Charoen Pokphand Indo (TP Rp2000)

Playing chicken with the capex cycle

Initiating coverage with an Underperform recommendation
We initiate coverage of CPIN with an Underperform call and Rp2,000/share valuation and PT (21.6% downside). We believe the substantial margin expansion CPIN has delivered in recent years has been due to cyclical factors, and we expect margins to start to mean revert from FY12E on the back higher
industry capex. Our Rp2,000 valuation represents FY11–12E PERs of 13.3x and 12.0x, and still-rich 5.7x and 3.7x multiples current book and replacement cost.

Getting the industry economics right: a cyclical industry
We believe the market is currently fundamentally misreading the economic characteristics of the poultry industry (in capitalising CPIN at 7.3x book). 90% of CPIN’s earnings come from the feed (predominantly) and also day old chick (DOC) segments, which we believe are in essence relatively commoditised agrimanufacturing industries, with limited product differentiation and a lack of sustainable entry barriers. We highlight that historically, the industry has been a highly cyclical one, with large margin cycles, and we do not believe the industry leopard has changed its spots (while at 7.3x BV the market seems to disagree).

Industry capex cycle now well underway; margins to revert
The crux of our investment thesis is summarised in Figures 2 and 3 on pg3. Since 2007, CPIN has delivered substantial operating margin expansion (from 5.5% to 16.9% in FY11E), as the industry has enjoyed a large cyclical upswing in margins as it emerged from a period of under-investment (following a protracted period of poor profitability), amidst an environment of booming industry demand and softening input costs. Industry capacity has remained relatively tight, which has granted incumbent operators temporarily improved pricing power/margins. However, the industry response has been highly predictable – i.e. a four-folding in FY11 industry capex vs. FY07A levels. Discussions with industry contacts confirm that a high level of industry investment activity is underway – much of
which will come onstream during FY12E. As in the past, we expect margins to decline as industry pricing power weakens alongside these capacity increases.


We expect CPIN’s EPS growth rate to disappoint
To date, the bull case for CPIN has centred around the industry growth upside, which will be underpinned by growth in chicken consumption from current levels of only 5–6kg per capita, to levels we believe could reach c30kg long term. Indeed, we expect industry volume growth to trend at a relatively robust 10% pa. However, while we expect that growth to materialise (we have forecast a 16.8% five-year revenue CAGR), we expect a simultaneous reversion in margins to 10.3% by FY16E (which will still be above CPIN’s 10-year average of 7.8%) to largely offset this growth. Our FY12E EPS growth of 10.5% is below consensus’ 17.0%, and our five-year forecast EPS CAGR is only 6.4% – relatively modest compared to CPIN’s 17.0x FY11E PER and Indonesia’s c5% inflation rate.

We believe Rp2,000 to be a more realistic valuation
Our Rp2,000 valuation represents a 3.7x multiple of estimated replacement cost, 5.7x multiple of 3Q11A book, and a 24.0x PER of normalised earnings, which we believe comfortably factor in CPIN’s strong market position and growth potential.

Source: Macquarie Research