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Japfa Ltd Has Fallen By More Than 30% Since Its IPO: Is There A Bargain Here?

Japfa Ltd (SGX: UD2) is an agri-food company that got listed only relatively recently back in August 2014.

It has been a disappointing investment for its early investors with its shares having fallen by 34% from its listing price of S$0.80 to S$0.525 currently.

Let’s reassess the company’s business to see if there’s a bargain in there for investors.

The business of Japfa

With a track record of over 40 years, Japfa has grown over the years to become one of the largest poultry producers in Indonesia and a leading premium milk producer in China. The company also has operations in other Asian countries like India, Myanmar, and Vietnam.

As my colleague Sudhan describes, “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.”

Japfa’s downstream consumer brands include Greenfields, So Nice, and So Yumm among others. (Interestingly, I’ve noticed that Greenfields milk is being used in Starbucks outlets in Singapore, which may point toward the high quality of Japfa’s products.)

Falling earnings and a highly-geared balance sheet

According to Japfa’s latest set of financials for the year ended 31 December 2014, the agri-food outfit had seen its PATMI (profit after tax and minority interests) fall by 25.3% to US$31.2 million despite experiencing a 9.3% increase in revenue to US$2.95 billion.

The revenue growth had occurred due to broad-based growth from the firm’s Animal Proteins and Dairy business segments. Meanwhile, the PATMI decline can be attributed mainly to two things:

  1. The PT Japfa Comfeed segment, which contributes the lion share of the company’s profits, had recorded lower profit margins (gross, operating, as well as core PATMI margins) as a result of oversupply in its market.
  2. The gain of US$6.3 million in the fair value of Japfa’s biological assets in 2013 had become a loss of US$40.2 million in 2014; a fall in raw milk prices in China and a review of Japfa’s swine breeding practices in Vietnam were the main culprits.

Besides the falling profits, the high amount of borrowings on the company’s books is another key concern investors may have.

As of end-2014, Japfa had US$287 million in cash on its balance sheet but some US$993 million in borrowings. These borrowings aren’t cheap too, as alluded to by the finance costs of US$82.1 million in 2014, which give rise to an average interest rate of more than 8% (US$82.1 million divided by US$993 million) for Japfa’s borrowings.

Furthermore, Japfa’s EBITDA (earnings before interest, taxes, depreciation, and amortisation) of US$264 million in 2014 does not give the firm much room for error when it comes to servicing its borrowings (the EBITDA of US$264 million is just 3.2 times higher than the finance costs of US$82.1 million).

In addition, credit rating agency Standard & Poor’s had revised the ratings outlook for PT Japfa Comfeed in November 2014 from stable to negative on tougher industry conditions and inflated capital spending. The negative outlook implies that there’s a one-in-three chance that PT Japfa Comfeed’s credit ratings may be downgraded over the 12-month period following the ratings outlook revision.

Looking ahead

To counter some of the issues I mentioned earlier that resulted in the fall in profit and to drive long-term growth, Japfa’s expanding its dairy operations in China so as to use an increase in production levels to help offset lower prices.

The company’s also temporarily scaling back its poultry business in Indonesia to improve operational efficiency (it’s also  a likely attempt to curb an over-supply in the market).

In addition, Japfa is also diversifying its business to reduce reliance on PT Japfa Comfeed by investing heavily into “high-growth consumer food brands in the region.”

On a shorter-term bright note, despite PT Japfa Comfeed’s lower profit margins in 2014, the final quarter of the year actually saw those margins improve over the levels seen in the same period in 2013. The current higher margins are a mainly a result of lower raw material costs (such as cheaper corn and soybean meal) and will bode well for Japfa as a whole if the margin-recovery persists.

Foolish Bottom Line

A glance at Japfa Ltd’s financials over the past four years does not reveal a nice picture.

While the agri-food outfit’s revenue has grown strongly, its net profit has actually moved in the opposite direction. Furthermore, the growth of the company has been funded primarily through borrowings as attested to by the increase in borrowings and the negative free cash flows. You can see all these in the chart below:

Japfa's revenue, net income, debt, and free cash flow (FCF)

Source: S&P Capital IQ

Despite its sub-par financial performance in recent years, the company has been expanding aggressively (I’ve mentioned some of its growth strategies earlier), trying to gain more traction across the Asia Pacific region. Whether Japfa’s shares will be a bargain at current levels or not will depend heavily on whether the company can grow profitably and sustainably in the future.

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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 James Yeo doesn’t own shares in any companies mentioned.