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What Investors Need to Know About Japfa Limited’s Initial Public Offering

Samudra Energy might have decided to shelve its plans for listing on Singapore’s share market, but that has not stopped Japfa Limited, an industrial farmer, from launching its own initial public offering. The farming outfit plans to raise S$198.4 million from its listing.

There has been no real shortage of IPOs in Singapore lately given that 16 shares have been listed between the start of this January and 1 August 2014. Some of these newly-listed shares include Terratech Group Ltd (SGX: 40I), Spackman Entertainment Group Ltd (SGX: 40E), and Starburst Holdings Ltd (SGX: 40D).

What is Japfa Limited?

With over 40 years of experience, Japfa is an agri-food company that produces multiple types of protein foods. The company’s corporate headquarters is here in Singapore and it has operations in China, India, Indonesia, Myanmar, and Vietnam.

Japfa has a vertically integrated business model which covers the entire value chain for many of its protein products. That value chain extends from feed production and breeding, to commercial farming and processing.

At the downstream end of its business, Japfa processes and distributes consumer foods such as dairy products and processed meats. According to research outfit Frost & Sullivan, Japfa’s milk, which is marketed under the Greenfields brand, was the market leader for premium fresh milk in Indonesia last year. The brand had a market share of around 38%. Incidentally, Greenfields milk can also be found in Singapore.

The animal protein products produced in-house by the company are used as raw materials for its own consumer food segment; the segment produces ambient-temperature and chilled/frozen food products using chicken, beef, and seafood and are marketed under brands such as So Good, So Good Sozzis, and So Nice. In Indonesia, Japfa’s consumer food segment “has the second-largest market share in frozen consumer food and the third-largest market share in ambient-temperature food,” according to the company’s listing prospectus. The firm expects its downstream consumer food brands to be a key driver for its future growth.

Japfa views the Thailand-based Charoen Pokphand Group, one of Asia’s largest conglomerates, as its main competitor. For a sense of scale, the Thailand-listed Charoen Pokphand Foods Public Co. Ltd. (a subsidiary of Chaoren Pokphand Group) had achieved S$15 billion in sales in 2013.

The nitty-gritty

Japfa will be offering 248 million shares at S$0.80 apiece. Of the 248 million shares, only 16.8 million will be offered to the public, while the rest will be offered to institutional investors, Japfa’s directors, employees, and business associates, among others.

The public offering opened on 8 August 2014 and would close five days later on 13 August. Its shares will commence trading on 15 August at 9am.

The net proceeds from the IPO will be used by Japfa mainly for the following purposes: 1) To grow its dairy business in China and construct a second five-farm hub in Inner Mongolia; 2) to invest in its animal protein business in its target markets; and 3) to repay its debts partially. The last point brings me to one of the biggest risks about Japfa that potential investors need to note.

Japfa’s financial statements reveal some important risks

In 2013, Japfa’s revenue came in at US$2.7 billion, a rise of 16% from 2012. Its net profit, however, slumped 22% to US$41.8 million. That translates to a net margin of only 1.5% for 2013.

For the three months ended 31 March 2014, Japfa’s revenue was at US$690.1 million while it made US$13.6 million in profit – that’s a net margin of only 2%.

As of 31 March 2014, the firm had total borrowings of US$1.1 billion which carry interest rates in the range of 2.35% to 16% per annum. In a low-interest rate environment (which is what we find ourselves in currently), interest rates as high as 16% do raise an eyebrow or two. If there’s a general rise in interest rates, Japfa may have difficulty repaying its loans given its already-thin profit margin.

Besides the high interest rates on its borrowings, there were a couple of other balance sheet-related concerns related to Japfa: 1) the company’s ratio of total borrowings to equity is rather high at 1.4; and 2) it has borrowings that are around 25 times its profit for 2013.

Japfa generated US$89.1 million in net cash from operations in 2013 as compared to US$27 million in 2012. However, capital expenditures in 2012 and 2013 were at US$201 million and US$212 million, respectively. This translates to the industrial farmer actually earning negative free cash flow in both years.

Free cash flows can be used by any company for many different purposes: To reward shareholders in the form of dividends; to re-invest into the business; to buy back shares; or to pare down debt. Without sufficient free cash flow for extended periods of time, a company really only has a few choices with which to obtain capital – and one such choice is to rely on borrowings. There’s nothing inherently wrong with relying on debt if it’s handled skilfully by management, but the act of borrowing heavily would also expose a company to higher financial risks especially during times of an economic crisis when banks generally tighten their lending.

Valuation

Japfa earned 2.82 US cents per share in 2013, which translates to around 3.53 Singapore cents. At an offer price of S$0.80, Japfa’s shares would carry a price-to-earnings ratio of 22.7. Japfa does not have a dividend policy currently.

Foolish Summary

Japfa likely has economies of scale as it covers the entire value chain for its protein products and its consumer brands have commanding market share in a number of its markets. However, potential investors have to take note of the balance sheet of the industrial farmer: The company has borrowings with rather high interest rates; it has a large amount of debt; and it hasn’t been able to earn any meaningful amounts of free cash flow for a number of years.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.