June 12, 2017 / 4:23 AM / 5 months ago

Fitch Affirms Japfa Comfeed at 'BB-'/'AA-(idn)'; Outlook Stable

(The following statement was released by the rating agency) SINGAPORE/JAKARTA, June 12 (Fitch) Fitch Ratings has affirmed PT Japfa Comfeed Indonesia Tbk's Long-Term Issuer Default Rating (IDR) at 'BB-' with a Stable Outlook. Fitch Ratings Indonesia has also affirmed Japfa's National Long-Term Rating at 'AA-(idn)' with a Stable Outlook. A complete list of rating actions is at the end of this commentary. Japfa plans a tap of its USD150 million 5.5% senior unsecured notes maturing in 2022, which have also been affirmed at 'BB-'. The company intends to use the proceeds mainly to repay its existing working capital loans, and for capex and other corporate purposes. Japfa's annualised leverage, measured by net debt to EBITDA, increased to 2.3x at end1Q17 from 0.9x at end-2016 due to weaker profitability. This brings it close to the 2.5x level at which Fitch would consider a negative rating action, but we believe it should moderate with improved profitability from 2Q17. Factors important to our Stable Outlook include sustained government intervention to maintain a demand-supply balance for chicken in Indonesia and Japfa's ability to pass-through costs to customers in its animal feed segment. 'AA' National Ratings denote expectations of very low default risk relative to other issuers or obligations in the same country. The default risk inherently differs only slightly from that of the country's highest-rated issuers or obligations. KEY RATING DRIVERS Profitability to Improve from 2Q17: Japfa's EBITDA margin declined by more than our expectations to 6.6% in 1Q17, from 13.1% in 2016 and 8.4% in 1Q16. Japfa incurred an operating loss for its commercial farming segment (40% of external revenue, 30% of gross) due to an oversupply of broiler chickens that resulted in weaker prices, while margins in the animal feed segment (37% of external revenue, 46% of gross) were squeezed by higher raw-material costs. We believe margins will improve from 2Q17 based on government directives to poultry companies to reduce the domestic chicken supply and Japfa's ability to pass-through higher costs in the animal feed segment. However, we expect margins to remain below the 2016 level. Government Directives to Manage Supply: The Indonesian government in late March 2017 directed the poultry industry to reduce the supply of day-old chicks. Following a government directive in October 2015, the industry culled around 3 million birds (parent stock), which was the main driver of improved profitability for Japfa and other poultry companies in 2016. We think that the latest government directive, if properly implemented, should result in a better industry demand-supply balance and improved margins for the breeding and commercial farming segments from 2Q17. Domestic Sourcing Raises Costs: The government has also introduced restrictions on the import of corn, a key raw material for animal feed, to encourage domestic sourcing of corn. Japfa, which used to import around 30% of its needs, is now required to seek government approval for imports. This has reduced its raw-material sourcing flexibility and increased costs due to higher local corn prices given increased demand. The company plans to invest in additional corn drying and storage facilities to prepare for increased domestic procurement, as corn harvesting in Indonesia normally happens only in the first and third quarters of the year. Cost Pass-Through Ability: Japfa is able to mitigate risk from rising raw-material costs through a strong ability to pass through cost increases to customers in the key animal-feed segment. This is due to its high market share and its ability to retain corn inventory and adjust output. PT Charoen Pokphand Indonesia Tbk (CPIN) and Japfa together control about 50% of Indonesia's poultry feed market, and react similarly to increases in raw material costs by seeking to raise prices. Japfa's corn dryers also allow it to store dried corn for up to four months, providing some flexibility in production. Higher Capex Expected in 2017: Japfa is planning to increase its spending to over IDR1.5 trillion in 2017 from around IDR800 billion in 2016. The higher capex is aimed at increasing corn drying and storage capacity for the animal feed segment, and expanding its market share in the breeding and commercial farming segments where the company sees an opportunity due its cost efficiencies. However, Japfa has flexibility to delay its capex plans based on market conditions and cash flows, especially for the breeding and commercial farming segments. Moderate Leverage: We expect Japfa's leverage to remain at around 2.0x on average over 2017-19, after factoring in higher capex in 2017, moderation in EBITDA margin from 2017 from the 2016 level and the tap issue. We also estimate Japfa's free cash flows to improve from 2018, after being negative in 2017, and fixed-charge cover to average more than 4x over 2017-19. DERIVATION SUMMARY Japfa's IDR can be compared with that of Fufeng Group Limited (Fufeng, BB+/Stable), which is largest producer of monosodium glutamate globally. Fufeng enjoys advantages such as economies of scale, integrated facilities and proximity to raw materials that are difficult to replicate. These advantages justify Fufeng's higher rating than Japfa's. Japfa's National Rating can be compared with that of PT Sumber Alfaria Trijaya Tbk (Alfamart, AA-(idn)/Stable) which benefits from its solid position as Indonesia's largest mini market operator by number of stores. It accounts for about 30% of modern retail revenue in the country. Alfamart is bigger in terms of revenues and EBITDA, but these advantages are offset by Japfa's higher margins and a better projected leverage profile. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Animal-feed sales volume to rise by 3% annually from 2017 - Average annual sales volume growth of 3%-5% for day-old chicks and live poultry from 2017 - EBITDA margin of around 8% in 2017 and 9% from 2018 - Capex of around IDR1.5 trillion in 2017 and around IDR900 billion annually thereafter RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: - Leverage (net debt/EBITDA) below 1.5x on a sustained basis (2016: 0.9x) - No significant weakening of industry fundamentals and Japfa's market position Future developments that may, individually or collectively, lead to negative rating action include: - Leverage above 2.5x on a sustained basis - Significant reduction in size of the animal-feed segment, which would be demonstrated by its share of total revenue falling below 30% (2016: 36%) LIQUIDITY Japfa had IDR7.2 trillion of debt and IDR3.3 trillion of cash at end-March 2017. Out of total debt, IDR5.5 trillion was long-term debt comprising of unsecured US dollar- and rupiah-denominated bonds. The company used its cash balance to redeem IDR2.6trillion of US dollar bonds in 2Q17. The remaining bond maturities are relatively spread out, with IDR850 billion maturing in 2019 and the remaining in 2021-22. We believe that Japfa should not face any significant issues in addressing its debt maturities based on our expectation of improving free cash flows and its access to diverse funding sources. FULL LIST OF RATING ACTIONS PT Japfa Comfeed Indonesia Tbk -- Long-Term IDR affirmed at 'BB-'; Outlook Stable -- National Long-Term Rating affirmed at 'AA-(idn)'; Outlook Stable -- Senior unsecured rating affirmed at 'BB-' -- USD150 million 5.5% US dollar senior unsecured notes due in 2022 affirmed at 'BB-' -- IDR3 trillion bond programme and IDR2 trillion of bonds issued under the programme affirmed at 'AA-(idn)' Contact: Primary Analysts Akash Gupta (International Ratings) Associate Director +65 67967242 Fitch Ratings Singapore Pte Ltd One Raffles Quay South Tower #22-11 Singapore 048583 Bernard Kie (National Ratings) Associate Director +62 21 29886815 PT Fitch Ratings Indonesia DBS Bank Tower Jl Prof Dr Satrio Kav 3-5 Jakarta 12940 Secondary Analyst Bernard Kie (International Ratings) Associate Director +62 21 29886815 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com. 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