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Japfa: Growth Via Southeast Asia’s Bellies
Corporate Digest | 26 August 2014
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By: Shane Goh
Articles (99) Profile

Japfa is an Indonesian-based animal protein producer. It also operates dairy farms in China and distributes brands including Greenfields milk in Southeast Asia and Hong Kong. Additionally, Japfa produces and processes animal protein-based consumer food.

In FY13, sales of animal protein accounted for 87 percent of the firm’s turnover, with consumer food contributing 8.4 percent and the dairy segment making up the remaining 4.6 percent.

Geographically, Indonesia is the main market for Japfa, posting 81.9 percent of its top line. The balance was derived from Vietnam (10.7 percent), China (3.5 percent) and Myanmar and India (3.9 percent).

Since its initial public offering (IPO) on 15 August, Japfa’s share price has surged 13.8 percent to close at $0.91 a week later.

Vertically Integrated
Japfa breeds and processes four types of protein: chicken, pork, beef and aquaculture. It prides itself on its vertically-integrated production model.

What does the term vertically integrated in the animal protein business mean?

The production of chicken, beef and poultry involves three steps.

1. Upstream: Animal feed and breeding
2. Midstream: Milking and fattening
3. Downstream: Processing and distribution

Source: Company

Comparatively, in the US, only the chicken industry has vertically-integrated players, while the beef and pork segments tend to have each step managed by different companies.

Needless to say, if you control the entire process, not only will the quality control be higher, your ability to extract all the profits from the production is higher as well.

It also means that Japfa is able to adapt to the market conditions. As it produces the feed used in animal breeding, the firm is able to channel its resources to the business process that offers the best margins at any given time.

Dairy Expansion
Although Japfa has a dairy presence in both China and Indonesia, we should understand the difference in their business models. The company only produces raw milk in China, which are sold to dairy processors or other businesses like Starbucks.

On the other hand, it has its own processing plant in Indonesia, which churns out the milk brand, Greenfields that we see in our local supermarkets. Based on a report by Frost & Sullivan, Japfa’s Greenfields brand was the market leader in Indonesia in 2013 with an estimated market share of 38.4 percent by value.

Although the segment contributes a mere fraction of its protein’s revenue, Japfa intends to drive the growth in its dairy operations. Out of its IPO net proceeds of US$174 million, about US$70 million will be used to construct another five farms, on top of its existing five, in China.

The firm intends to tap on the growth of China’s milk consumption and address the shortfall of domestic dairy supply within the country.

China Food Scares
China’s food scares are well-known and reported. One of the famous scandals was the tainted baby formula back in 2008, contaminated by melamine. Recently, the sale of expired meat to global brands including McDonald’s and KFC has hit headlines.

However, Japfa counters it by highlighting its production process. By offering world-standard facilities, the company is better able to emphasis quality control on its products.

As Japfa supplies raw milk to businesses in China, the firms there wish to procure a supplier that can ensure a stringent check. Its raw milk has consistently exceeded both the local and international standards for nutrition and safety.

Parallel Milking Parlour. Source: Company

Inherent Translation Risk
In its latest fiscal year ended 31 December 2013, Japfa’s revenue rose 16.2 percent to US$2.7 billion. However, net profit fell 21.6 percent to US$41.8 million. The disparity was caused by two factors.

An increase in raw material costs in Indonesia impacted gross profit margin negatively (FY13: 18.5 percent, FY12: 19.3 percent), while a depreciation of the Indonesian Rupiah against the US dollar rendered Japfa unable to pass the cost over to its consumers.

Last year, the Rupiah fell about 26.8 percent against the US dollar. While exchange rate has somewhat stabilised since the start of 2014, it has not returned to levels seen before 2013.

Apart from a foreign currency translation effect, a weakening Rupiah may potentially soften consumer confidence in Indonesia and reduce their consumption for Japfa’s goods.

High Borrowing Cost
As of 31 March, Japfa carries US$1.1 billion in debt. Interest rates on the borrowings range from 2.4 percent to 16 percent. Given the current low interest-rate environment that we are in, this does give investors some pause.

About US$70 million from the IPO proceeds will be tasked to repay Japfa borrowings. I’d like to think that the firm will choose to terminate its debt which bears higher interest rates.

This will lower Japfa’s net-debt-to-equity from 1.1 times to 0.7 times. Management has guided that its comfortable leverage ratio is about 1 to 1.2 times net-debt-to-equity.

SI Research Takeaway
Personally, I like consumer businesses which are easy to understand and are used often. In the case of animal protein and milk, I believe this is part of a daily diet for many across Southeast Asia.

The key drag on the firm will be its currency exchange risk and high borrowing cost. If it’s able to address these two factors, I expected its mainstay business to thread a slow but steady growth path.

Disclaimer: The author has a stake in Japfa.

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

Japfa  0.475 -0.015 -3.06%   
Business: Co is an agri food company that produces multiple types of protein foods. It is headquarterd in Singapore and has operations in China, India, Myanmar and Vietnam.

Insight: Apr-19, 1Q19 revenue rose 7.8% lifted by broad-bas... Read More

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