, we have compiled farmers cost breakdown this year versus last year to grow an average 1.5kg chicken below. Farmers earnings are down 29% YoY Figure 5 Farmers income statement (Rp) Revenue from selling 1 chicken (1.5kg) 36,225 33,677 Cost of chicken sold: DOC (1 unit) 4,300 5,000 Feed (1.7 conversion ratio x 1.5kg) 11,208 14,025 Profit (before water, electricity, labor, and depreciation) 20,716 14,652 %YoY -29% 1Q11 strong results are likely to be a one-off Therefore, strong earning in 1Q11 is likely to be a one-off event of the year. 1Q11 gross margins slumped down to 23% from 27% the previous quarter. We think that in the next few quarters, margins should continue to slide down to below 20%. 18 May 2011 jessica.irene@clsa.com 4

5 Upgrade earnings to price in strong 1Q11 Earnings revision We upgrade our earnings forecast by 18% this year to adjust for the supernormal 1Q11. Our new assumptions are based on 28% revenue growth this year, primarily driven by price increases in feed and DOC, and capacity expansion in processed chicken. Higher revenue base this year should drive next year s profit higher, given that corn prices start to normalize by end of this year when corn harvest season usually come. Given the oligopolistic nature of the industry, CP Indo is likely to absorb the cost savings and let its margins expand. Figure 6 Key assumptions and forecast change summary (Rpbn) 2011CL 2012CL 2013CL 2014CL 2015CL Key assumptions Feed price 25% -5% 5% 5% 5% Feed volume 5% 5% 5% 5% 5% DOC price 10% 5% 5% 5% 5% DOC volume 5% 5% 5% 5% 5% Corn price 45% -10% 8% 8% 8% Soybean meal price 25% -5% 8% 8% 8% Revenue New 19,357 19,954 22,190 24,696 27,507 Old 18,263 18,508 20,391 22,467 24,755 % Change 6.0% 7.8% 8.8% 9.9% 11.1% Gross profit New 3,735 4,490 5,140 5,793 6,140 Old 3,268 3,808 4,446 5,092 5,456 % Change 14.3% 17.9% 15.6% 13.8% 12.5% Operating profit New 2,693 3,375 3,924 4,467 4,695 Old 2,206 2,671 3,207 3,741 3,984 % Change 22.1% 26.3% 22.4% 19.4% 17.9% Net profit New 2,067 2,593 3,038 3,466 3,655 Old 1,755 2,123 2,569 3,005 3,211 % Change 17.8% 22.2% 18.3% 15.4% 13.8% Margins changes Gross margin 1.4% 1.9% 1.4% 0.8% 0.3% EBIT margin 1.8% 2.5% 2.0% 1.4% 1.0% Net margin 1.1% 1.5% 1.1% 0.7% 0.3% Processed chicken is growing in significance Future growth driver will partly come from processed chicken segment. Processed chicken currently contributes only less than 10% of total revenue. The company intends to grow this segment to contribute more than 15% of total revenue. Going forward, CP Indo expects at least 20% growth per year to tap into the growing middle class and shift in consumerism into consuming more value added products. 18 May 2011 jessica.irene@clsa.com 5

6 Long term fundamental story remain intact despite short term margin pressure Maintain SELL with TP suggesting 8% downside Valuations Long term fundamental story for CP Indo remains intact. As the largest poultry and poultry feed player in the country, CP Indo benefits from growing per capita protein intake that follows rising income. Competitive landscape is relatively mild for the existing players, given high barriers to entry and oligopoly-like nature. In the short term however, the company is facing pressure from sky rocketing costs, while passing on costs are becoming more challenging. We upgrade our target price by 9% to Rp1,750 per share following our earnings upgrade for the year. Our new target price is derived from 14x 11CL earnings, in line with JCI Index PE, suggesting an 8% downside to current share price. Cash is the fastest growing item in the balance sheet, thus we might potentially see an increase in dividend payout. In the next AGM in May, management is planning to propose for higher dividends this year. We forecast an increase from 40% to 60% payout ratio this year, yielding 4% on yesterday s close. The stock however still offers 4% net downside for investors, hence we maintain our SELL recommendation. CP Indo currently trades at 15.2x 11CL earnings, expensive compared to its regional peers who are trading at 13x. Figure 7 Peer comps PE PB ROE Net gearing Bloomberg (x) (x) (%) (%) CP Indo CPIN IJ (19.3) CP group peers CP Foods CPF TB CP Enterprises 1215 TT n/a Local competitors Sierad Produce SIPD IJ Multibreeder Adirama MBAI IJ Japfa Comfeed JPFA IJ Regional comparables Lee Feed Mill LEE TB (14.5) Agfeed Industries FEED US n/a 0.9 n/a 34.0 Nippon Formula Feed 2056 JP Woosung Feed KS Brasil Foods BRFS3 BZ Nutreco NUO NA Ras Al Khaima RAPCO UH (36.6) Universal Robina URC PM (5.4) San Miguel Pure Foods PF PM Rainbow Chicken RBW SJ (20.3) Average May 2011 jessica.irene@clsa.com 6

7 7% earnings decline this year on lower margins Strong cashflow generation Cash build up calls for an increase in dividend payout ratio Net cash as of last year Summary financials Year to 31 December 2009A 2010A 2011CL 2012CL 2013CL Summary P&L forecast (Rpbn) Revenue 14,559 15,078 19,357 19,954 22,190 Op Ebitda 2,183 2,898 2,880 3,641 4,239 Op Ebit 2,057 2,761 2,693 3,375 3,924 Interest income Interest expense (202) (55) (32) (21) (3) Other items Profit before tax 2,160 2,818 2,698 3,385 3,965 Taxation (541) (598) (621) (778) (912) Minorities/Pref divs (7) (10) (11) (13) (15) Net profit 1,613 2,210 2,067 2,593 3,038 Summary cashflow forecast (Rpbn) Operating profit 2,057 2,761 2,693 3,375 3,924 Operating adjustments Depreciation/amortisation Working capital changes (122) 9 (954) (303) (384) Net interest/taxes/other (523) (713) (686) (789) (905) Net operating cashflow 1,538 2,194 1,241 2,549 2,950 Capital expenditure (154) (383) (600) (700) (800) Free cashflow 1,383 1, ,849 2,150 Acq/inv/disposals Int, invt & associate div Net investing cashflow 12 (189) (525) (669) (756) Increase in loans (1,784) (411) (151) (89) (146) Dividends 0 (644) (1,326) (1,343) (1,815) Net equity raised/other (5) (62) (7) (9) (10) Net financing cashflow (1,788) (1,116) (1,484) (1,442) (1,971) Incr/(decr) in net cash (238) 889 (769) Exch rate movements Opening cash , Closing cash 388 1, ,209 Summary balance sheet forecast (Rpbn) Cash & equivalents 388 1, ,209 Debtors ,356 1,397 1,550 Inventories 1,972 1,950 2,599 2,853 3,170 Other current assets Fixed assets 1,685 1,931 2,344 2,777 3,263 Intangible assets Other term assets Total assets 5,349 6,518 7,309 8,475 9,654 Short-term debt Creditors ,036 1,037 1,134 Other current liabs Long-term debt/cbs Provisions/other LT liabs Minorities/other equity Shareholder funds 2,933 4,458 5,200 6,450 7,673 Total liabs & equity 5,349 6,518 7,309 8,475 9,654 Ratio analysis Revenue growth (% YoY) Ebitda growth (% YoY) (0.6) Ebitda margin (%) Net profit margin (%) Dividend payout (%) Effective tax rate (%) Ebitda/net int exp (x) Net debt/equity (%) 18.2 (19.0) (4.5) (12.0) (15.3) ROE (%) ROIC (%) EVA /IC (%) May 2011 jessica.irene@clsa.com 7

8 Recommendation history - Charoen Pokphand Indonesia CPIN IJ Date Rec level Closing price Target 28 April 2011 SELL 1, , December 2010 SELL 1, , July 2010 BUY , July 2010 BUY , Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local market by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%. Performance is defined as 12-month total return (including dividends) CLSA Asia-Pacific Markets ( CLSA ). Note: In the interests of timeliness, this document has not been edited. The analyst/s who compiled this publication/communication hereby state/s and confirm/s that the contents hereof truly reflect his/her/their views and opinions on the subject matter and that the analyst/s has/have not been placed under any undue influence, intervention or pressure by any person/s in compiling such publication/ communication. The CLSA Group, CLSA's analysts and/or their associates do and from time to time seek to establish business or financial relationships with companies covered in their research reports. As a result, investors should be aware that CLSA and/or such individuals may have one or more conflicts of interests that could affect the objectivity of this report. The Hong Kong Securities and Futures Commission requires disclosure of certain relationships and interests with respect to companies covered in CLSA's research reports and the securities of which are listed on The Stock Exchange of Hong Kong Limited and such details are available at Disclosures therein include the position of the CLSA Group only and do not reflect those of Credit Agricole Corporate & Investment Bank and/or its affiliates. If investors have any difficulty accessing this website, please contact webadmin@clsa.com or (852) If you require disclosure information on previous dates, please contact compliance_hk@clsa.com IMPORTANT: The content of this report is subject to and should be read in conjunction with the disclaimer and CLSA's Legal and Regulatory Notices as set out at a hard copy of which may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) /01/ May 2011 jessica.irene@clsa.com 8