Charoen Pokphand, TP of Rp3,200

Eyeing a better performance

Volume as a catalyst for growth this year. We expect the sales volume of poultry products will be the catalyst for growth this year, supported by the following factors: i) Higher chicken prices. In the fourth week of January, the prices of chickens and DOC rebounded by 10% and 20% respectively to Rp16,870/kg and Rp4,022/bird, from an average price of Rp15,392/kg and Rp3,231/bird respectively last year; ii) No increase in the price of poultry feed this year. Together with higher chicken prices, this will result in better margins for farmers, and encourage farmers to increase chicken breeding; and iii) Robust demand for chicken. Chicken consumption is still strong amid higher purchasing power, in turn supported by higher regional minimum wages.

Lower raw material cost to boost margins. Prices of corn and soybean meal (key raw materials for chicken feed) have declined by 20% and 19% respectively from their mid-2011 peaks. Lower raw material costs will boost the company’s margins. Historically, the company does not lower the ASP of its feed mill products when raw material prices decline. Assuming the company maintains ASPs of feed mills this year, and cost is down by 1%, gross margins of feed mills will increase from 20.5% to 21.3%.

Changes in assumptions. Due to lower raw material costs, we cut our assumption of an increase in feed mill ASPs from 28% to 20% in FY11.
We had previously assumed a 28% increase in FY11 feed mill ASPs to Rp5,824 per kg, as we had anticipated higher raw material costs. Meanwhile, we increase our sales volume growth assumption to 10% from 9% this year, as we anticipate better demand for poultry products.
We also change our capital expenditure assumption from Rp2.08t to Rp2.4t to account for capacity expansion.

Maintain BUY and TP of Rp3,200. Despite the changes in assumptions, we still maintain our TP at Rp3,200. Our TP pegs the stock at 18x 2012 PER. Reiterate BUY.

Volume as a catalyst for growth this year
We expect CPIN’s sales volumes to be a catalyst for growth this year, supported by several factors, as follows:
1) Higher chicken prices. Surprisingly, in the fourth week of January, the price of chickens and day-old chicks (DOC) rebounded by 10% and 20% respectively to Rp16,870/kg and Rp4,022/bird, from an average price of Rp15,392/kg and Rp3,231/bird respectively last year. The
higher chicken prices early this year are mainly due to:
a) Supply shortages. The shortage in chicken supply is caused by the following: i) Rainy season reducing productivity; ii) Small players are reluctant to enter the market amid volatility in DOC prices, which hit a low of Rp800/bird in 3Q11, and iii) An avian flu outbreak in several areas in Jakarta this month; and

b) A switch in meat consumption from beef to chicken, amid higher beef prices of Rp65,000-70,000/kg from Rp60,000/kg. The higher chicken and DOC price patterns in January 2012 are similar to those of 2010, when a shortage of DOC resulted DOC prices rising to their highest level of Rp6,000/bird in May 2010. If chicken and DOC prices stay high until the end of this year, it would benefit the poultry industry, and boost farmer profitability.

Illustration of profitability and production cost for
broiler chicken breeding
We illustrate the differences in the profitability and cost of production for broiler chicken breeding in a one-month cycle for large-scale and small farmers. Note that in January 2012, the average chicken price was Rp16,870/kg while the price of DOC was Rp4,000/bird, and poultry feed
cost Rp5,500/kg.

In Illustration A, large farmers who produced 10,000 birds per cycle would enjoy a profit margin of 20.3% per cycle. The Break Even Point (BEP) price for chicken breeding (Rp12,766/kg) is lower than the chicken ASP of Rp16,870/kg.
In Illustration B, small farmers who produced 1,000 birds per cycle will also enjoy profits as the BEP price for chicken breeding, at Rp14,710/kg, is below the chicken ASP of Rp16,870/kg. The farmers would net a profit margin of 8.2% per cycle.

From the illustrations, it can be seen that in the current situation, large and small farmers would be interested in chicken breeding.

2) The company has no plan to raise the price of its poultry feed
this year.
Management indicated that it had increased ASPs of feed mills by around 20% last year in anticipation of higher raw material costs. Prices of corn and soybean meal increased by 59% and 21% YoY respectively last year. For this year, however, management has no plan to raise the
price of feed mills further, as prices of corn and soybean meal have been falling since mid-2011. Higher chicken prices and the lack of further rises in the price of poultry feed will result in better margins for farmers, and encourage farmers to increase chicken breeding.

3) Robust demand for chicken. Chicken consumption is still strong amid higher purchasing power, in turn supported by higher regional minimum wages (UMR) in 2012 in several regions (the average increase is 10.9% YoY). Purchasing power, as represented by the Indonesia Consumer Confidence Index, has been on an upward trend since 2008. Assuming chicken consumption increases 0.5kg per capita per year, chicken production will need to increase by 100m birds per year. Judging by the capacity expansion taking place, the poultry industry appears to have anticipated the growth in chicken demand.

Lower raw material cost to boost margins
Prices of corn and soybean meal (key raw materials for chicken feed) have declined by 20% and 19% respectively from their mid-2011 peaks. Lower raw material costs will boost the company’s margins. Historically, CPIN does not lower ASPs of its feed mill products when raw material prices decline. Assuming the company maintains the ASP of feed mills this year, and cost is down by 1%, gross margins of feed mills will increase from 20.5% to 21.3%.

Changes in assumptions
We change our assumptions, as follows:
1. Price of feed mills. Due to lower raw material costs, we cut our assumptions of an increase in feed mill ASPs from 28% to 20% in FY11. Previously, we had assumed a 28% increase in FY11 feed mill ASPs to Rp5,824/kg, as we had anticipated higher raw material costs.

2. Volume. We increase our sales volume growth assumption to 10% this year (from 9%), as we anticipate better demand for poultry products.

3. Gross margin. As we now anticipate lower raw material costs this year, we cut our COGS assumption for feed mills by 1% per kg. Since we do not increase our ASP of feed mills this year, the net result is that gross margins on feed mills will increase from 20.5% in
FY11 to 21.3% this year.

4. Capital expenditure. We also change our capital expenditure assumption from Rp2.08t to Rp2.4t to account for capacity expansion in 2011-2013. Previously, we had not factored in further
expansion of feed mills and processed chicken capacity. During our company visit, however, management indicated it plans to construct new feed mills in Cirebon, west Java (this year) and Bali (next year), each with a capacity of 500,000-600,000tpa, and to double processed chicken capacity to 100.8tpa next year. Last year CPIN increased total capacity of feed mills to 5.1m tpa from 4.5m tpa, after raising the capacity of its plants in Lampung. We believe the capacity expansion will be financed largely from internal cashflows.

Maintain BUY and TP of Rp3,200
Despite the changes in assumptions, we still maintain our TP at Rp3,200. Our TP pegs the stock at 18x 2012 PER. Reiterate BUY.

Source: KIMENG dated 1 February 2012