Animal Protein. Indonesia Industry Focus. Supply adjustment to nullify the impact of weak demand. DBS Group Research. Equity 26 Oct 2017

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1 Indonesia Industry Focus Animal Protein Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Oct 2017 Supply adjustment to nullify the impact of weak demand The culling programmes have stabilised prices 3m parent stock (PS) culling to stabilise prices in 2018 Maintain positive view on the sector Our top pick in the sector is Japfa Comfeed Indonesia (JPFA) due to its valuation and earnings delivery Broiler price has been stable thanks to the mandatory culling programmes. Excluding the first quarter s poor ASP, we found that the second and third quarter ASPs were flat y-oy at Rp17.5k/kg livebird. We believe the flat y-o-y livebird price is good enough considering the weak purchasing power of the lower-income segment, low inflation level, and price has rebounded from the first quarter low. The implementation of the first two culling programmes has helped support livebird price in a weak demand environment, in our view. We imagine that the price could be much lower (perhaps below cost of production as in 1Q17) if supply had not been adjusted. We also believe the 3m PS culling conducted in 21 June 2017 will support broiler price in 2018 like what the previous 3m PS culling conducted in Dec 2015 did in stabilising prices in We are positive on the sector in anticipation of demand recovery and manageable supply. The oversupply occurred in 1Q17 has caused the sector s performance to diverge from the JCI s. The JCI rose while the animal protein sector remained flat. We believe the oversupply situation is over and expect the sector to follow the movement of the JCI in the long run. Maintain BUY call on JPFA, HOLD on MAIN, and downgrade CPIN to FULLY VALUED. We prefer Japfa to Malindo due to its higher economies of scale and to Charoen (CPIN) due to its cheap valuation. In term of size, Japfa s EBITDA is four times Malindo s (MAIN) while its EV/EBITDA multiple stood at a tad higher at 5.6x compared to MAIN s 5.1x. At current level, CPIN is still trading at huge premium compared to its integrator peers at 9.2x EV/EBITDA. We believe CPIN s valuation premium will narrow due to its decision to include the commercial farm business in its books. The commercial farm/broiler business has been the main source of volatility due to its inherent volatile pricing nature. Key risk to our view. Prolonged weak purchasing power in the lower-income segment might put broiler and DOC prices under pressure despite the lower level of supply which has been and will still be adjusted. Failed to boost local corn production could also lead to lower margins, if feed wheat imports will be put under restrictions once again. JCI : 6, Analyst Victor STEFANO victor.stefano@id.dbsvickers.com STOCKS Peers comparison Stock Ta rget price Source: DBSVI YTD share performance Source: DBSVI Ta rge t EV/EBITDA Targe t P/E Current price Current EV/EBITDA Curre nt P/E CPIN JPFA MAIN JCI CPIN JPFA MAIN 12-mth Price Mkt Cap Target Performance (%) Rp US$m Price Rp 3 mth 12 mth Rating Charoen Pokphand Ind. 3,200 3,865 2, (12.3) FULLY Japfa Comfeed Indonesia 1,410 1,185 1, (19.7) BUY Malindo Feedmill (12.5) (41.7) HOLD Source: DBSVI, Bloomberg Finance L.P. Closing price as of 25 Oct % 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 5.0% 10.0% 15.0% ed: CK / sa:ma, PY

2 Industry Focus The culling programmes have stabilised prices Lower ASP y-o-y due to oversupply in first quarter Lower ASP in the first quarter of 2017 (-10% y-o-y) has caused 9M17 ASP to drop by 3.4% y-o-y to Rp16.6k/kg livebird. Our view of the oversupply situation in Feb-March 2017 can be found in Animal Protein: Oversupply returning? The weak price in 1Q17 has rebounded due to mandatory culling programme held in late March as well as the demand boost of Lebaran. Y-o-y comparison between 9M broiler price 18,000 17,000 16,000 15,000 14,000 13,000 12,000 11,000 10,000 17,242 Source: company, DBSVI 16,649 Excluding the first quarter s poor ASP, we found that the second and third quarter ASPs were flat y-o-y at Rp17.5k/kg livebird. We expect broiler prices to remain on a positive level (above breakeven cost) in 4Q17 on the back of stronger demand and manageable supply. Demand should recover from higher government spending and supply should be adjusted by the implementation of the fourth culling programme held in Sep Y-o-y comparison of average 2Q-3Q broiler prices 18,000 17,000 Average 9M16 3.4% Average 9M17 17,500 17,504 flat Culling programme has supported broiler price We believe the flat y-o-y livebird price is good enough considering the weak purchasing power of the lower-income segment, low inflation level, and price has rebounded from first quarter low. The implementation of the first two culling programmes has helped support livebird price in a weak demand environment, in our view. We imagine that the price could be much lower (perhaps below cost of production as in 1Q17) if supply had not been adjusted. The following are the implications of the four culling programmes that have been conducted this year: 1. The first culling programme conducted in 27 March 2017 has partly helped broiler price to rebound from the Feb-Mar 2017 low. 2. The second culling programme conducted in 23 May 2017 has helped to support weak prices post Lebaran season. 3. The third culling programme conducted in 21 June 2017 has not shown any effect due to the nature of PS culling which will take effect after six months. 4. The fourth culling programme conducted in 12 Sep 2017 has helped to support weak prices during Suro month which fell on 21 Sep 2017 to 20 October Overall, we noticed that there were price fluctuations but they were rather short term in nature. We believe an oversupply situation like the one in and 1Q17 will not happen again after witnessing the government s proactive stance in managing supply to reduce price fluctuations. We also believe the 3m PS culling conducted in 21 June 2017 will support broiler price in 2018 like what the previous 3m PS culling conducted in Dec 2015 did in stabilising prices in ,000 15,000 14,000 13,000 12,000 11,000 10,000 Average 2Q16 & 3Q16 Source: company, DBSVI Average 2Q17 & 3Q17 Page 2

3 Industry Focus Historical mandatory culling programme rd culling st culling 2nd culling take effect in 6 month take effect in 1 month take effect in 1 month 4th culling take effect 12.0 in 1 month oversupply 10.0 Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17 Source: Pinsar, DBSVI Historical mandatory culling programme No Culling date Type Amount Duration % of population 1st 27-Mar-17 FS 5 millions/week 2 weeks 8% 2nd 23-May-17 FS 24 millions/week 1 weeks 40% 3rd 21-Jun-17 PS 3 millions 1 time 18% 4th 12-Sep-17 FS 2.4 millions/week 5 weeks 6% Source: DBSVI Page 3

4 Industry Focus Where the animal protein sector is heading? Post 1Q17 oversupply, the sector is still in a state of confusion At this point, we will examine the history of the animal protein sector s relationship with the JCI. Using Jan 2013 as the basis, we found that our animal protein sector is highly correlated to the JCI, under normal conditions. During the oversupply condition in , which is the second worst after the GFC in 1998, we found that their relationship was broken. The JCI was slightly moving northeast while the animal protein sector was moving southeast rather dramatically. We believe the underperformance of the animal protein sector (from Apr 2014 to Apr 2015) was justified, given the oversupply situation was out of control at that time. Now, looking at the small oversupply situation that occurred in early 2017, or Feb-Mar 2017 to be precise. We found out that animal protein sector performance has diverged from the JCI s, in line with historical trends. Despite the small magnitude of divergence, the underperforming animal protein sector was consistent with its poor performance in 1Q17. However, post the oversupply situation in 1Q17, the sector has not been moving anywhere. The JCI went up while the animal protein sector remained flat, with some ups and downs. We believe the oversupply situation is over and expect the sector to follow the movement of the JCI in the long run. DBS Animal Protein Index (DAPI) vs Jakarta Composite Index (JCI) DAPI JCI oversupply 3 1Q17 oversupply Wide gap ? 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 Source: Bloomberg Finance L.P., DBSVI 1. The animal protein sector followed the broader market movement (JCI) as the main driver of the chicken consumption is GDP growth. 2. Due to over-optimism about the Indonesian economy, the industry was facing an oversupply of chicken after the overimported grandparent stock (GPS) was producing much more than the demand can absorb. 3. The supply and demand dynamics were reaching an equilibrium, partly helped by 3m PS culling held in Dec Demand was increasing steadily while the supply cut has helped prices to recover. 4. Oversupply happened once again due to weak purchasing power. This time, prices were not as low as in where there was a massive oversupply. The problem was resolved quicker than expected in late-march, thanks to the government s instruction to cull FS to adjust supply in a faster manner. 5. Several culling programmes to adjust supply in both the short term and long term were being conducted. Weak purchasing power remained but supply was adjusted quickly, resulting in more stable prices. The GDP is improving but the positive impact has yet to be seen in the animal protein sector. This has resulted in a wide performance gap between the animal protein sector and the JCI. Page 4

5 Industry Focus Top pick and recommendation We prefer JPFA over MAIN and CPIN due to its valuation and earnings delivery During periods of weak demand and higher raw materials cost, we believe the company with higher economies of scale will reap the benefits. Among integrators in our coverage, Charoen Pokphand (CPIN) is the largest, followed by Japfa Comfeed (JPFA) and Malindo Feedmill (MAIN). We maintain our BUY call on JPFA and reiterate our HOLD calls on both CPIN and MAIN. We prefer Japfa to Malindo due to its higher economies of scale and to Charoen due to its cheap valuation. In terms of size, Japfa s EBITDA is four times Malindo s while its EV/EBITDA multiple stood at a tad higher at 5.6x compared to Malindo s 5.1x. At the current level, Charoen is still trading at a huge premium compared to its integrator peers at 9.2x EV/EBITDA. We think Charoen Pokphand deserves a valuation premium compared to its peers due to its stronger economies of scale and regional presence. Moreover, more stability in earnings delivery and higher margins have historically made Charoen a more preferred stock. However, we noticed that the premium is narrowing after its decision to include the commercial farm business in its books. The commercial farm/broiler business has been the main source of volatility due to its inherent volatile pricing nature. CPIN`s overall gross margin Lower than oversupply H17 Source: Bloomberg Finance L.P., DBSVI 13.0 Companies EBITDA comparison (Rp bn) Companies EPS comparison (Rp/share) EBITDA Consensus EBITDA DBSVI EPS Consensus EPS 6, , , ,000 2, , CPIN JPFA MAIN Source: company, DBSVI Companies EV/EBITDA multiple CPIN JPFA MAIN Companies PE multiple Target EV/EBITDA Current EV/EBITDA CPIN JPFA MAIN Source: company, DBSVI Target P/E Current P/E CPIN JPFA MAIN Page 5

6 Industry Focus Companies net profit margin 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2.0% CPIN JPFA MAIN 2014/2015 oversupply Higher margin on price recovery and lower feed cost 4.0% Source: company, DBSVI Companies net gearing position CPIN JPFA MAIN Capex expansion Normalise gearing 0.50 (0.50) 1Q10 2Q10 3Q10 4Q10 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 Source: company, DBSVI Page 6

7 Industry Focus Segmental EBIT contribution (1H17) Others 13.8% Broiler 31.4% Feed 93.4% Charoen Pokphand Main contributor from feed Moderate DOC contribution Negative broiler Positive processed food DOC 24.2% Others 21.0% DOC 29.4% Broiler 2.2% Feed 89.4% Japfa Comfeed Main contributor from feed High DOC contribution Positive broiler Negative processed food DOC 23.2% Broiler 2.2% Others 22.9% Malindo Feedmill Main contributor from feed Negative DOC contribution Positive broiler Negative processed food Feed 143.9% Source: company, DBSVI Page 7

8 Industry Focus Company Guides Page 8

9 Indonesia Company Guide Charoen Pokphand Indonesia Version 7 Bloomberg: CPIN IJ Reuters: CPIN.JK Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Oct 2017 FULLY VALUED (Downgrade from HOLD) Last Traded Price ( 25 Oct 2017): Rp3,200 (JCI : 6,025.40) Price Target 12-mth: Rp2,780 (-13% downside) (Prev Rp3,170) Analyst Victor STEFANO victor.stefano@id.dbsvickers.com What s New Strong 1H17 performance from higher topline growth, but lower margin is expected going forward De-rating catalyst arising from new episode of earnings volatility Downgrade to FULLY VALUED with TP of Rp2,780 Price Relative More volatility baked into the business Lower margin recorded in the first half. We expect CPIN to continue to suffer from lower margins compared to the historical average on the back of its low-margin new commercial farm business. CPIN had merged with its shareholder s breeding business and acquired additional commercial farms at the end of We expect the Livebird segment to still contribute a small loss this year, given the weak ASP on a YTD basis. Where we differ? We are positive on broiler and DOC prices despite concerns of weaker broiler and day-old-chicks (DOC) prices. We opine that the government s more active involvement in balancing supply and demand should support prices going forward. However, we believe the share price is above its fair level in view of the fact that its commercial farm segment comes with inherent earnings volatility. Potential catalyst. In this report, we adjust our forecasts for broiler and DOC prices to reflect the weak demand in the Indonesian market. We believe as long as broiler price is volatile, CPIN s valuation premium over its peers will deteriorate. Forecasts and Valuation FY Dec (Rp m) 2016A 2017F 2018F 2019F Revenue 38,257 44,799 48,307 52,374 EBITDA 5,354 4,792 5,503 6,375 Pre-tax Profit 3,984 3,534 4,353 5,243 Net Profit 2,221 2,646 3,260 3,926 Net Pft (Pre Ex.) 2,221 2,646 3,260 3,926 Net Pft Gth (Pre-ex) (%) EPS (Rp) EPS Pre Ex. (Rp) EPS Gth Pre Ex (%) Diluted EPS (Rp) Net DPS (Rp) BV Per Share (Rp) ,146 1,333 PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) CASH ROAE (%) Earnings Rev (%): (4) (6) (7) Consensus EPS (Rp): Other Broker Recs: B: 4 S: 2 H: 6 Source of all data on this page: Company, DBS Bank, DBSVI, Bloomberg Finance L.P. Valuation: We downgrade our HOLD call to FULLY VALUED with a revised TP of Rp2,780/share, as we adjust our assumptions for broiler price and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 8.8x, -1SD from the average to account for its commercial farm inclusion which entails the element of cyclicality. Our TP implies 14.0x FY18 PE. Key Risks to Our View: Our investment thesis is premised on stability and recovery of DOC/broiler prices on the back of improved demand. If this does not materialise, our forecasts could be undermined. Our sensitivity analysis shows that every 10% drop in DOC price has a commensurate impact on net profit, all else constant. At A Glance Issued Capital (m shrs) 16,398 Mkt. Cap (Rpbn/US$m) 52,474 / 3,865 Major Shareholders (%) Central Agromina 55.5 Free Float (%) m Avg. Daily Val (US$m) 1.6 ICB Industry : Consumer Goods / Food Producers ed: CK / sa:ma, PY

10 Charoen Pokphand Indonesia WHAT S NEW Strong 1H17 performance from topline growth but lower margin expected Strong 1H17 performance compared to peers from its additional breeding and commercial farm acquisition Charoen Pokphand Indonesia (CPIN) delivered 2Q17 earnings of Rp898bn (-7% y-o-y, 44% q-o-q). Cumulatively,1H17 earnings slid 12% y-o-y. CPIN s 1H17 net profit came in at Rp1,524bn, representing 55% of our FY17 forecast vs historical average of 60%. 2Q17 earnings are broadly in-line, but the below-expected net profit in 1Q17 has weighed on cumulative 1H17 profit. Thus, net margin improved to 6.9% vs 5.2% in 1Q17 but still lower than 9.9% recorded in 2Q16 on the back of higher raw material cost and lower livebird price. Compared to peers, CPIN s performance in the first half is stronger due to its robust topline growth from its merger with its shareholders breeding division and additional commercial farms acquisition. Strong topline but lower margin from its commercial farm division. CPIN booked net revenue of Rp12,923bn in 2Q17, which implies a solid growth rate of 31% y-o-y. Significant growth is mainly driven the by broiler segment, after the acquisition of PT Multi Sarana Pakanindo, CPIN was able to book solid growth for broiler segments of 142% y-o-y in 2Q17 and 123.8% y-o-y in 1Q17. Despite this, the broiler segment booked a loss of Rp181bn in 2Q17 at the operational level. The poor earnings have been affected by lower-than-expected broiler ASP recorded in the first half of 2017 on the back of low purchasing power for the lower-end segment. CPIN`s overall gross margin Lower than oversupply H17 Source: Bloomberg Finance L.P., DBSVI 13.0 Outlook Commercial farm continues its loss-making streak. We expect CPIN to continue to book negative contribution from its commercial farm division in 3Q17 on lower 3Q17 broiler price compared to 2Q17 due to seasonally lower ASP stemming from the Lebaran season. But we believe prices should recover in 4Q17 from higher demand on the back of government spending and manageable supply through mandatory culling programmes. This might help CPIN to book positive earnings in its commercial farm division but negative FY17F earnings are expected. A breakthrough from high local corn price. The recent imported feed wheat will help to ease pressure on animal feed margin that is caused by higher local corn price. Although small in number (200,000 tonnes vs last year s import of 2m tonnes), the recent imported feed wheat might recur in the future, if no problem occurs. Also take note that the 200,000-tonne feed wheat are to be used in the 4Q17 (for three months production) while the 2m feed wheat was used in 2Q16 and 3Q16 (six months production). Going forward, the imported feed wheat will provide Charoen Pokphand with better feed margins, especially when local corn prices are high. Net gearing remains low. As of Jun 2017, CPIN net gearing ratio inched up to 29% vs 27% in 1Q17 due to a 17% increase in its short-term debt while long-term debt remained flat (-1% compared to 1Q17). Its cash position rose by 7% to Rp2,040bn from the 1Q17 position of Rp1,910bn. Valuation We downgrade our HOLD call to FULLY VALUED with a revised TP of Rp2,780/share, as we adjust our assumptions for broiler price (-3%) and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 8.8x, - 1SD from the average to account for its commercial farm inclusion which the element of cyclicality. Our TP implies 14.0x FY18 PE. Peers comparison Stock Ta rge t price Ta rge t Current Ta rge t P/E EV/EBITDA price Current Current P/E EV/EBITDA CPIN JPFA MAIN Source: Bloomberg Finance L.P., DBSVI Page 10

11 Charoen Pokphand Indonesia CRITICAL DATA POINTS TO WATCH Poultry feed prices (Rp/kg) Critical Factors DOC as a proxy to demand. Unlike feed, price and margin for the DOC segment have been historically positive for the share price. So is volume. We believe DOC price and volume have a strong relationship with demand for chicken, thus affecting its share price directly. Broiler price has lower correlation with share price. Although the broiler price drop in 1Q17 has caused the share price to drop significantly, historically it was DOC price that drove the share price. Long broiler supply chain might cause its DOC price to diverge from actual demand. Rising poultry feed ASP is not a good thing. As the largest integrators in Indonesia, the feed business is the largest contributor to CPIN s earnings. Then, one would also think that higher volume and ASP will boost its bottomline, and thus its share price. However, our study shows that poultry feed ASP has negative correlation with its share price, historically. Margin does not have or little correlation with share price. Avg realised corn cost (Rp/kg) Avg realised soy meal cost (Rp/kg) Corn makes up half of poultry feed. Since corn import restrictions were imposed, CPIN has to use 100% local corn. Rising local corn price will be passed on to poultry feed, thus weighing down on its share price. A lot of corn field has been planted since the government banned corn imports. Success in achieving selfsufficiency in corn will provide a positive catalyst for CPIN s share price. Feed volume growth supports share price. Historically, when poultry feed production volume increases, CPIN s share price tend to increase, except for the period of economic downtrend in Unlike ASP which might increase due to raw material prices, volume growth indicates that there is demand growth for poultry products. Less impact from USD fluctuation. Since the import ban on corn and feed wheat was instituted, the company had to use local corn. The import ban has reduced CPIN s operational risk against USD movement. It still sources 100% of its soybean meal requirement from imports. DOC prices (Rp/chick) Broiler prices (Rp/kg live) Source: Company, DBS Bank, DBSVI Page 11

12 Charoen Pokphand Indonesia Appendix 1: A look at Company's listed history what drives its share price? Share price movement vs Consumer Confidence Index Share price BI CCI Gap between CCI and share price /1/2012 1/1/2013 1/1/2014 1/1/2015 1/1/2016 1/1/ Source: Bloomberg Finance L.P., DBSVI CPIN share price has been moving along with Consumer Confidence Index (BI) 1. During economic expansion, CPIN s share price experienced a dramatic jump as chicken consumption increases. Population growth and rising income has fuelled chicken consumption growth. In mid-2013, the rupiah weakened and GDP growth headed south. Production capacity has been ramped up while demand growth began to turn sluggish. Imported corn price rose due to a high exchange rate, thus pushing poultry feed ASP up. Combined with plunging DOC price and declining CCI, CPIN s share price drop significantly. 2. Late 2015, CCI started to recover and CPIN s share price has been catching up following its declining poultry feed ASP (despite the ban on imported corn) and higher DOC ASP. 3. Late 2016 share price movement has deviated from CCI due to concerns over commercial farm segment. CPIN`s valuation has drop due to its decision to include broiler division, which is the source of cyclicality, into the book. DOC price is critical for share price movement Share price DOC ASP Break even / supportive price Positive DOC ASP should be supportive to share price Jan-14 Jan-15 Jan-16 Jan-17 0 Source: Bloomberg Finance L.P., Company, DBSVI Page 12

13 Charoen Pokphand Indonesia DOC price reflects demand We believe DOC price is a good measure of chicken demand. For simplicity, our graph shows that when DOC price meets a certain level (i.e. Rp4,000/chick), CPIN s share price tends to increase, and vice versa. We expect DOC price to remain in positive territory in 2H17. However, we believe CPIN s share price is above fair level in view of the fact that its commercial farm segment comes with inherent earnings volatility. Page 13

14 Charoen Pokphand Indonesia Balance Sheet: Deleveraging The group has made efforts to cut borrowings, especially its USD-denominated debt. CPIN s net debt to total equity ratio had shrunk to 29% at end-fy16 vis-à-vis 46% in FY15, as the group repays its borrowings, reduces capex and lowers its USD debt exposure. We expect CPIN to be in a net cash position by end-fy18f. Slower capex ahead In view of the recent DOC oversupply, the group reduced its capital spending on new capacities in FY15, and this translates to Rp711bn capex in FY16. We expect the capex to reach Rp836bn in FY17F. ROA is likewise expected to improve to 15% by FY18F from 9% FY16. Rpbn Leverage & Asset Turnover (x) Capital Expenditure Share Price Drivers: Better-than-expected feed/doc/broiler prices. A higher-thanexpected recovery in feed/doc/broiler prices could act as a positive catalyst for the stock, as DOC prices affect the group s earnings significantly. Key Risks: Outbreak of diseases affecting livestock at the group s poultry farms would have a material effect on the group s business and financial status. While the group has instituted strict biosecurity measures to reduce the risk of these events happening, there is no assurance that CPIN would be immune to them. Additionally, an outbreak (such as bird flu) would likely have an adverse impact on demand. Changes in government regulation, licensing, change in raw material import policy (as demonstrated by the corn import restriction in Aug 2015) and price/volume controls across various jurisdictions may adversely affect CPIN s profitability. For example, the requirement to reduce DOC supply post-eid given the oversupply situation would temporarily affect the group s financial performance. The group is also exposed to volatile movements in raw material costs and currencies across its key markets. For example, the recent drop in the rupiah and weakness in consumer purchasing power in Indonesia had resulted in delays in passing on higher raw material costs. ROE (%) Forward PE Band (x) Company Background Charoen Pokphand Indonesia (CPIN) is the market leader in all its business segments, such as poultry feed, day-old-chicks (DOC), and processed chickens with strong established brands. CPIN listed its shares on the IDX in CPIN was established in 1972 as the first high-volume feedmill in Jakarta, Indonesia. Today, the group has operations throughout Indonesia, supported by an extensive distribution network and integrated strategy. PB Band (x) Source: Company, DBS Bank, DBSVI Page 14

15 Charoen Pokphand Indonesia Key Assumptions FY Dec 2015A 2016A 2017F 2018F 2019F Poultry feed prices (Rp/kg) 6,280 6,356 6,421 6,473 6,601 Avg realised corn cost 3,776 3,602 4,358 4,396 4,519 Avg realised soy meal cost 7,099 5,784 6,318 6,289 6,351 DOC prices (Rp/chick) 4,400 5,214 5,245 5,376 5,516 Broiler prices (Rp/kg live) 16,150 17,226 16,812 17,022 17,376 Segmental Breakdown FY Dec 2015A 2016A 2017F 2018F 2019F Revenues (Rpbn) Poultry feed 21,979 22,341 24,629 25,790 27,514 DOC 3,714 4,691 4,716 5,248 5,725 Live birds 0.0 6,038 9,310 9,946 10,371 Processed chicken 3,121 3,537 4,342 5,340 6,575 Others 1,108 1,651 1,803 1,983 2,190 Total 29,921 38,257 44,799 48,307 52,374 Gross profit (Rpbn) Poultry feed 3,982 4,264 4,256 4,505 4,824 DOC (39.6) 1, ,141 1,251 Live birds (588) (785) (939) Processed chicken 1,067 1,084 1,395 1,716 2,113 Others Total 5,103 6,514 6,377 7,191 8,206 Gross profit Margins (%) Poultry feed DOC (1.1) Live birds N/A 0.7 (6.3) (7.9) (9.1) Processed chicken Others Total Income Statement (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Revenue 29,921 38,257 44,799 48,307 52,374 Cost of Goods Sold (24,817) (31,743) (38,422) (41,116) (44,168) Gross Profit 5,103 6,514 6,377 7,191 8,206 Other Opng (Exp)/Inc (1,757) (2,055) (2,311) (2,474) (2,661) Operating Profit 3,346 4,459 4,066 4,716 5,545 Other Non Opg (Exp)/Inc (541) 127 (77.9) (55.8) (50.0) Associates & JV Inc Net Interest (Exp)/Inc (620) (602) (454) (307) (252) Exceptional Gain/(Loss) Pre-tax Profit 2,185 3,984 3,534 4,353 5,243 Tax (449) (1,732) (884) (1,088) (1,311) Minority Interest 4.40 (4.8) (4.3) (5.3) (6.4) Preference Dividend 96.4 (26.4) Net Profit 1,837 2,221 2,646 3,260 3,926 EBITDA 3,506 5,354 4,792 5,503 6,375 Growth Revenue Gth (%) EBITDA Gth (%) (10.5) Opg Profit Gth (%) (8.8) Net Profit Gth (Pre-ex) (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Source: Company, DBS Bank, DBSVI Page 15

16 Charoen Pokphand Indonesia Quarterly / Interim Income Statement (Rpbn) FY Dec 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017 Revenue 9,835 9,274 9,904 12,014 12,923 Cost of Goods Sold (8,016) (7,671) (8,218) (10,595) (11,096) Gross Profit 1,818 1,603 1,686 1,418 1,828 Other Oper. (Exp)/Inc (467) (500) (647) (546) (611) Operating Profit 1,351 1,104 1, ,216 Other Non Opg (Exp)/Inc 39.2 (2.6) (42.1) Associates & JV Inc Net Interest (Exp)/Inc (150) (152) (121) (117) (120) Exceptional Gain/(Loss) Pre-tax Profit 1, ,136 Tax (267) (184) (1,128) (130) (239) Minority Interest (4.0) (1.7) Net Profit (274) EBITDA 1,391 1, ,257 Growth Revenue Gth (%) 6.4 (5.7) EBITDA Gth (%) 26.8 (20.8) (9.4) (12.5) 44.1 Opg Profit Gth (%) 40.1 (18.3) (5.8) (16.1) 39.4 Net Profit Gth (Pre-ex) (%) 27.2 (21.3) (136.0) (328.0) 43.5 Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) (2.8) Balance Sheet (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Net Fixed Assets 11,310 11,234 11,260 11,297 11,341 Invts in Associates & JVs Other LT Assets 1, Cash & ST Invts 1,679 2,525 1,728 3,833 6,302 Inventory 5,484 5,110 6,411 6,861 7,370 Debtors 2,998 2,316 3,112 3,355 3,638 Other Current Assets 1,897 2,108 1,992 1,816 1,711 Total Assets 24,917 24,205 25,424 28,092 31,301 ST Debt 1,710 1,400 1,400 1,400 1,400 Creditor 2,464 1,267 2,258 2,416 2,596 Other Current Liab 1,530 2,883 1,344 1,475 2,736 LT Debt 5,881 3,646 3,281 3,032 1,658 Other LT Liabilities ,010 Shareholder s Equity 12,772 14,138 16,210 18,784 21,866 Minority Interests Total Cap. & Liab. 24,917 24,205 25,424 28,092 31,301 Non-Cash Wkg. Capital 6,386 5,384 7,914 8,141 7,387 Net Cash/(Debt) (5,911) (2,521) (2,953) (599) 3,244 Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) CASH Net Debt/Equity ex MI (X) CASH Capex to Debt (%) Z-Score (X) Source: Company, DBS Bank, DBSVI Page 16

17 Charoen Pokphand Indonesia Cash Flow Statement (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Pre-Tax Profit 2,185 3,984 3,534 4,353 5,243 Dep. & Amort Tax Paid (449) (1,732) (884) (1,088) (1,311) Assoc. & JV Inc/(loss) Chg in Wkg.Cap. (485) 112 (1,222) (229) (364) Other Operating CF (170) 1, Net Operating CF 1,782 4,157 2,233 3,879 4,449 Capital Exp.(net) (2,014) (679) (837) (880) (925) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF 69.8 (498) (0.7) (6.7) (6.9) Net Investing CF (1,944) (1,177) (838) (887) (932) Div Paid (295) (476) (575) (685) (844) Chg in Gross Debt 1,667 (1,654) (1,673) (248) (256) Capital Issues 0.0 (165) Other Financing CF (416) Net Financing CF 956 (2,155) (2,193) (887) (1,049) Currency Adjustments Chg in Cash (798) 2,105 2,468 Opg CFPS (Rp) Free CFPS (Rp) (14.1) Source: Company, DBS Bank, DBSVI Target Price & Ratings History Source: DBS Bank, DBSVI Analyst: Victor STEFANO Page 17

18 Indonesia Company Guide Japfa Comfeed Indonesia Version 12 Bloomberg: JPFA IJ Reuters: JPFA.JK Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Oct 2017 BUY Last Traded Price ( 25 Oct 2017): Rp1,410 (JCI : 6,025.40) Price Target 12-mth: Rp1,700 (21% upside) (Prev Rp1,600) Analyst Victor STEFANO victor.stefano@id.dbsvickers.com What s New Expect stronger 2H17 results from better demand Supply to remain adjustable from culling programme Feed wheat to ease pressure on animal feed margin Maintain BUY with TP of Rp1,700 Price Relative Stable broiler price to support 2H17 performance Expect a stronger second half. We expect Japfa Comfeed to book Rp260bn net profit in 3Q17 or lower than 2Q17 s net profit of Rp396bn on the back of lower ASP from a Lebaran season-induced high base in 2Q17. We believe the weak purchasing power seen in 1H17 will gradually rebound in the second half on higher government spending and supply to remain manageable from mandatory culling programmes. Where we differ? Positive on broiler and DOC prices Despite concerns of weaker broiler and day-old-chicks (DOC) prices, we opine that with the government being more active in balancing supply and demand, this should provide support for prices going forward. We believe the share price decline YTD due to 1) fear of oversupply, and 2) weak 1H17 results, has been excessive and is not justified. Potential catalyst. In this report, we adjust our forecasts on broiler and DOC price to reflect the weak demand in the Indonesian market. We believe prices will remain healthy despite the usual fluctuations. Forecasts and Valuation FY Dec (Rp m) 2016A 2017F 2018F 2019F Revenue 27,063 29,164 32,378 35,868 EBITDA 3,866 2,686 3,430 3,753 Pre-tax Profit 2,767 1,602 2,330 2,648 Net Profit 2,065 1,140 1,657 1,883 Net Pft (Pre Ex.) 2,065 1,140 1,657 1,883 Net Pft Gth (Pre-ex) (%) (44.8) EPS (Rp) EPS Pre Ex. (Rp) EPS Gth Pre Ex (%) 312 (45) Diluted EPS (Rp) Net DPS (Rp) BV Per Share (Rp) ,109 PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): (18) (15) (15) Consensus EPS (Rp): N/A N/A N/A Other Broker Recs: B: 13 S: 2 H: 2 Source of all data on this page: Company, DBSVI, Bloomberg Finance L.P Valuation: We maintain our BUY call with a revised TP of Rp1,700/share, as we adjust our assumptions for broiler and DOC prices and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 6.9x, the average. Our TP implies 11.7x FY18 PE. Key Risks to Our View: Our investment thesis is premised on stability and recovery of DOC/broiler prices on the back of improved demand. If this does not materialise, it could undermine our forecasts. Our sensitivity analysis shows that every 10% drop in DOC price has a commensurate impact on net profit, all else constant. At A Glance Issued Capital (m shrs) 11,411 Mkt. Cap (Rpbn/US$m) 16,089 / 1,185 Major Shareholders (%) Japfa Pte Ltd 51.0 KKR Jade 12.0 Free Float (%) m Avg. Daily Val (US$m) 0.54 ICB Industry : Consumer Goods / Food Producers ed: CK / sa:ma, PY

19 Japfa Comfeed Indonesia WHAT S NEW Stronger 2H17 output from 4Q performance Weak 1H17 performance was expected given 2016 high base Given the strong performance last year, due to its ability to use feed wheat, as well as strong DOC and broiler ASP, we saw 1H17 net profit cut by half. Subsequently net profit margin also dropped from 6.5% to 3.3%. Most of the poor 1H17 performance was attributable to 1Q17 when the oversupply occurred, coupled with the booking of high bonus payment arising from a strong 2016 performance. We believe both negative factors will disappear in 2H17. Outlook Higher DOC and broiler ASP on demand recovery and supply cut. We expect Japfa to book lower 3Q17 profit compared to 2Q17 due to seasonally lower ASP from the Lebaran season. But we believe prices should recover in 4Q17 from higher demand on the back of government spending and manageable supply through mandatory culling programmes. A breakthrough from high local corn price. The recent imported feed wheat will help to ease pressure on animal feed margin that is caused by higher local corn price. Although small in number (200,000 tonnes vs last year import of 2m tonnes), the recent imported feed wheat might recur in the future, if no problem occurs. Also take note that the 200,000-tonne feed wheat are to be used in the 4Q17 (for three months production) while the 2m feed wheat was used in 2Q16 and 3Q16 (six months production). Going forward, the imported feed wheat will provide Japfa with better feed margins, especially when local corn prices are high. Lower 2H17 operating expense. As mentioned in our previous report, 2Q17 operating expense should decrease in the absence of high bonus payment made in 1Q17 but it should be higher than 3Q17 and 4Q17, as the 13th salary would be made in the quarter. We maintain our view on lower 2H17 operating expense vis-a-vis 1H17. Quarterly net profit margin (ex. FX gain/loss) (2) (4) Stock 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17F Source: Bloomberg Finance L.P, DBSVI Valuation We maintain our BUY call with a revised TP of Rp1,700/share, as we adjust our assumptions for broiler and DOC prices and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 6.9x, the average. Our TP implies 11.7x FY18 PE. Peers comparison Targe t price Targe t EV/EBITDA Ta rget P/E Current price 1.1 Current EV/EBITDA Curre nt P/E CPIN JPFA MAIN Source: Bloomberg Finance L.P, DBSVI Page 19

20 Japfa Comfeed Indonesia CRITICAL DATA POINTS TO WATCH Poultry feed prices (Rp/kg) Critical Factors DOC as a proxy to demand. Unlike feed, price and margin for the DOC segment have been historically positive for the share price. So is volume. We believe DOC price and volume have a strong relationship with demand for chicken, thus affecting its share price directly. Broiler price has lower correlation with share price. Although the broiler price drop in 1Q17 has caused the share price to drop significantly, historically it was DOC price that drove the share price. Long broiler supply chain might cause its DOC price to diverge from actual demand. Rising poultry feed ASP is not a good thing. No one would argue that the feed business is the largest contributor to JPFA s earnings. Then, one would also think that higher volume and ASP will boost its bottom line, and thus its share price. However, our study shows that poultry feed ASP has negative correlation with its share price, historically. Margin does not have or little correlation with share price. Poultry feed production (m kg) Chicken consumption per capita (kg/year) Corn makes up half of poultry feed. Since corn import restrictions were imposed, JPFA has to use 100% local corn. Rising local corn price will be passed on to poultry feed, thus weighing down on its share price. A lot of corn field has been planted since the government banned corn imports. Success in achieving selfsufficiency in corn will provide a positive catalyst for JPFA s share price. Feed volume growth supports share price. Historically, when poultry feed production volume increases, JPFA s share price tend to increase, except for period of economic downtrend in Unlike ASP which might increase due to raw material prices, volume growth indicates that there is demand growth for poultry products. Less impact from USD fluctuation. Since the import ban on corn and feed wheat was instituted, the company had to use local corn. The import ban has reduced JPFA s operational risk against USD movement. It still sources 100% of its soybean meal requirement from imports. DOC prices (Rp/chick) Broiler prices (Rp/kg live) Source: Company, DBSVI Page 20

21 Japfa Comfeed Indonesia Appendix 1: A look at Company's listed history what drives its share price? Share price movement vs Consumer Confidence Index Share price BI CCI Gap between CCI and share price Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan Source: Bloomberg Finance L.P., DBSVI JPFA share price has been moving along with Consumer Confidence Index (BI) 1. During economic expansion, JPFA s share price experienced a dramatic jump as chicken consumption increases. Population growth and rising income has fuelled chicken consumption growth. In mid-2013, the rupiah weakened and GDP growth headed south. Production capacity has been ramped up while demand growth began to turn sluggish. Imported corn price rose due to a high exchange rate, thus pushing poultry feed ASP up. Combined with plunging DOC price and declining CCI, JPFA s share price drop significantly. 2. Late 2015, CCI started to recover and JPFA s share price has been catching up following its declining poultry feed ASP (despite the ban on imported corn) and higher DOC ASP. 3. Early 2017 share price movement has deviated from CCI due to concerns over oversupply. Indeed, the price of DOC has been falling for two months, but it is still at a positive level. DOC price is critical for share price movement Share price DOC ASP Break even/ supportive DOC price Positive DOC ASP should be supportive to share price Jan 14 Jan 15 Jan 16 Jan Source: Bloomberg Finance L.P., company, DBSVI Page 21

22 Japfa Comfeed Indonesia DOC price reflects demand We believe DOC price is a good measure of chicken demand. For simplicity, our graph shows that when DOC price meets a certain level (i.e. Rp4,500/chick), JPFA s share price tends to increase, and vice versa. We expect DOC price to increase to Rp5,200/chick in 3Q17 from Rp5,370/chick in the previous quarter. Despite the lower DOC ASP q-o-q, we believe the DOC ASP will remain healthy to support share price. Poultry feed production volume affects share price Share price Poultry feed production 2, ,000 1,500 1, Jan 14 Jan 15 Jan 16 Jan 17 Source: company, Bloomberg Finance L.P., DBSVI Gap between poultry feed production volume and share price Poultry feed volume as earnings and share price driver Though feed price increase does not help boost JPFA s share price, volume growth does. However, the economic downtrend since mid-2013 had offset gains from high 2014 poultry feed production. In 2015, its production volume dropped back to the 2013 level. Combined with an economic slowdown, this has resulted in JPFA s share price dropping excessively. In 2016, production volume began to increase, i.e. back to the 2014 level. This increase, combined with an economic recovery, has resulted in a stellar share price uptrend. As we expect poultry feed production to increase by c.8% this year, we think that its share price retracement fails to reflect its intrinsic value, in our view. Page 22

23 Japfa Comfeed Indonesia Balance Sheet: Lower capital spending overtime. Between FY11 and FY16, JPFA expanded its poultry feed capacity by c.50% while utilisation rate declined (from 75% to 61%). We expect the group s expansion plan to decelerate in FY17F, having halted most of its expansion plans in FY16 (due to industry overcapacity in DOC breeding nationwide). However, given the normalisation of the group s margins this year, JPFA s ROA is forecast to ease to 5.7% from 11.3% in FY17F; before recovering towards 7.5% in FY18F. Small leverage for the year. As of end-june 2017, JPFA s total borrowings decreased to Rp6.5tr from Rp7.2tr in March The decrease in borrowings was due to lower short-term bank borrowings. We expect net gearing to increase slightly to 39% by end-fy17f before dropping to 30% in FY18F. As at end- March 2017, JPFA had US$194.5m bonds due in 2018, which we expect to be called and refinanced through the recent issuance of US$250m bonds (BB- rating by S&P and Fitch); as well as additional Rp1tr re-tap bonds. The group has earlier this year refinanced Rp1.5tr notes through Rp1.0tr issuance from its new re-tap bonds in December Share Price Drivers: DOC and broiler prices. Higher DOC and broiler prices could act as positive catalysts for the stock, as both have a significant impact on JPFA s earnings. Key Risks: Miscalculation of demand and slower government response. Licensing, as well as other interventions, change in raw material import policy (as demonstrated by corn import restrictions in Aug 2015), and price/volume controls across various jurisdictions may adversely affect JPFA s profitability. For example, the required reduction in DOC supply to control post-eid oversupply would temporarily affect the group s financial performance. Also, a reduction in quota and/or restrictions for the importation of live cattle would adversely affect the group s beef feedlot operations Rpbn Leverage & Asset Turnover (x) Capital Expenditure ROE (%) Forward PE Band (x) Company Background The group was established in 1971 under Java Pelletizing Factory as a copra pellet producer. Following its listing in Jakarta and Surabaya stock exchanges in 1989 and the acquisition of four poultry feed producers in 1990, its name was changed to Japfa Comfeed Indonesia (JPFA IJ). The group is now run by the second generation of the Santosa family. In the control of the family, the group has transformed into one of the largest and most integrated poultry companies in Indonesia. PB Band (x) Source: Company, DBSVI Page 23

24 Japfa Comfeed Indonesia Key Assumptions FY Dec 2015A 2016A 2017F 2018F 2019F Poultry feed prices (Rp/kg) 5,810 5,875 5,945 6,243 6,567 Poultry feed production 2,610 2,735 2,944 3,148 3,347 Chicken consumption per DOC prices (Rp/chick) 4,452 5,363 5,395 5,664 5,959 Broiler prices (Rp/kg live) 16,151 17,121 16,710 17,545 18,458 Segmental Breakdown FY Dec 2015A 2016A 2017F 2018F 2019F Revenues (Rpbn) Poultry + aqua feed 11,138 12,056 13,036 14,439 15,961 DOC 1,494 1,932 2,384 2,676 2,993 Broiler 10,270 10,894 11,446 12,848 14,373 Others 2,120 2,181 2,299 2,415 2,541 Total 25,023 27,063 29,164 32,378 35,868 Gross profit (Rpbn) Poultry + aqua feed 2,457 3,113 2,803 3,118 3,459 DOC 375 1, ,054 1,180 Broiler Others ,284 1,350 Total 3,993 5,479 4,718 5,678 6,246 Gross profit Margins (%) Poultry + aqua feed DOC Broiler Others Total Income Statement (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Revenue 25,023 27,063 29,164 32,378 35,868 Cost of Goods Sold (21,030) (21,584) (24,446) (26,700) (29,623) Gross Profit 3,993 5,479 4,718 5,678 6,246 Other Opng (Exp)/Inc (2,265) (2,558) (2,638) (2,918) (3,228) Operating Profit 1,728 2,921 2,080 2,760 3,018 Other Non Opg (Exp)/Inc (367) 330 (66.1) (15.5) (3.9) Associates & JV Inc Net Interest (Exp)/Inc (663) (484) (412) (415) (366) Exceptional Gain/(Loss) Pre-tax Profit 698 2,767 1,602 2,330 2,648 Tax (173) (595) (401) (582) (662) Minority Interest (56.3) (107) (61.9) (90.1) (102) Preference Dividend Net Profit 468 2,065 1,140 1,657 1,883 EBITDA 2,400 3,866 2,686 3,430 3,753 Growth Revenue Gth (%) EBITDA Gth (%) (30.5) Opg Profit Gth (%) (28.8) Net Profit Gth (Pre-ex) (%) (44.8) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Source: Company, DBSVI Page 24

25 Japfa Comfeed Indonesia Quarterly / Interim Income Statement (Rpbn) FY Dec 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017 Revenue 7,108 7,059 6,462 6,625 7,507 Cost of Goods Sold (5,512) (5,374) (5,381) (5,528) (6,117) Gross Profit 1,596 1,685 1,081 1,097 1,391 Other Oper. (Exp)/Inc (591) (573) (672) (827) (648) Operating Profit 1,005 1, Other Non Opg (Exp)/Inc (16.2) (65.4) Associates & JV Inc Net Interest (Exp)/Inc (141) (120) (82.6) (93.3) (108) Exceptional Gain/(Loss) Pre-tax Profit 848 1, Tax (121) (282) (69.2) (127) (134) Minority Interest (39.7) (27.2) (10.4) (43.3) (39.5) Net Profit Net profit bef Except EBITDA 989 1, Growth Revenue Gth (%) 10.5 (0.7) (8.5) EBITDA Gth (%) (57.8) (29.3) 90.9 Opg Profit Gth (%) (63.2) (33.9) Net Profit Gth (Pre-ex) (%) (55.3) (73.1) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Balance Sheet (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Net Fixed Assets 6,809 7,512 8,103 8,663 9,174 Invts in Associates & JVs Other LT Assets Cash & ST Invts 913 2,713 2,497 2,999 2,705 Inventory 5,855 5,500 6,430 7,023 7,792 Debtors 1,200 1,212 1,299 1,443 1,598 Other Current Assets 1,637 1,637 1,909 2,105 2,341 Total Assets 17,160 19,251 20,982 23,000 24,395 ST Debt 1,863 2, , Creditor 2,746 2,317 2,867 3,131 3,474 Other Current Liab LT Debt 4,757 3,609 5,419 4,589 4,593 Other LT Liabilities 940 1,076 1,138 1,242 1,377 Shareholder s Equity 5,612 8,844 9,614 11,067 12,655 Minority Interests Total Cap. & Liab. 17,160 19,251 20,982 23,000 24,395 Non-Cash Wkg. Capital 5,202 5,414 6,190 6,768 7,511 Net Cash/(Debt) (5,707) (3,155) (3,694) (3,207) (2,655) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) Source: Company, DBSVI Page 25

26 Japfa Comfeed Indonesia Cash Flow Statement (Rpbn) FY Dec 2015A 2016A 2017F 2018F 2019F Pre-Tax Profit 698 2,767 1,602 2,330 2,648 Dep. & Amort Tax Paid Assoc. & JV Inc/(loss) Chg in Wkg.Cap (833) (592) (753) Other Operating CF (173) (881) (404) (586) (666) Net Operating CF 1,453 2, ,822 1,965 Capital Exp.(net) (1,089) (1,550) (1,196) (1,230) (1,247) Other Invts.(net) 32.8 (134) (3.8) (3.9) (4.0) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF 374 1, (0.7) (0.7) Net Investing CF (682) (498) (1,191) (1,235) (1,252) Div Paid 0.0 (160) (369) (204) (296) Chg in Gross Debt (436) (1,815) 12.2 (3.7) (0.6) Capital Issues Other Financing CF (231) (711) Net Financing CF (667) (447) 15.4 (84.1) (1,008) Currency Adjustments 28.3 (9.4) Chg in Cash 133 1,800 (204) 503 (294) Opg CFPS (Rp) Free CFPS (Rp) (19.8) Source: Company, DBSVI Target Price & Ratings History Source: DBSVI Analyst: Victor STEFANO Page 26

27 Indonesia Company Guide Malindo Feedmill Version 8 Bloomberg: MAIN IJ Reuters: MAIN.JK Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Oct 2017 HOLD Last Traded Price ( 25 Oct 2017): Rp875 (JCI : 6,025.40) Price Target 12-mth: Rp975 (11% upside) (Prev Rp1,225) Analyst Victor STEFANO victor.stefano@id.dbsvickers.com What s New Margin to recover in 2H17 from 1H17 low Limited impact from Lebaran season in 2Q17 Feed wheat to ease pressure on animal feed margin Maintain HOLD call with revised TP of Rp975 Price Relative Forecasts and Valuation FY Dec (Rp m) 2016A 2017F 2018F 2019F Revenue 5,246 6,388 7,307 8,408 EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex.) Net Pft Gth (Pre-ex) (%) nm (47.4) EPS (Rp) EPS Pre Ex. (Rp) EPS Gth Pre Ex (%) (561) (47) Diluted EPS (Rp) Net DPS (Rp) BV Per Share (Rp) ,089 PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): (33) (21) (12) Consensus EPS (Rp): N/A N/A N/A Other Broker Recs: B: 5 S: 1 H: 6 Green shoots expected in 2H17 Margin recovery in the second half. Near-term headwinds from changes in the regulatory environment and weaker purchasing power have decelerated MAIN s earnings growth vis-à-vis our previous forecasts. We believe its margin to recover from the 1H17 low on higher ASP on the back of stronger demand and continuing supply management. We expect MAIN to achieve a net margin of 2.4% in FY17F vs June 2017 s 1.0%. We expect MAIN s earnings to grow by 4% CAGR from F. Where we differ? Lower FY17F and FY18F net profit. As the third largest integrator, we believe the lack of economies of scale compared to its peers will put pressure on its margin amid a weak consumption environment and higher local corn price. Potential catalyst. In this report, we adjust our forecasts on broiler and DOC prices to reflect weak demand in the Indonesian market. Continuing pressures on margin are expected given its lack of scale relative to its peers. Lower-thanexpected volume growth for its processed food segment could also drag down margin further. Valuation: We maintain our HOLD call with a revised TP of Rp975/share, as we adjust our assumptions for broiler and DOC prices and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 5.6x, the average. Our TP implies 9.9x FY18 PE. Key Risks to Our View: Our investment thesis is premised on higher animal feed and DOC prices on the back of improved demand. Continued weak purchasing power could lead to prolonged weak margins going forward. At A Glance Issued Capital (m shrs) 2,239 Mkt. Cap (Rpbn/US$m) 1,959 / 144 Major Shareholders (%) Dragon Amity Ltd 57.1 Free Float (%) m Avg. Daily Val (US$m) 0.02 ICB Industry : Consumer Goods / Food Producers Source of all data on this page: Company, DBSVI, Bloomberg Finance L.P. ASIAN INSIGHTS VICKERS SECURITIES ed: CK / sa:ma, PY

28 Malindo Feedmill WHAT S NEW Higher feed ASP to support margin in 2H17 1H17 performance was expected given 2016 high base Malindo Feedmill s (MAIN) 2Q17 earnings slumped to only Rp2.3bn (-98% y-o-y, -90.7% q-o-q). The significant drop was due to lower margin from the feed and breeding segment, combined with higher SG&A expense (+37.7% q-o-q, +50% y-o-y). This brings 1H17 earnings to Rp26.9bn (-83% y-o-y). This represents 18% of our FY17F earnings. Margin dropped on lower feed ASP. MAIN s 2Q17 gross margin dropped to 12.2% from 13.1% in 1Q17 and 18.5% in 2Q16. The lower gross margin was attributable to lower feed ASP of -2.4% q-o-q due to lower layer feed ASP that contributed about 10% of total animal feed. According to the company, the drop in layer feed was due to the decline in egg prices as well as MAIN`s strategy to gain market share. Top-line growth was limited. Higher consumption arising from the Lebaran effect has limited impact on MAIN s top-line growth as weaker-than-expected purchasing power persisted. 2Q17 revenue improved by 13% q-o-q, but inched down by 0.75% y-o-y. Segment-wise, poultry feed, DOC and broiler posted modest y-o-y volume growth. But note that the processed food segment recorded >50% y-o-y growth for the last four quarters, as Sunny Gold and Chiki Wiki gained traction due to commercial TV advertising. The segment is expected to continue its loss-making streak until next year on higher marketing expenses. Outlook Higher DOC and broiler ASP on demand recovery and supply cut. We expect Malindo to book Rp50bn net profit in 3Q17, higher compared to 2Q17, thanks to higher ASP. We believe prices should remain stable during 2H17 from higher demand from government spending and manageable supply through mandatory culling programmes. A breakthrough from high local corn price. The recent imported feed wheat will help to ease pressure on animal feed margin that is caused by higher local corn price. Although small in number (200,000 tonnes vs last year s import of 2m tonnes), the recent imported feed wheat might recur in the future, if no problem occurs. Also take note that the 200,000-tonne feed wheat is to be used in 4Q17 (for three months production) while the 2m feed wheat was used in 2Q16 and 3Q16 (six months production). Going forward, the imported feed wheat will provide Malindo with better feed margins, especially when local corn prices are high. Stable gearing ratio. MAIN s cash dropped to Rp95bn in 2Q17, the lowest cash level since 1Q14. However, the debt level also decreased with both short-term debt and long-term debt declining to Rp1,130bn and Rp468bn respectively. No significant change in MAIN s gearing ratio as it remains at 84%. Malindo Feedmill`s net gearing ratio 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% ` 0% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q16 Source: Company, DBSVI Valuation We maintain our HOLD call with a revised TP of Rp975/share, as we adjust our assumptions for broiler and DOC prices and roll forward our valuation to FY18F. Our TP is based on a forward EV/EBITDA multiple of 5.6x, the average. Our TP implies 9.9x FY18 PE. Peers comparison Target price Target EV/EBITDA Target P/E Current price Current EV/EBITDA Current P/E CPIN JPFA MAIN Source: Bloomberg Finance L.P., DBSVI ASIAN INSIGHTS VICKERS SECURITIES Page 28

29 Malindo Feedmill Poultry feed prices (Rp/kg) CRITICAL DATA POINTS TO WATCH Critical Factors Earnings as driver for share price. Unlike it peers, MAIN earnings driver is its bottom-line delivery. The recent share price drop has been expected given its weak bottom-line performance in We expect net profit to rebound in 2H17 with modest growth but its share price has limited upside potential, in our view. Broiler price has lower correlation with share price. Although the broiler price drop in 1Q17 has caused the share price to drop significantly, historically it was DOC price that drove the share price. Long broiler supply chain might cause its DOC price to diverge from actual demand. Rising poultry feed ASP is not a good thing. No one would argue that the feed business is the largest contributor to MAIN s earnings. Then, one would also think that higher volume and ASP will boost its bottom-line, and thus its share price. However, our study shows that poultry feed ASP has negative correlation with its share price, historically. Margin does not have or little correlation with share price. Corn makes up half of poultry feed. Since corn import restrictions were imposed, MAIN has to use 100% local corn. Rising local corn price will be passed on to poultry feed, thus weighing down on its share price. A lot of corn field has been planted since the government banned corn imports. Success in achieving selfsufficiency in corn will provide a positive catalyst for MAIN s share price. Feed volume growth supports share price. Historically, when poultry feed production volume increases, MAIN s share price tend to increase, except for a period of economic downtrend in Unlike ASP which might increase due to raw material prices, volume growth indicates that there is demand growth for poultry products. Less impact from USD fluctuation. Since the import ban on corn and feed wheat was instituted, the company had to use local corn. The import ban has reduced MAIN s operational risk against USD movement. It still sources 100% of its soybean meal requirement from imports. Avg realised corn cost (Rp/kg) Avg realised soy meal cost (Rp/kg) DOC prices (Rp/chick) Broiler prices (Rp/kg live) Source: Company, DBSVI ASIAN INSIGHTS VICKERS SECURITIES Page 29

30 Malindo Feedmill Appendix 1: A look at Company's listed history what drives its share price? Share price movement vs Consumer Confidence Index Share price BI CCI Gap between CCI and share price Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan Source: Bloomberg Finance L.P., DBSVI MAIN share price has been moving along with Consumer Confidence Index (BI) 1. During economic expansion, MAIN s share price experienced a dramatic jump as chicken consumption increases. Population growth and rising income has fuelled chicken consumption growth. In mid-2013, the rupiah weakened and GDP growth headed south. Production capacity has been ramped up while demand growth began to turn sluggish. Imported corn price rose due to a high exchange rate, thus pushing poultry feed ASP up. Combined with plunging DOC price and declining CCI, MAIN s share price drop significantly. 2. CCI started to recover and MAIN s share price has been catching up (although in lesser magnitude). 3. Late 2016 share price movement has deviated from CCI due lower net profit due to higher realised corn cost. The trend continued in 1H17 because of negative sentiments from oversupply. The oversupply has caused MAIN DOC and broiler segments to book a loss and erode its bottom-line. Share price movement vs net profit Share price Net profit Concern of oversupply 0 still linger Jan 13 Jan 14 Jan 15 Jan 16 Jan (50.0) (100.0) (150.0) (200.0) Fair price given weak bottom-line Source: Bloomberg Finance L.P., company, DBSVI ASIAN INSIGHTS VICKERS SECURITIES Page 30

31 Malindo Feedmill Net profit drives its share movement Unlike its peers, MAIN`s main share price driver is its bottom-line. It can be seen in 2016 when broiler and DOC price were rebounded, MAIN share price has not rebounded as much after the 3Q16 and 4Q16 booked lower net profit than 2Q16. The trend continued in 2017 when oversupply occurred in 1Q17 and eroded the whole industry s profitability. The share price dropped even further after the company posted 2Q17 weak results on the back of lower margin and higher operating cost for its TV commercial advertisement. Given the weak bottom-line, we believe MAIN s share price has reached a fair level. We maintain our HOLD call for the stock in view of the limited upside for its 2H17 earning recovery. ASIAN INSIGHTS VICKERS SECURITIES Page 31

32 Malindo Feedmill Balance Sheet: Leveraging down The group has taken steps to lower its debt burden, such as the recent rights issue, which brought down net gearing to 84% as of Jun-17. In our estimates, the group s net gearing should settle at 69% by end-of FY18F. The lower interest expense and reduced FX exposure should help to reduce volatility in the group s earnings outlook. MAIN s interest coverage ratio is also expected to steadily improve from 2.3x this year to 3.1x next year. Capex cut to boost ROA The group s ROA is forecast to recover towards 5.3% by FY18F from 3.8% in FY17F thanks to reduced capital spending program instituted from FY15 onwards. MAIN is expected to spend Rp352.3bn this year and Rp154.7bn in FY18F, down from Rp338bn in FY16. Rpbn Leverage & Asset Turnover (x) Capital Expenditure Share Price Drivers: Better-than-expected DOC and broiler prices A stronger recovery in both DOC and broiler prices could act as a positive catalyst for the stock, as both have a significant impact on the company s earnings. Key Risks: Diseases outbreak affecting livestock at the group s poultry farms would have a material effect on the group s business and financial status. While the group has instituted strict biosecurity measures to reduce the risk of these events happening, there can be no assurance that MAIN would be immune to them. Additionally, an outbreak (such as bird flu) would likely have an adverse impact on demand. ROE (%) Changes in government regulations, licensing, as well as interventions, change in raw material import policy (as demonstrated by corn import restrictions) and price/volume controls across various jurisdictions may adversely affect MAIN s profitability. For example, the required reductions in DOC supply to control post-eid oversupply would temporarily affect the group s financial performance. Forward PE Band (x) Foreign exchange risk. Some of the raw materials (i.e. soybean) are purchased in USD, while sales are recognised in rupiah. Therefore, there is some foreign exchange risk. Furthermore, the group does have a big portion of debt in USD, and has limited hedging experience. PB Band (x) Company Background Malindo Feedmill (MAIN) was established in 1997 and listed on the Indonesian stock exchange in The group is one of the growing main players in Indonesia s poultry industry, despite having a far shorter history in Indonesia than its key competitors. Source: Company, DBSVI ASIAN INSIGHTS VICKERS SECURITIES Page 32