Poultry. Reaching equilibrium. Signs of recovery in purchasing power. Seeking supply and demand equilibrium. Poultry companies covered in this report

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1 Reaching equilibrium Overweight (Initiate) Initiation April 27, 2016 PT Daewoo Securities Indonesia Basic Industry Mimi Halimin Signs of recovery in purchasing power products embed quality protein at affordable price. Given Indonesia is the most populous Muslim country (c.87%+ of the total population), c.62% of meat consumption comes from chicken meat. Amid a slowdown of the broader economic growth (GDP growth slowed from 6.4% YoY growth in 2010 to 4.8% in 2015), demand for chicken has remain soft. In line with the slowing economic growth, private consumption growth has also decelerated, albeit trending above par growth of c.5.0% YoY. In response to the slowing macroeconomic backdrop, the government introduced multiple stimulus packages to bolster the sagging economy. Furthermore, Bank of Indonesia s key interest rate has been cut by 75bps, supporting the government s growth agenda. Through various policy measures, consumer confidence index has shown modest signs of recovery bouncing back from the trough in September 2015 at 97.5 to in March We believe this is a concrete sign of purchasing power recovery. Seeking supply and demand equilibrium In our view, the key threat hanging over the poultry industry is the large mismatch between supply and demand. On the demand side of the equation, decelerating economic growth and softening purchasing power have placed negative implications on consumer sentiment. On the supply side, we have witnessed sizeable production expansions which led to heightened competition, thus compressing profit margins across the board. In an attempt to ease oversupply conditions, the Directorate General of Livestock and Animal Health Services announced the culling of 6mn parent stocks (PS). Although this movement has triggered heavy positive and negative discussions within the industry, it has led to improved sentiment on poultry companies through better margins in the DOC segment. The government also limited GPS import quota to reduce oversupply. Volatility in commodities prices can be passed on to customer Raw materials account for c.70% of poultry companies total expenses. We believe that the global commodity price outlook will still remain soft. However, corn price in Indonesia will prove to be volatile due to government s policy that only allows State Procurement Agency to import corn. We predict volatile raw material price trends in 2016, however, poultry companies have the ability to pass on the volatility to customers. Initiating coverage on poultry sector with an Overweight recommendation We are initiating our coverage on the poultry sector with an Overweight call. Our positive stance reflects the following: a) Chicken is the largest source of meat consumption in Indonesia; b) government s favorable policies such as culling program and GPS quota will equalize the oversupply backdrop; c) the ability of poultry companies to pass on the raw material price volatility to customers. Risks to our investment call include the weakening of purchasing power, prolonged oversupply condition due to unsettled cartel issue, potential price spike in commodities especially corn and soybean, and greater-than-expected currency volatility. companies covered in this report Company name Ticker Rating TP (IDR) ROE (%) P/E(x) P/B(x) 2016F 2017F 2016F 2017F 2016F 2017F Japfa Comfeed Ind. JPFA T.BUY 1, Malindo Feedmill MAIN Hold 1, Source: Daewoo Securities Research Analysts who prepared this report are registered as research analysts in Indonesia but not in any other jurisdiction. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

2 Mapping Indonesia s poultry players In Indonesia, large integrated poultry companies dominate the DOC and animal feed markets. companies which are listed on the exchange (IDX) are PT Charoen Pokphand Indonesia Tbk (CPIN), PT JAPFA Comfeed Indonesia Tbk (JPFA), PT Malindo Feedmill Tbk (MAIN) and PT Sierad Produce Tbk (SIPD). These 4 big companies dominate more than 50% of the entire market (see Figure 1 and 2). Figure 1. Indonesia feed production capacity share (2015) Figure 2. Indonesia DOC production capacity share (2015) CPIN JPFA MAIN SIPD CJ Others CPIN JPFA WJ MAIN SIPD Others 21% 7% 5% 8% 25% 34% 22% 3% 7% 8% 22% 38% Source: MAIN presentation, Daewoo Securities Research Source: MAIN presentation, Daewoo Securities Research -related products such as chicken and eggs are largely homogenous products and thus we believe it is hard to differentiate the quality and price. Hence, in order to add value to each production stages, poultry companies which have reached economies of scale, such as CPIN, JPFA and MAIN are vertically integrated from upstream to downstream (economies of scope). For most of the integrated poultry companies, animal feed segment plays an important role evident by the fact that approximately 70% of total costs stem from this segment (i.e., raw materials). Most of the poultry companies have business segment ranging from feed, DOC breeding farms to chicken processing plants. Listed integrated poultry companies are as follows: PT Charoen Pokphand Indonesia Tbk (CPIN) CPIN was established in 1972 under the business name of PT Charoen Pokphand Indonesia Animal Feedmill Co. Limited. CPIN was listed on the Jakarta Stock Exchange in CPIN has 4 business segments which are feeds, day-old chicks (DOC), processed chicken and others. Its business is dominated by feeds segment which contributed 73% to its total revenue in 2015, while DOC was 13%, processed chicken was 10% and others was 4%. CPIN s feeds production has the largest installed production capacity with approximately 6mn tons. CPIN is the market leader for both feed production capacity and DOC production capacity. Figure 3. PT Charoen Pokphand Indonesia Tbk Figure 4. CPIN s business 2

3 PT JAPFA Comfeed Indonesia Tbk (JPFA) JPFA was established in 1971 and engaged in commercial production of copra pellets. JPFA commenced poultry feed business in 1975 and poultry breeding operations in In 1989, JPFA was listed on the Jakarta and Surabaya Stock Exchanges. JPFA has 6 business segments which are animal feeds, commercial farms and consumer product, aquaculture, cattle, DOC, trading & others. Similar to its competitor, CPIN, JPFA s business is also dominated by feeds segment accounting c.45% of its total revenue in Total JPFA s production capacity in 2014 stood at c.4mn tons. JPFA is the second largest player in Indonesia in terms of feed production capacity share and DOC production capacity share with 25% and 22%, respectively as of Figure 5. PT JAPFA Comfeed Indonesia Tbk Figure 6. JPFA s business PT Malindo Feedmill Tbk (MAIN) MAIN was established in 1997 and was listed on the Indonesia Stock Exchange in It has 5 business segments which are feeds, DOC, broiler, processed foods and others. Its feed segment is MAIN s dominant business accounting for c.69% of its total revenue. MAIN has a production capacity of c.1.5mn tons for its feed business. MAIN holds 8% capacity share for feed production and 7% for DOC production capacity as of Figure 7. PT Malindo Feedmill Tbk Figure 8. MAIN s business PT Sierad Produce Tbk (SIPD) SIPD was established in 1985 under the name of PT Betara Darma Ekspor Impor. The company changed its name to PT Sierad Produce in 1996 and was listed on the Jakarta Stock Exchange in the same year. SIPD divides its business segments into 3 categories which are poultry, fast food, and poultry equipment and others. SIPD holds 5% capacity share for feed production and 3% for DOC production capacity as of

4 Figure 9. PT Sierad Produce Tbk Figure 10. SIPD s business Table 1. Financial comparison big three companies Financial comparison of big three companies Given CPIN, JPFA and MAIN dominate the market with more than 50% market share, we are inclined to focus on the big three companies. The comparisons of their financial statements are as follow: Revenue (IDRbn) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 CPIN 6, , , , , , , ,591.7 JPFA 5, , , , , , , ,287.3 MAIN 1, , , , , , , ,240.6 Operating expenses (selling expenses + GA expenses) - IDRbn 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 CPIN JPFA MAIN Operating Profit - IDRbn 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 CPIN JPFA MAIN Net profit - IDRbn 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 CPIN JPFA MAIN From the revenue side, CPIN, JPFA and MAIN demonstrated relatively sound recovery in 4Q15 compared to 4Q14. CPIN, JPFA and MAIN staged 3.1%, 9.1% and 12.2% YoY growth, respectively in 4Q15 which was relatively well-delivered. We judge this robust YoY growth to be a solid recovery trend going forward. From the operating expenses side, CPIN showed higher QoQ growth in 4Q15 although it showed lower growth in yearly basis compared to its peers, in line with its revenue growth. All companies showed recovery (YoY) in operating profit in 3Q15 with MAIN showed significant improvement operating profit in yearly basis from negative to positive. 4

5 JPFA demonstrated outstanding earnings turnaround following 2 consecutive quarters of net losses by booking a net profit of IDR124.9bn in 3Q15 and IDR615.5bn in 4Q15. MAIN also booked a net profit of IDR13.1bn in 3Q15, which marked a solid earnings turnaround after four consecutive quarters of net losses. However, its net profit decreased to IDR8.1bn in 4Q15. CPIN booked a net profit of IDR290.9bn in 3Q15 (-45.0% QoQ) but it improved significantly to IDR586.7bn in 4Q15 Price trends and valuations of big three companies companies share prices underwent turbulent times over the past 2 years. Indeed, price performances as of end 2015 were well below the JCI, where CPIN posted -31.2%, JPFA posted %, and MAIN posted -28.4%. This is comparable to the price performance of JCI which delivered -12.1% returns. Figure 11. companies price trend JPFA MAIN CPIN (Jan 2014 = 100) /14 04/14 06/14 09/14 12/14 03/15 06/15 09/15 12/15 Source: Bloomberg, Daewoo Securities Research We noticed that these three companies are still trading below their 5 years average P/B. Figure 12. CPIN P/B standard deviation (as of April 21) (x) /11 10/11 04/12 10/12 04/13 10/13 04/14 10/14 04/15 10/15 04/16 Source: Bloomberg, Daewoo Securities Research 5

6 Figure 13. JPFA P/B standard deviation (as of April 21) 6 (x) /11 10/11 04/12 10/12 04/13 10/13 04/14 10/14 04/15 10/15 04/16 Source: Bloomberg, Daewoo Securities Research Figure 14. MAIN P/B standard deviation (as of April 21) (x) /11 10/11 04/12 10/12 04/13 10/13 04/14 10/14 04/15 10/15 Source: Bloomberg, Daewoo Securities Research Signs of purchasing power recovery Indonesia is one of the most populous countries in the world, with estimated population of more than 250mn people. According to Kadence s survey result (2013), Indonesians spend 24% of their total income on food and beverages. This food and beverages consumption is the largest spending component which was followed by utilities (19%; electricity, water bills, rent), leisure and clothing (17%), etc. According to USAID Indonesia s Value Chain (2013), Indonesians spent 1.85% of their income on meat, of which 62% came from poultry. They also spent 2.88% of their income on eggs. products such as chicken and egg have quality protein with affordable price (see table 2). Table 2. Chicken protein content Protein source Price/kg (IDR) Protein content Protein price/g (IDR) Egg 23, % 188 Chicken (broiler) 35, % 189 Fresh milk 25, % 714 Beef 190, % 950 Fish 167, % 957 Source: MAIN Presentation, Daewoo Securities Research 6

7 industry growth is also supported by religious restrictions. The majority of the population in Indonesia is Muslim (see figure 15). According to the Quran, there is a strict restriction related to pork consumption. It is written in Quran 2:173 as follow: He has forbidden you only dead animals, and blood, and the swine, and that which is slaughtered as a sacrifice for other than God. Figure 15. Religion in Indonesia 1.7% 0.7% 0.6% 9.9% Islam Christianity Hinduism Buddhism Confucianism and others 87.2% Source: Wikipedia, Daewoo Securities Research This religious restriction combined with affordable price and high protein contents will prove to be supportive advantage to the growth of the poultry industry. The fact that chicken consumption in Indonesia is still low (see Figure 16), is another advantage to the poultry industry. Indonesian consumption of poultry meat per capita is approximately 8kg/year, which is relatively lower than its neighboring countries such as Thailand (16kg/year) and Philippines (9kg/year). Generally, chicken consumption has positive correlation with the GDP (see Figure 17). Therefore, we conclude that along with the government s initiative to boost infrastructure development, we expect a modest boost to Indonesia GDP per capita and also to the nation s chicken consumption. Figure 16. Chicken consumption Figure 17. GDP vs. consumption per capita Chicken consumption per capita (LHS) Income per capita (RHS) (kg/year) (USD '000) Brunei Malaysia Thailand Philippines Indonesia Vietnam Cambodia Source: MAIN presentation, Daewoo Securities Research Source: Company report, Daewoo Securities Research Although the broader macroeconomic backdrop remains conducive for poultry industry to grow, the industry suffered during 2014 ~ 2015 when the global economic slowdown spilled over to Indonesia s economy. Indonesia felt the blow amidst softening of global growth given its commodity-based nature. Global economic slowdown, especially in China (which is Indonesia s largest trading partner), has acted as a big drag on Indonesian economy in 2015 (see Figure 18). This weak backdrop also exacerbated the state budget absorption, inevitably leading to delays in the government s infrastructure development initiative (see Figure 19). 7

8 Figure 18. Indonesia GDP growth Figure 19. Government spending rate in state budget YoY (%) APBN Q 2Q 3Q 4Q (%) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Bloomberg, Daewoo Securities Research Source: Kemenkeu, Daewoo Securities Research In response to the economic growth deceleration, the government released multiple stimulus packages to boost the economy. The first stimulus package was released in September And to date, there are more than ten stimulus packages that have been announced to boost the sagging economy. These stimulus packages were targeted to boost government spending, investments and purchasing power through de-regulation, fast-track business licensing, business incentives, and lower energy prices, etc. The effect of this stimulus packages in consumption may not be seen suddenly but the sentiment is very positive. According to Bank Indonesia, consumer confidence index has showed recovery sign from its 2015 lowest index in September 2015 at 97.5 to in November 2015, in December 2015 (see Figure 21) and stood at in March We believe this is a sign of recovery in consumer sector. Another positive sentiment for the consumer sector came from the central bank (Bank Indonesia). In our view, Bank Indonesia is committed to maintaining accommodative monetary policy. Year-todate, Bank Indonesia cut the reference rate by 75bps (see Figure 20), indicating that it is endorsing the government s economic growth agenda. On top of that, we predict Indonesia GDP will recover by growing 5.1% YoY in 2016 (vs. 4.8% posted in 2015), supported by higher government spending and investments. Since economic growth shows positive correlation with chicken consumption, we believe Indonesia s chicken consumption will grow going forward. Figure 20. Policy rate trend Figure 21. Consumer confidence index 7.60% (%) 7.50% (ppt) % 7.25% % 7.00% 7.00% % 6.75% % % % 12/15 01/16 02/16 03/ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: BI, Daewoo Securities Research Source: BI, Daewoo Securities Research 8

9 Seeking supply and demand equilibrium According to our observation on-the-ground, chicken price is highly volatile. We suspect that this is largely due to the fact that 1) most of the chicken-related products are sold through the wet market (e.g. JPFA sells 85-90% its chicken production to wet market through third party), and 2) the movement of supply and demand is extremely fast. In 2014, the market was flooded with oversupply which led the DOC price to hit IDR976 (see Figure 22). We note that this price is just for the West Java region which represents 60% of the aggregate market. This unfavorable backdrop was realized due to the softening of purchasing power amidst abundant supply. Generally, the oversupply condition is one of the late stages in the poultry business cycle. We underscore that oversupply condition will be followed by industry consolidation which several small-scale producers will be consolidated and thus a supply demand equilibrium will be reached again. Figure 22. DOC monthly prices Figure 23. Live birds monthly prices (IDR) (IDR) 6,000 22,000 5,000 Recovery sign 20,000 4,000 low season in 1Q 18,000 3,000 16,000 2,000 14,000 1,000 Oversupply condition hit the DOC price 12, /14 04/14 07/14 10/14 01/15 04/15 07/15 10/15 01/16 10,000 01/14 04/14 07/14 10/14 01/15 04/15 07/15 10/15 01/16 Source: Company report, Daewoo Securities Research Source: Company report, Daewoo Securities Research In 2015, economic growth slowdown accelerated which weakened the value of the rupiah (see Figure 24) and hampered purchasing power of households. To make things worse, oversupply condition remained intact while demand softened. According to press reports, in August 2015, chicken production recorded a surplus of 18mn chicken/week (see Figure 25). Figure 24. USD/IDR performance Figure 25. Oversupply condition in August 2015 (USDIDR) 16,000 (mn chicken /week) 70 15, ,000 13,000 12,000 11, , , ,000 01/13 07/13 01/14 07/14 01/15 07/15 01/16 0 Demand Supply Source: Bloomberg, Daewoo Securities Research Source: Press report, Daewoo Securities Research In order to break out of the vicious oversupply environment, government banned the import of GGP (great grandparent) and also reduced GP (grandparent) import quota. In line with the GGP import ban, the government (through Directorate General of Livestock and Animal Health Services) along with poultry companies aimed to cull 6mn PS (parent stock). This action was announced to reverse the price of DOC and live birds. The culling program involves approximately 9

10 12 companies, namely, PT Charoen Phokphand Indonesia (CPIN), PT Japfa Comfeed Indonesia (JPFA), PT Wonokoyo Jaya Corp, PT Malindo (MAIN), PT Satwa Borneo, PT Cibadak Indah Sari, PT Reza Perkasa, PT Expravet Nasuba, PT CJ-PIA, PT Hybro Indonesia, PT Taat Indah Bersinar and CV Missouri. PT Charoen Pokphand Indonesia Tbk (CPIN) is expected to cull 50% of the total 6mn PS while JPFA will cull 16%, and other companies will cull around 0.35%-7.24%. This culling program is divided into three stages and each stage involves the culling 2mn PS. The first stage has been realized (which took place on October 23, 2015). The second stage began on December 7, The culling program reversed the DOC and live bird prices from October 2015 to January 2016 (see Figure 22 and Figure 23). However, the last culling stage has yet to be implemented due to the cartel investigation from Commission for the Supervision of Business Competition (KPPU). Based on the last update, there is still 3mn PS which hasn t been culled since the process has been halted by KPPU. According to the disclosure of information by JPFA, On March 3, KPPU has commenced preliminary examination of 12 poultry companies in relation to the culling program. In accordance with KPPU procedure, the preliminary examination is a period of 30 working days following which a decision will be made as to whether to cease investigations or to progress investigations to further examination. We hope the government can settle this issue immediately so that this issues can be settled well this year. Although the rest of culling program is still uncertain, we still believe that poultry business will recover in the future due to lower supply stemming from the reduced GP import quota and GGP import ban since Commodities price volatility can be passed on to customers Corn and soybean are important raw materials for the animal feed industry. According to the USDA, livestock feed is composed of c.50% corn and c.15-20% soybean meal, 3% corn gluten meal, 2% CPO, 5% fish meal, 15% rice bran, 8% wheat pollard and 0.6% premix on average. In Indonesia, the corn needs for the total animal feed industry stands at c.7.5mn tons in If we include animal feed produced by local breeding through self-mixing, the total corn needs stands at c.12mn tons per year. Indonesian animal feed producers are heavily reliant on imported raw materials, partially due to limited and inconsistent corn supplies in Indonesia. In 2013, imported corn for animal feed reached c.3.0mn tons vs. c.1.7mn tons in 2012 (see Figure 27). Figure 26. Indonesia corn consumption Figure 27. Indonesia corn import ('000 MT) ('000 MT) 12,500 12,000 11,500 11,900 12,200 4,000 3,500 3,000 2,500 2,719 3,501 3,381 11,000 10,900 2,000 1,724 10,500 10,500 10,000 1,500 1, , / / / / / / / /15 Source: USDA (Jan 2016), Daewoo Securities Research Source: USDA (Jan 2016), Daewoo Securities Research According to USDA, the poultry industry consumes approximately 83% of Indonesia s animal feed, while aquaculture industry consumes 11% and cattle and swine industries consume the rest. Recently, there was a difference of opinion between the government and animal feed producers. The government believed that domestic corn supply was sufficient to meet corn demand despite animal feed producers disagreement (according to BPS, 2014 corn production was 19.0mn tons of dry loose, which showed different number with USDA data). 10

11 Figure 28. Indonesia corn production (USDA) Figure 29. Indonesia corn production (BPS) ('000 MT) 9,200 9,100 9,100 9,000 8,900 8,850 8,800 8,800 8,700 8,600 8,500 8,500 8,400 8,300 8, / / / /15 (mn tonnes) Source: USDA (Jan 2016), Daewoo Securities Research Source: BPS, Daewoo Securities Research Thus, the Ministry of Agriculture held hundreds of thousands of tons of imported corn at seven ports in Indonesia in October 2015 to create a price floor for domestic corn farmers. But, this led to a spike in corn prices due to insufficient supply. Corn prices reached IDR5,300/kg vs. normal price of around IDR2,800-IDR3,200/kg. The spike finally compelled the government to release the imported corn to the market. The global prices for corn and soybean have been decreasing in 2015 (see Figure 30 and 31). We still believe that the global commodity price outlook for corn and soybean will continue to remain soft this year. However, corn price in Indonesia will be more volatile due to the government policy that only allows State Procurement Agency (Bulog) to import corn. Bottom line, we predict a volatile raw material price in 2016 but we believe integrated poultry companies still have the ability to pass on the volatility to the customers. Figure 30. Corn price Figure 31. Soybean price (USD/bu) (USD/bu) Source: Bloomberg, Daewoo Securities Research Source: Bloomberg, Daewoo Securities Research Initiating coverage on poultry sector with an Overweight recommendation We are initiating our coverage on the poultry sector with an Overweight call. Our positive stance reflects the following: a) Chicken is the largest source of meat consumption in Indonesia; b) government s favorable policies such as culling program and GPS quota limitation will equalize the oversupply backdrop; c) the ability of poultry companies to pass on the raw material price volatility to customers. Risks to our investment call include the weakening of purchasing power, prolonged oversupply condition due to unsettled cartel issue, potential price spike in commodities especially corn and soybean, and greater-than-expected currency volatility. 11

12 Appendix: Vertically integrated poultry operations Figure 32. Typical structure of vertically integrated broiler company Given the nature of poultry business which deals with homogenous products, large poultry manufacturers need integrated business in order to add efficiency and value. Integrated business line consists of a) animal feed business to produce poultry feed, b) breeding farms to produce DOC both for broiler and layer, c) broiler and layer farm to raise chickens and d) slaughter house to process broiler meat and further process food to produce value added food. Figure 33. feed s production process The production process for poultry feed begins with sourcing raw materials such as corn, soybean meal and other feed ingredients. The raw materials will go to the grinding process; the processed material will be mixed to a certain formula to produce complete feed. After that, the feed will go to pelleting process which involves producing poultry feed into pellets. 12

13 Figure 34. DOC production process The production process for Final Stock (FS) DOC usually initiates from Grand Parent Stock (GPS) DOC procurement process which is imported from other countries such as Germany, USA, United Kingdom and Australia. Figure 35. Structure of breeder farms in the US Source: thepoultrysite.com, Daewoo Securities Research After the maintenance and enlargement of the DOC GPS, it will produce Parent Stock (PS) when it reaches the production stage. This Parent Stock (PS) will produce the Final Stock (FS). DOC FS is sold to commercial farmers who then raise them to become either broiler or layer. Figure 36. Illustration for broilers value chain Source: standardbank.co.za, Daewoo Securities Research 13

14 Broilers DOCs are one day-old-chicks which are sold to farmers to produce poultry meat. Broilers are raised for approximately days before being harvested at an average weight of 1.39kg 2.45kg or equivalent to 1.11kg 1.96kg poultry meat. Layer DOCs are one day-old-chicks which are sold to farmers to be raised and produce eggs. Layers start to produce eggs at an average age of 18 weeks until 80 weeks. On average, a layer is capable of producing 1 egg every 24~ 28 hours during its laying phase. Figure 37. Commercial DOC Broiler Figure 38. Commercial DOC Layer Source: JPFA, Daewoo Securities Research Source: JPFA, Daewoo Securities Research 14

15 Japfa Comfeed Indonesia (JPFA IJ) A classic turnaround story (Initiate) Trading Buy Target Price (12M, IDR) 1,080 Share Price (4/26/16, IDR) 955 Expected Return 13.1% OP (16F, IDRbn) 1,750 Consensus OP (16F, IDRbn) 1,516 EPS Growth (16F, %) 55.7 Market EPS Growth (16F, %) 24.7 P/E (16F, x) 13.9 Market P/E (16F, x) 17.4 JCI (4/26/2016) 4,814.1 Market Cap (IDRbn) 10,180.8 Shares Outstanding (mn) 10,640.2 Free Float (%) 42.5 Foreign Ownership (%) NA Beta (5Y) Week Low (IDR) Week High (IDR) 1,040 (%) 1M 6M 12M Absolute Relative Sector recovery should bring positive sentiment After two consecutive quarters of recording net losses (-IDR50.4bn in 2Q15 and -IDR221.7bn in 1Q15), Japfa Comfeed Indonesia (JPFA) was able to deliver positive earnings in 3Q15 (IDR124.9bn) and exceptional results in 4Q15 (IDR615.5bn). JPFA s earnings recovery has been seen since 6M15, when profit from operation for commercial farm and consumer product segment swung to positive territory although DOC segment was still in the negative. JPFA s feed business went smooth in 2015 with operating profit margin at c.10.9%. We think that JPFA s turnaround story remains intact with DOC price recovery supplementing the rosy outlook. One-stop protein solution provider Japfa Comfeed Indonesia (JPFA) operates 6 business segments of which 3 are vertically integrated poultry divisions and the rest diversification products of aquaculture (which produce aquaculture product such as fish feed, breeding of freshwater fish and saltwater fish, shrimp farming, etc.), beef cattle (which operates beef cattle breeding, fattening, slaughterhouse facilities and the production of value-added meat) and trading & others. With diversified segments ranging from poultry, fish to beef, JPFA has competitive advantage as a one-stop protein solution provider. Bargaining power on feed price As one of the largest animal feed companies, JPFA has the ability to pass on the raw material cost volatility to customers, in our view. While DOC and broiler segments booked negative operating profits in 2014, the company s animal feed booked positive earnings which we consider to be clear evidence supporting our argument. Feed OP margins exhibited stable trends: 10.9% (2015), 11.6% (2014), 9.7% (2013), 12.5% (2012) and 9.9% (2011). Initiate coverage on JPFA with a Trading Buy rating Our investment points on JPFA are as follows: a) JPFA has well diversified products to cater changing consumer demand for protein, b) the earnings recovery sign has been witnessed since 3Q15 and we expect the trend to continue going forward, c) JPFA has ability to pass on the raw material price volatility to customers. According to our DCF approach, we rate JPFA with a Trading Buy recommendation and a target price of IDR1,080 (potential upside 13.1%). Risks to our investment call include weakening of purchasing power, prolonged and unresolved oversupply due to unsettled cartel issues, potential price spike in commodities especially corn and soybean, and greater-than-expected currency volatility. FY (Dec.) 12/12 12/13 12/14 12/15 12/16F Revenue (IDRbn) 17,833 21,412 24,459 25,023 29,655 Gross profit (IDRbn) 3,184 3,618 3,426 3,993 4,389 Operating profit (IDRbn) 1,668 1,803 1,285 1,728 1,750 NP (IDRbn) EPS (IDR) BPS (IDR) P/E (x) ROE (%) 22.8% 12.7% 7.1% 8.3% 12.5% ROA (%) 9.0% 4.0% 2.2% 2.7% 4.1% Note: NP refers to net profit attributable to controlling interests Source: Company data, estimates 15

16 JPFA at a glance Business Overview JPFA was established in 1971 and mainly engaged in commercial production of copra pellets. JPFA commenced poultry feed business in 1975 and poultry breeding operations in In 1989, JPFA was listed on the Jakarta and Surabaya Stock Exchanges. As of end-2015, JPFA is owned by Japfa Ltd (57.95%) and public (41.86%). Japfa Ltd is a public company listed in Singapore, while 81.41% of Japfa Ltd shares are owned by Santosa Family. Figure 39. JPFA s shareholding structure **) According to share register report as of December 31, 2015, Japfa Ltd. Currently, JPFA divides its business segments to 6 categories, namely, animal feed, commercial farm and consumer products, DOC, aquaculture, beef cattle farming and trading & other businesses. JPFA has integrated business from upstream to downstream (see Figure 40). Figure 40. JPFA s business lineup 16

17 division, which consists of three businesses segments (Animal feeds, DOC, and commercial farm and consumer product), dominates JPFA s total gross sales with around c.85% portion in Figure 41. JPFA s integrated poultry division Source: Company report, Daewoo Securities Research Details of each business segments are as follows: Animal feed Animal feed contributed c.45% of JPFA s total gross sales in JPFA has 16 feed mills which consist of 13 feed mills commercials and 3 breeder feed mills. JPFA s feed mills are spread across Medan, Padang, Lampung, Tangerang, Cikande, Purwakarta, Cirebon, Sragen, Grobogan, Sidoarjo, Gresik, Gedangan, Surabaya, Banjarmasin and Makassar. The total production capacity is around 4.3mn tons with total sales volume of c.2.6mn tons in JPFA targets local farmers across Indonesia. It distributes poultry feed products to agents/distributors, poultry shops, and direct farms. Figure 42. JPFA s coverage mapping 17

18 Commercial farm and consumer products This segment is focus on broiler chicken farming and chicken slaughterhouses to produce fresh chicken. It contributed c. 31% of JPFA s total gross sales in Around 85-88% of operations in commercial farm units are conducted with partner farmers, while the rest are owned and operated by JPFA. Currently, JPFA has fostered more than 9,000 partnerships with farmers. The total production capacity of commercial farms are around 687K tons with sales volume of c.584k tons in 2014 while chicken slaughterhouse booked sales volume of c.44k tons with around 103K tons production capacity in DOC / breeding breeding unit produces and markets broiler and layer DOC. This segment contributed c.9% of JPFA s total gross sales in JPFA has exclusive rights to sell and distribute Indian River grandparent stocks from Aviagen and Lohmann Brown (Lohmann Tierzucht Germany) in Indonesia. It is said that Indian River grandparent has strong resistance to disease, humidity and high temperature so that it is most suitable to the Indonesia s climate. JPFA has wide spread DOC production facilities which consists of 65 broilers and layer chicken breeding farms and 24 central hatcheries across Indonesia. Figure 43. JPFA s DOC distribution network Source: Company report, Daewoo Securities Research Aquaculture Aquaculture segment contributed c.7% of JPFA s total gross sales in This segment covers the production of fish feed, eel feed, shrimp feed, shrimp breeding, breeding of freshwater fish and saltwater fish, shrimp farming, the cultivation of saltwater and freshwater fish and processing (cold storage and food products). Aquaculture division is operated by the management of PT Suri Tani Pemuka (STP). Beef cattle farming Cattle segment contributed c.4% of JPFA s total gross sales in This segment has vertically integrated operations which are beef cattle breeding, fattening, slaughterhouse facilities and the production of value-added meat. The beef cattle division is operated by the management of PT Santosa Agrindo (Santori). Santori owns a cattle feedlot in Bekri (Central Lampung),Jabung (East Lampung), and Probolinggo (East Java). Santori is also developing its beef cattle breeding Centre at Jabung, East Lampung. In 2013, Japfa Santori Australia Pty Ltd, a subsidiary of Santori, purchased beef cattle breeding operation in Australia. This breeding operation will supply live cattle to meet a part of feedlot operational needs in Indonesia. Japfa also has slaughterhouse which produces premium quality meat under the brand name Tokusen Wagyu Beef. 18

19 Trading & other businesses This segment contributed only c.4% of JPFA s total gross sales in It mainly operates to supplement JPFA s business lines in order to increase the overall production quality and competiveness. One of the business units in this segment is animal vaccine unit. This unit operates under PT Vaksindo Satwa Nusantara (Vaksindo) with vaccine production facilities located in Gunung Putri, Bogor. This business unit makes JPFA the only poultry company in Indonesia with the ability and facilities to research viruses and produce autogenous vaccines. Cost decomposition As 2015, most of JPFA s production cost (85%) was raw material. The raw materials were comprised of c.40% domestic and c.60% imported products. As an animal feed company, it is worth noting the importance of corn and soybean meal prices. In terms of volume, corn contributes c.50% of feed content while soybean contributes c.25%. In term of value, corn contributes 40% while soybean 35% of the total raw material expenses. JPFA uses 70% domestic corn and 100% imported soybean meal. JPFA imports corns from India, Argentina, and the US while soybean meals are imported from Argentina, India, Brazil and the US. Management JPFA is managed by experienced management team in the industry. The profiles of the management team are presented below as we cited from JPFA s report: Figure 44. JPFA s Board of Commissioners H. Syamsir Siregar (President Commissioner) Indonesian citizen. He was born in Pematang Siantar in He graduated from the National Military Academy in 1965 and Army Command Staff School in Active member of the Indonesian National Armed Forces up to He joined the Company since 2010 and appointed to serve as the President Commissioner pursuant to decision of Annual General Meeting of Shareholders. Hendrick Kolonas (Vice President Commissioner) Indonesian Citizen. He was born in Jakarta in He holds a Bachelor of Arts (BA- Hons) degree in Accounting and Finance from Middlesex University-England in 1982, Master of Business Administration degree from Schiller International University, London- England in 1983, and Master of Arts degree in Banking Administration from The University of Hull, England in He has extensive experience in finance and banking. As he built his career, he became one of the founders of several consumer finance companies such as PT Wahana Ottomitra Multiarta and corporate financial institutions such as PT SMS Finance, PT Asuransi Jaya Proteksi, PT Pan Pacific Insurance and others. Since 2012, he has served as Deputy Commissioner pursuant to decision of the Annual General Meeting of Shareholders. 19

20 Retno Astuti Wibisono (Independent Commissioner) Indonesian citizen. She was born in Blitar in She graduated from the University of Airlangga, Surabaya, Faculty of Law in After graduation, she served and held various positions in the Legal and Licenses field in various companies. In addition, she has also served as Corporate Secretary in several public companies. Since 2000, she served as Head of Legal & Licenses and Corporate Secretary of the Company until she approached to retirement period. She served as an Independent Commissioner of the Company since 2013 in accordance with the decision of the Annual General Meeting of Shareholders. Ignatius Herry Wibowo (Independent Commissioner) Appointed as Independent Commissioner in Graduated from the University of Diponegoro, Surabaya, Faculty of Economy, in He started his career at PT Bomo Semarang ( ), then held some positions at some companies, such as among others, as Marketing Group Head of PT Bank Niaga, Semarang ( ), Branch Manager of PT Bank Dagang Nasional Indonesia (BDNI) ( ), Regional Manager of BDNI Surabaya in 1988, Director of BDNI ( ), Director of PT Bank Tiara Asia ( ), Vice President Director of PT Bank Tiara Asia ( ), President Director of PT Bank Tiara Asia Tbk ( ) and Finance Director of PT Japfa Comfeed Indonesia Tbk (1998 until retired in June 2014). Besides, he had educational training from Bank Indonesia SESPIBI (Sekolah Pimpinan Bank Indonesia) batch XVII in Figure 45. JPFA s Board of Directors Handojo Santosa (President Director) Indonesian citizen. He was born in Surabaya in He started his career with the Company in 1986 as Manager in the edible oil division at Nilam in Surabaya. He has gained extensive experience by holding various positions in the Company, including in the poultry feed, breeding and processing and aquaculture division. He was appointed as Vice President Director of the Company since 1989 and has held the position of President Director of the Company from 1997 until present pursuant to Decision of the Annual General Meeting of Shareholders. Bambang Budi Hendarto (Vice President Director) Indonesian citizen. He was born in Bondowoso in Graduate of the Department of Farming at Brawijaya University, Malang in He obtained further education and training in the Netherlands, Taiwan and the United States. He served as Director of the Company since 1989 and as Vice President Director since 1997 pursuant to Decision of the Annual General Meeting of Shareholders. In particular, he oversees the Division that consists of the Feed Unit, the Breeding Unit and the Commercial Farm and Consumer Products Unit. Koesbyanto Setyadharma (Director) Indonesian citizen. He was born in Bandung in He earned bachelor s degree in Economics from Padjajaran University, Bandung, in He joined the Company in Since 2014, he was appointed as Director pursuant to Decision of the Annual General Meeting of Shareholders. He was entrusted to supervise Division of Finance in the Company, which consists of Corporate Finance, including Banking Relation, Financial Controller, Taxation and Accounting. 20

21 Tan Yong Nang (Director) Singaporean citizen. Born in Singapore in In 1987, he earned a Master s degree in the field of Economics from the University of Cambridge, United Kingdom, and he is a Chartered Financial Analyst, CFA. He has held posts as the Managing Director, CEO and Project Director at various companies in Singapore and Hong Kong. He was appointed as Director of the Company since 2008 pursuant to Decision of the Annual General Meeting of Shareholders. Rachmat Indrajaya (Independent Director) Indonesian citizen. He was born in Jakarta in Graduated from the University of Trisakti, Faculty of Engineering, with a degree in civil engineering in He has ample experience in various industries, including the agribusiness industry (in particular the poultry industry) and property. He has served and occupied a variety of positions, such as Director and Deputy Director of several companies. Since 2005 until June 2012, he has served as Independent Commissioner of PT Multibreeder Adirama Indonesia Tbk. Since 2013, he has served as Non Affiliated (Independent) Director pursuant to Decision of the Annual General Meeting of Shareholders. At the Company, his position is vital to create and enhance the atmosphere of independency; a key to encouraging the implementation of Good Corporate Governance for the interests of minority shareholders and other stakeholders. Share price performance During 2012~ 2014, JPFA s share price always outperformed the benchmark JCI (see Figure 46). However, we witnessed a reversal of trend at the beginning of 2015 which was accompanied by deteriorating financial performance driven by unfavorable DOC price trend and rupiah depreciation. We believe that the trend will reverse in the near term together with the recovery of the DOC price. Figure 46. JCI vs. JPFA share price performance (as of March end) (Jan 2011 = 100) JPFA JCI 20 01/11 07/11 01/12 07/12 01/13 07/13 01/14 07/14 01/15 07/15 01/16 Source: Bloomberg, Daewoo Securities Research 21

22 Sector recovery should bring positive sentiment sector has suffered over the past two years due to the strengthening of the USD and oversupply. The greenback strengthened 24.3% during 2013 from IDR9,795 in early January to IDR12,171 as of end of The weakening of the rupiah continued in 2014 and 2015 (see Figure 47). Figure 47. FX rate trajectory (USDIDR) Figure 48. JPFA s fixed asset (IDRtr) /13 07/13 01/14 07/14 01/15 07/15 01/ Source: Bloomberg, Daewoo Securities Research From supply side, poultry companies, including JPFA, have conducted massive expansions (see Figure 48) which flooded the market with supply. As a result of such unfavorable backdrop, JPFA demonstrated two consecutive years of earnings squeeze in 2013 and 2014 (see Figure 49). Although revenue still exhibited an uptrend, profit margins remained depressed since cost and expenses went up (largely due to currency losses). Bottom line, JPFA s net profit went down from IDR991.7bn in 2012 to IDR595.2bn in 2013 and IDR339.3bn in 2014 before it rebound to IDR468.2bn in Figure 49. JPFA s revenue and net profit on an annual basis Figure 50. JPFA s net profit in quarterly basis (IDRbn) 30,000 Revenue Net profit (IDRbn) 1,200 (IDRmn) 700,000 25,000 1, , ,000 20, ,000 15, , ,000 10,000 5, , ,000 4Q14 1Q15 2Q15 3Q15 4Q , ,000 The industry supply glut also hit JPFA s operating profit. In 2014, JPFA booked operating losses from DOC segment (-IDR350.1bn), commercial farm and consumer product (-IDR43bn) and also trading and others (-IDR326.1bn). 22

23 Figure 51. JPFA s income from operations for DOC segment (IDRmn) 500, , , , , , , , ,000 However, JPFA s recovery has been witnessed since 6M15, when profit from operation for commercial farm and consumer products segment has returned to positive. Although DOC segment still booked negative earnings (see Figure 52), operations from commercial farm and consumer segment showed significant recovery from IDR54bn in 6M15 to IDR308.2bn in 9M15 as selling price of broiler improved. This could be realized because broiler farmers cut production post Hari Raya Idul Fitri as they expected a drop in demand for chicken. JPFA still booked loss from DOC operation (-IDR129.4bn in FY15) however, the segment also showed recovery compared to last year (see Figure 51) All in all, JPFA has exhibited a classic turnaround through exceptional 4Q15 net profit of IDR615.5bn (see Figure 50) which was driven by better operating profit from commercial farm and consumer product businesses and DOC business (see Figure 52). We judge this turnaround to be sustainable driven by the DOC price recovery (see Figure 53). Figure 52. Operating profit from each segment Figure 53. DOC price trend (IDRmn) 2,500, ,000 (IDR) 2,000,000 5,000 Recovery sign 1,500,000 4,000 low season in 1Q 1,000,000 3, ,000 2, ,000 Animal feeds Commercial farm and consumer product Aquaculture Cattle DOC Trading and others 1,000 Oversupply condition hit the DOC price 0 01/14 04/14 07/14 10/14 01/15 04/15 07/15 10/15 01/16 One stop protein solution products are characterized as homogenous products and thus we believe it is hard to differentiate the quality and price. In order to reach efficiency and synergize, large poultry companies are generally vertically integrated from upstream to downstream. One of the largest poultry players in Indonesia is PT Japfa Comfeed Indonesia Tbk (JPFA), with c.25% feed production capacity share and c.22% DOC production capacity share. Japfa Comfeed Indonesia (JPFA) operates 6 business segments of which 3 are vertically integrated poultry divisions and the rest diversification products of aquaculture (which produce aquaculture product such as fish feed, breeding of freshwater fish and saltwater fish, shrimp farming, etc.), beef cattle (which operates beef cattle breeding, fattening, slaughterhouse facilities and the production of value-added meat) and trading & others. 23

24 Figure 54., beef cattle and aquaculture The operation of JPFA s aquaculture division is managed by PT Suri Tani Pemuka. JPFA is optimistic about its aquaculture business potential given Indonesia s abundant natural resources. Its beef division is operated under PT Santosa Agrindo. JPFA s slaughterhouse also produces premium quality meat under the brand name of Tokusen Wagyu Beef. Although its sales volume is relatively small, JPFA s beef products contribute to the company with better margins. With diversified segments in poultry, fish and beef, JPFA has competitive advantage as a one stop protein solution provider. As JPFA has a comprehensive lineup of protein products, potential underperformance of a certain sector will be supported by other segments, in our view. Bargaining power on feed price Raw material costs accounted for around 85% of total JPFA s COGS. As an animal feed company, corn and soybean are two important cost components. Corn accounts for c.40% of the total raw material expenses while soybean accounted for c.35%. JPFA is using 70% domestic corn and 100% imported soybeans. Prices of the comodities were soft in 2015 compared to a year earlier, positively impacting JPFA s margins. Raw material used declined from IDR18.5tr in 2014 to IDR17.9tr in However, there is growing debate on corn import between the government and poultry producers in Indonesia. The government believed that domestic corn supply was sufficient to meet corn demand despite animal feed producers disagreement. In order to maintain food price stability, government has ordered State Logistics Agency (Bulog) to be the single corn importer, which we think would lift up local corn price due to limited supply. Although there is potential risk from shortage corn supply, JPFA has alternative to change the corn with wheat. According to our discussion with management, wheat can be used as corn substitution. However, corn will still be the first choice since it still can be obtained in domestic, while wheat is 100% import. As one of the biggest animal feed companies, JPFA has ability to pass on the volatility of raw material price to customer. It can be seen from JPFA s animal feed operating profit that booked positive even in 2014 when DOC and broiler segments booked negative operating profit. Feed operating margin is maintained at level 10.9% (2015), 11.6% (2014), 9.7% (2013), 12.5% (2012) and 9.9% (2011). 24

25 Figure 55. JPFA s poultry feed products Figure 56. JPFA s feed operating profit margin (%) 14.0% 12.0% 10.0% 9.9% 12.5% 9.7% 11.6% 10.9% 8.0% 6.0% 4.0% 2.0% 0.0% JPFA has 16 poultry feed production facilities across Java, Sumatra, Kalimantan and Sulawesi. Through its wide networking, JPFA can supply and obtain the best raw materials and distribute the products fast and efficient across regions. This economic of scale is one of JPFA s advantages in term of raw materials purchases and cost efficiency. We think that the 2016 cogs will be higher than last year due to the volatility of corn domestic price but still manageble since it can be pass on to customers. Valuation and Recommendation Our investment points on JPFA are as follows: a) JPFA has well diversify products to complete protein meets, b) the earnings recovery sign has been seen since 3Q15 result performance, c) JPFA has ability to pass on the volatility of raw material price to customer. According to our DCF approach, we rate JPFA with a Trading Buy recommendation and a target price of IDR1,080 (potential upside 13.1%). Risks to our investment call include the weakening of purchasing power, prolonged oversupply condition due to unsettled cartel issue, potential price spike in commodities especially corn and soybean, and greater-than-expected currency volatility. 25

26 Income Statement (Summarized) Statement of Financial Condition (Summarized) (IDRbn) 12/13 12/14 12/15 12/16F (IDRbn) 12/13 12/14 12/15 12/16F Revenue 21,412 24,459 25,023 29,655 Cash 1, Cost of Goods Sold -17,794-21,033-21,030-25,266 Trade Receivables 1,197 1,243 1,200 1,300 Gross Profit 3,618 3,426 3,993 4,389 Inventories 4,727 5,134 5,855 6,299 Operating Expenses -1,815-2,141-2,265-2,639 Other CA 1,334 1,564 1,648 1,676 Operating Profit 1,803 1,285 1,728 1,750 PPE 5,272 6,362 6,809 7,026 other income/(loss) , Other Non-CA Pretax Profit ,047 Total Assets 14,936 15,759 17,159 17,593 Income Tax Trade Payables 995 2,004 2,746 2,951 Non-Controlling Interest Accruals Net Profit Other CL Other Non-CL 5,399 5,663 5,697 5,785 Profitability ratio Total Liabilities 9,760 10,579 11,050 11,272 Gross Profit Margin (%) 16.9% 14.0% 16.0% 14.8% Common Stock 1,666 1,666 1,666 1,666 Operating Profit Margin (%) 8.4% 5.3% 6.9% 5.9% Paid in Capital Net Profit Margin (%) 2.8% 1.4% 1.9% 2.5% Retained Earnings 2,114 2,299 2,798 3,367 Return on Equity (%) 12.7% 7.1% 8.3% 12.5% Non-Controlling Interest Return on Asset (%) 4.0% 2.2% 2.7% 2.7% Equity (ex minority) 4,683 4,755 5,612 5,823 Cash Flow (Summarized) (IDRbn) 12/13 12/14 12/15 12/16F Operating Cash Flow Net income Depreciation in trade receivables in inventories 1, in others CA in trade payable 438 1, in accrued expense in others CL CFO Investing Cash Flow in PPE 1,556 1, CFI -1,748-1,558-1, Financing Cash Flow in other liability in equity in minority interest CFF 2, Net cash beginning balance 872 1, ending balance 1,

27 Malindo Feedmill (MAIN IJ) High risk, high return (Initiate) HOLD Target Price (12M, IDR) 1,525 Share Price (4/26/16, IDR) 1,400 Expected Return 8.9% OP (16F, IDRbn) Consensus OP (16F, IDRbn) EPS Growth (16F, %) NA Market EPS Growth (16F, %) NA P/E (16F, x) 16.8 Market P/E (16F, x) 16.2 JCI (4/26/2016) 4,814.1 Market Cap (IDRbn) 3,391.7 Shares Outstanding (mn) 1,865.8 Free Float (%) 58.7 Foreign Ownership (%) NA Beta (5Y) Week Low (IDR) 1, Week High (IDR) 1,895 (%) 1M 6M 12M Absolute Relative Sector recovery should bring positive sentiment Malindo Feedmill (MAIN) staged positive revenue growth in 4Q15. The company booked revenue of IDR1.2tr in 4Q15 (+12.2% YoY or 0.9% QoQ), supported by positive growth from the breeder segment. MAIN also booked positive net profit of IDR8.1bn in 4Q15. This figure showed significant improvement from last year when MAIN booked net loss of c.idr106bn. The earnings recovery story was evident since 3Q15 when the company booked positive net profit of c.idr13bn after four consecutive net losses since 3Q14. We think that this recovery will remain intact and improve going forward supported by the DOC price recovery. Minimizing currency volatility Since poultry companies have sizeable exposures to USD, the rupiah depreciation in 2015 severely impacted poultry companies including MAIN. The currency rate for USD/IDR closed at IDR13,795 as of end 2015 vs. IDR12,440 a year earlier. In an attempt to reduce its USD exposure, MAIN significantly reduced its USD short-term bank loans to USD915.3K (equivalent of IDR12.6bn) in 2015 from USD58.1mn (equivalent to IDR723.4bn) as of end With the reduced USD debt, we expect to see reduced earnings volatility heading forward. High risk, high return As a relatively smaller company compared to its well-established poultry peers (CPIN and JPFA), MAIN showed higher sales growth during 2010~ 2015 with 19% CAGR compared to CPIN (15%) and JPFA (12%). MAIN also has exposures to consumer food products with SunnyGold brand and CikiWiki brand names. However, given MAIN s DOC, broiler and food processing segments are still delivering negative operating profit as of 2015, we expect MAIN s earning to remain volatile compared to its peers. Initiate coverage on MAIN with a hold rating We initiate coverage on MAIN with HOLD rating. Our investment points on MAIN are as follows: a) recovery in supply and demand of DOC chicks, b) MAIN s efforts to reduce currency exposures (USD denominated debt), c) MAIN s characteristics as a growing company is accompanied by earnings volatility. Using our DCF approach, we rate MAIN a Hold and present a target price of IDR1,525 (potential upside 8.9%). Risks to our investment call include weakening of purchasing power, prolonged oversupply due to unsettled cartel issues, potential price spike in commodities especially corn and soybean, and greater-thanexpected currency volatility. FY (Dec.) 12/12 12/13 12/14 12/15 12/16F Revenue (IDRbn) 3,350 4,193 4,502 4,775 5,478 Gross profit (IDRbn) Operating profit (IDRbn) NP (IDRbn) EPS (IDR) BPS (IDR) P/E (x) ROE (%) 44.4% 27.8% -7.8% -4.1% 9.1% ROA (%) 16.8% 10.9% -2.4% -1.6% 3.7% Note: NP refers to net profit attributable to controlling interests Source: Company data, estimates 27

28 MAIN at a glance Business Overview Malindo Feedmill (MAIN) was established in MAIN produces animal feed (broiler breeder feed, broiler feed, layer breeder feed) and commercial Day Old Chicks (DOC). MAIN was listed on the Indonesia Stock Exchange (IDX) in As of 2014, MAIN s shareholders are Dragon Amity (51.5%) and public (48.5%). Figure 57. MAIN s corporate structure Currently, MAIN divides its business segments into 5 categories which are feeds, DOC, broiler, processed food and others. Figure 58. MAIN s business Details of each business segments are as follows: Feedmill division Feedmill division contributed c.69% of MAIN s revenue in MAIN has 5 feed mills plants located in Cakung-East Jakarta, Serang-Banten, Gresik-East Java, Semarang-Central Java and Makassar-South Sulawesi. MAIN has production capacity of c.1.5mn tons for its feed business. Breeder division / DOC Breeder division produces Parent Stock (PS) and Day Old Chick Final Stock (DOC FS). The division contributed c.18% of MAIN s revenue in MAIN s breeding farms are located across Sumatra, Java, Kalimantan and Sulawesi. Its total production capacity stands at 3.2mn PS DOC and 210mn DOC FS as of

29 Broiler division Broiler division contributed c.9% of MAIN s revenue in Its broiler farms are located in Bandung, Bogor, Sukabumi, Serang, Subang and Deli Serdang. Processed foods division Processed foods division contributed c.1% of MAIN s revenue in MAIN produces processed chicken-based products under the brand SunnyGold and Ciki Wiki. Its production capacity is 9,000 MT/ year. Others This segment contributed c.2% of MAIN s revenue in Management MAIN is managed by a qualified and experienced management team. The profiles of the management team are presented below as cited by the company: Figure 59. MAIN s Board of Commissioners Dato Lau Bong Wong (President Commissioner) Malaysian citizen, born in Johor-Malaysia in Dato' Lau is the Chairman and Managing Director of Emivest Berhad. He is also responsible for formulating business policy, business strategy, planning and operations of the Gymtech group, Malaysia. Dato Lau also presently serves as Chairman of Leong Hup Holdings Sdn Bhd and President Commisioner in PT Malindo Food Delight. Tan Lai Kai (Commissioner) Malaysian citizen, born in Johor-Malaysia in Mr Tan Lai Kai is a fellow member of the Chartered lnstitute of Management Accountants in The United Kingdom. He joined the Leong Hup business group at the end of 1990 as Internal Auditor. Mr Tan Lai Kai is one of the pioneers with his involvement in the incorporation of PT Leong Ayamsatu Primadona, which was the first investment of Leong Hup Group in Indonesia. Yongkie Handaya (Independent Commissioner) lndonesian citizen, born in Ambon in Mr. Handaya has served as the Company's Independent Commissioner since 24 June Mr. Handaya has also served as President Director of PT Buda Mitra in Denpasar since 1995, President Director of PT Dwiniaqa Pratama Sarana since 1993, and PT. Bali since 2002, and also as Director of PT Es Hupindo since Koh Bock Swi Raymond Koh (Independent Commissioner) Koh Bock Swi (Raymond Koh) passed from University of Singapore in 1973 with Bachelor of Business Administration. He began his career as a Consumer Lending Officer at OCBC Finance in , and then at Bank of Montreal, Bank of America, Rabobank Nederland and Arab Bank. 29

30 Brian M. O Connor (Independent Commissioner) Brian M O'Connor was born in New York, USA in1968. He is a professional senior leading investment with over 24 years of experience in the Asian region. He is a Founding Partner of Falcon House Partners, a private equity firm focused on Southeast Asia and has headquarters in Singapore. Previously, Brian worked at Lehman Brothers for 18 years. Figure 60. MAIN s Board of Directors Lau Chia Nguang (President Director) Malaysian citizen, born in He once served as Director of Ayam A1 Food Corporation, Ayam A1 Chicken Sdn Bhd, Leong Hup Contract Farming Sdn Bhd, Aispuri Sdn Bhd, Ayam A1 Chicken Shop Sdn Bhd, Ayam A1 Food Processing Sdn Bhd, Emerging Success Pte. Ltd, Emivest Bhd, Leong Hup Management Sdn Bhd, PT Quality Indonesia (2006 present), Raffles Star Pte Ltd (2000 present) and also as President Directorof PT Malindo Food Delight (2010 present). Lau Chia Nguang received The Asia Pacific Entrepreneurship Award 2013 from Enterprise Asia. Tan Sri Lau Tuang Nguang (Director) Malaysian citizen, born in Johor - Malaysia, on Tan Sri Lau Tuang Nguang has served as a Director in Leong Hup Holding Sdn Bhd. He sits on the Board of Directors of Leong Hup and its subsidiaries and other affiliated companies in Philippines, Vietnam and Indonesia. Mazlan Bin A. Talib (Director) Mr. Mazlan Bin Talib was born in Johor-Malaysia, in He earned his Bachelor s Degree from Universiti Malaya and Master in Economics from Universiti Kebangsaan Malaysia. He has extensive experience in the agriculture industry for 28 years. Dato Seri Abdul Azim Bin Moh. Zabidi (Independent Director) Malaysian citizen, born in Perak, in Graduated from the lnstitute of Chartered Secretaries and Administrators in England in 1982, he obtained his Masters of Arts degree in Business Law from London Metropolitan University. Prior to serving as the Company s lndependent Director, Dato' Seri Abdul Azim worked with the Commerce Asset Holding Group for 15 years. From 1999 to 2009 he served as Chairman of Bank Simpanan Nasional, Malaysia. 30

31 Rewin Hanrahan ( Director) Rewin Hanrahan was born in Bogor, in He graduated from Faculty of Food Technology and Nutrition, Bogor Agricultural Institute. He started his career in PT Biotek Indonesia, and then joined with PT.Tigaraksa Satria / Mensa Prima, and PT. Wicaksana Overseas International / PT Jakarana Tama. Then, Rewin Hanrahan work on one of feedmill factory and then he joined PT Malindo Feedmill in 2008 Tbk as General Manager. He served as Director of Marketing Feed and DOC in 2012 and 2014 as the Director of PT Malindo Feedmill Tbk. Lau Joo Hwa (Director) Lau Joo Hwa was born in Muar, Johor Bahru, Malaysia, in He completed his college education at Victoria University of Melbourne, Australia by taking two departments of Bussiness Administration and Marketing / International Trade. After graduating from Victoria University of Melbourne in 2002 and holds a Bachelor of Business, Lau Joo Hwa working on PT Malindo Feedmill Tbk with a position as Marketing Manager until Subsequently Lau Joo Hwa trusted as Operational Manager PT Malindo Feedmill Tbk for the whole of Indonesia. Lau Joo Hwa not only has experience working in the country but also abroad. He worked at Bakers Cottage as Operational Manager and currently also holds the position as Deputy CEO in Singapore KSB Distribution, the company is headquartered slaughter plant in Singapore. Lau Joo Keat (Director) Lau Joo Keat was born in Johor, Malaysia, in He completed his college education at University of Kentucky, United States of America by taking Marketing Department at After graduation he working on PT Malindo Group with a position as Production Manager for breeding, hatchery and commercial farm Malindo Group as in Subang, Purwakarta, and Medan. Based on his experience, at 2007 Lau Joo Keat Trusted as a Production Head of breeding, hatchery, and broiler farm for the whole of Indonesia. Rudy Hartono Husin (Director) Rudi Hartono Husin was born in Jakarta, on He hold bachelor of economic degree from faculty of economic department accountant Atmajaya University. Rudi Hartono Husin worked as an external auditor at the public accountant firm Ernst & Young from After that, he joined to PT Malindo Feedmill Tbk as an head of Accounting and finance department. He responsible in company financial management and accounting as well as negotiating with the banks and financial institutions for financing facilities. In 2009 Rudy Hartono Husin trusted as Corporate Secretary Malindo Group. He representing company to communicate and deliver report to financial service authority, Indonesian Stock Exchange, Rating Agency and the others stakeholders. He also taking responsible in corporate action. 31

32 Share price performance During 2013~ 2014, MAIN s share price performance exhibited a wide gap to JCI s performance. However, due to unfavorable DOC market condition and rupiah depreciation, the gap has narrowed. Figure 61. JCI vs. MAIN share price performance (as of March end) (Jan 2011 = 100) MAIN JCI 20 01/11 07/11 01/12 07/12 01/13 07/13 01/14 07/14 01/15 07/15 01/16 Source: Bloomberg, Daewoo Securities Research Sector recovery should bring positive sentiment sector has suffered over the last two years due to strengthening of the USD and oversupply. In 2013, the USD strengthened 24.3% IDR9,795 in early January to IDR12,171 as of end The FX rate volatility continued to reign in 2014 and From supply side, poultry companies have engaged in massive expansion which triggered the oversupply. The rupiah depreciation and oversupply combination was followed by the economic slowdown which exacerbated the fundamental deterioration of the poultry companies. As a result, MAIN showed two consecutive years of earnings down turn in 2013 and 2014 (see Figure 62). However, MAIN successfully staged an earnings reversal in The recovery started since 3Q15 when net profit started to pick up and landed on the positive territory (see Figure 63) after four consecutive net losses since 3Q14 (loss c.idr67bn), 4Q14 (loss c.idr106bn), 1Q15 (loss c.idr60bn), and 2Q15 (loss c.idr24bn). From the revenue side, MAIN booked IDR1.2tr in 4Q15 (+12.2% YoY or 0.9% QoQ), supported by positive growth from breeder segments. Higher sales from the breeder segment were due to the recovery in ASP which picked up c.5% QoQ and also in volume growth which went up c.5.8% QoQ. Bottom line, MAIN booked positive net profit of IDR8.1bn in 4Q15. This figure reflects -37.8% QoQ net profit growth. Although it showed negative growth in quarterly basis, it showed significant improvement from last year when MAIN booked net loss of c.idr106bn. 32

33 Figure 62. MAIN s revenue and net profit Net Revenues Net profit (IDRmn) (IDRmn) 6,000, , ,000 5,000, ,000 4,000, , ,000 3,000, ,000 50,000 2,000, ,000,000-50, , , Figure 63. MAIN s net profit in quarterly basis (IDRbn) Q15 2Q15 3Q15 4Q Overall, MAIN booked revenue growth of +6.1% YoY to IDR4.8tr in FY15 but still delivered net loss of IDR62.8bn in FY15. MAIN s performance was dragged down by forex loss that hit c.idr112bn in 2015 (vs. forex loss of c.idr38.1bn in 2014) due to IDR depreciation. Feeds segment showed +0.1%YoY sales improvement, while DOC segment showed significant +38.5%YoY sales improvement. Broiler segment showed +13.7% YoY sales improvements, processed food segment showed +9.7% YoY sales improvements while other business showed -19.1% YoY sales drops. However, feed segment is still be the only segment that holds positive operating profit while other segments still hold negative operating profit. We predict that poultry sector will give better performance this year due to recovery sign from DOC price. We also believe that MAIN can book better performance in the future ahead along with the recovery of the poultry sector. Minimizing currency volatility As we have already discussed in our industry analysis, companies have sizeable exposures to USD-denominated debt. Hence the rupiah depreciation in 2015 (see Figure 64) placed negative impact on poultry companies including MAIN. The FX rate for USD/IDR was IDR13,795 as of end 2015 vs. IDR12,440 as of end The rupiah depreciation (c.11%) resulted in a IDR112bn translation losses for MAIN in FY15. In an attempt to reduce its volatility stemming from currency fluctuations, MAIN significantly reduced its USD debt. The company downsized its USD short-term bank loans to USD915.3K (equivalent of IDR12.6bn) in 2015 from USD58.1mn (equivalent to IDR723.4bn) as of end As of end 2015, MAIN is USD-debt free. Figure 64. USD/IDR volatility in (USDIDR) Source: Bloomberg, Daewoo Securities Research 33

34 MAIN increased its USD cash position significantly. The company currently holds USD36.2mn (equivalent with c.idr500bn) cash and cash equivalents position as of end 2015 vs. USD386.1K (equivalent with IDR4.8bn) in MAIN also conducted rights issue in 2015 to reduce its debt. Post the rights issue, MAIN s gearing ratio has come down low. While MAIN s debt-to-equity ratio was c.2.3x as of 9M15, it became c.1.3x by the end of We believe post the rights issue MAIN can maintain healthier balance sheet. Growing company embeds high risk, high return As a relatively smaller company compared to its well-established poultry peers (CPIN and JPFA), MAIN showed higher sales growth during 2010~ 2015 with 19% CAGR compared to CPIN (15%) and JPFA (12%). Despite slow economic activity in 2015, MAIN was still able to grow by 6.1% YoY in According to management s guidance, MAIN is expected to grow 13%~ 18% in However, since MAIN is relatively smaller than CPIN and JPFA, volatility is still higher. Its DOC, broiler and food processing still booked operating losses with -IDR168.2bn, -IDR25.4bn and -IDR45.1bn, respectively as of MAIN also has exposures to consumer food products with SunnyGold brand and CikiWiki brand names. This segment only contributed 9.7% to MAIN s total revenue in Sunny Gold is a premium brand which targets modern trade and is available at major supermarket chain stores such as Lottemart, Hero, Giant, Superindo, etc. Ciki Wiki is a mass retail brand which targets the traditional market. The processed food business typically embeds stable and higher margins since it is less volatile than breeder business and broiler business. Currently, MAIN s processed food installed production capacity is 9,000 tons p.a. Figure 65. MAIN s Sunny Gold processed food products Figure 66. MAIN s Ciki Wiki processed food products Valuation and Recommendation We initiate coverage on MAIN with HOLD rating. Our investment points on MAIN are as follows: a) recovery in supply and demand of DOC chicks, b) MAIN s efforts to reduce currency exposures (USD denominated debt), c) MAIN s characteristics as a growing company is accompanied by volatility. Using our DCF approach, we rate MAIN a Hold and present a target price of IDR1,525 (potential upside 8.9%). Risks to our investment call include weakening of purchasing power, prolonged oversupply due to unsettled cartel issues, potential price spike in commodities especially corn and soybean, and greater-than-expected currency volatility. 34