Completed 04 Dec 2016 03:54 PM HKT Disseminated 05 Dec 2016 12:15 AM HKT Asia Pacific Equity Research 05 December 2016
Initiation Neutral COFCO Meat Holdings 1610.HK, 1610 HK The pen is full. Initiate coverage at Neutral Price: HK$1.64 Price Target: HK$1.90
We initiate coverage of COFCO Meat with a Neutral rating and a Dec-17 China price target of HK$1.90. A subsidiary of COFCO Group, COFCO Meat operates Consumer a vertically integrated value chain including feed & hog production, slaughtering, AC production and sale of fresh pork and processed meat products. Near-term Ebru Sener Kurumlu earnings benefits from high hog prices and benign input costs (we expect COFCO (852) 2800-8521 Meat to post a profit in FY16E vs a loss in FY15), and ongoing market-share [email protected] Bloomberg JPMA KURUMLU
COFCO Meat Holdings (Reuters: 1610.HK, Bloomberg: 1610 HK) Rmb in mn, year-end Dec FY14A FY15A FY16E FY17E FY18E Company Data Revenue (Rmb mn) 3,746 5,056 7,239 8,363 9,967 Shares O/S (mn) 4,877 Net Profit (Rmb mn) (349) 210 618 1,513 1,078 Market Cap (Rmb mn) 7,101 EPS (Rmb) (0.09) 0.05 0.13 0.31 0.22 Market Cap ($ mn) 1,031 DPS (Rmb) - - - - - Price (HK$) 1.64 Revenue growth (%) 0.3% 35.0% 43.2% 15.5% 19.2% Date Of Price 01 Dec 16 EPS growth (%) 338.8% (160.0%) 136.0% 144.7% (28.7%) Free Float(%) - ROCE (4.3%) 1.3% 14.7% 11.5% 10.3% 3M - Avg daily vol (mn) - ROE (21.1%) (0.9%) 20.9% 14.3% 12.7% 3M - Avg daily val (HK$ mn) - P/E (x) NM 27.1 11.5 4.7 6.6 3M - Avg daily val ($ mn) - P/E(Recurring) NM NM 8.8 8.4 7.8 HSI 2,2878.23 P/BV (x) 2.4 2.1 1.4 1.1 0.9 Exchange Rate 7.76 EV/EBITDA (x) 164.9 26.6 5.8 5.4 4.7 Price Target End Date 31-Dec-17 Dividend Yield - - - - - Recurring Profit (Rmb mn) (286) (22) 810 841 911 Recurring EPS (Rmb) (0.07) (0.01) 0.17 0.17 0.19 Recurring EPS Growth 240.5% (92.2%) (3003.9%) 3.7% 8.4% Source: Company data, Bloomberg, J.P. Morgan estimates.
See page 52 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
www.jpmorganmarkets.com This document is being provided for the exclusive use of [email protected].
{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Key catalyst for the stock price: Upside risks to our view: Downside risks to our view: Hog price changes, and the ratio of hog (1) Near-term earnings benefits from cyclically high (1) Continuing earnings volatility due to hog price prices to feed prices, will remain the key hog prices and benign input costs cycle share price drivers in the near term (2) Solid long-term growth drivers for volume and (2) Earnings highly sensitive to hog and corn prices margins (3) China’s pork per capita consumption already at (3) Diversified shareholder structure and strong high levels, with risk of long-term growth flattening support from parent company likely to offer (4) Risk from rising US imports, which could cap the operational synergies price of pork in China (5) Food safety and regulatory risks
Key financial metrics FY14A FY15A FY16E FY17E Valuation and price target basis Revenues (LC) 3,746 5,056 7,239 8,363 Given the earnings volatility we use a DCF valuation and Revenue growth (%) 0.3% 35.0% 43.2% 15.5% arrive at a valuation of HK$9.2b and a Dec-17 PT of HK$1.9, EBITDA (LC) (24) (14) 288 1,316 based on hog-to-corn ratio of 6.5:1 (which is the 16-year EBITDA margin (%) -0.6% -0.3% 4.0% 15.7% average hog-to-corn ratio in China). This equates to a 2017E Tax rate (%) -1.0% 4.5% 5.0% 5.0% P/E of 9.6x vs China pork names trading in a range of 9-15x. Net profit (LC) (349) 210 618 1,513 Recurring EPS (LC) (0.07) (0.01) 0.17 0.17 EPS growth (%) 240.5% na na 3.7% COFCO Meat - Share price (HK$) DPS (LC) - - - - 2.5 BVPS (LC) 0.60 0.68 1.05 1.36 Operating cash flow (LC mn) (370) 381 597 1,101 2.2 Free cash flow (LC mn) (907) (268) (569) 32 1.9 Interest cover (X) 0.4 2.6 9.4 10.3 Net margin (%) -9.3% 4.1% 8.5% 18.1% 1.6 Sales/assets (X) 0.6x 0.7x 0.8x 0.8x 1.3 Debt/equity (%) 142.9% 91.7% 47.5% 36.6% Net debt/equity (%) 55.0% 85.0% 13.0% 13.6% 1 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------ROE (%) -21.1% -0.9% 20.9% 14.3% ------t v v v v v v v v v v v v v v v c c o o o o o o o o o o o o o o o e O
Key model assumptions FY14A FY15A FY16E FY17E N N N N N N N N N N N N N N N D ------1 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 3 Sales Growth 0.3% 35.0% 43.2% 15.5% 1 1 1 1 1 2 2 2 2 2 3 Gross Margin 3.2% 2.3% 5.1% 16.4% Operating Margin -4.7% 1.4% 13.0% 11.9% Source: Bloomberg, Company and J.P. Morgan estimates. Source: Bloomberg
JPMe vs consensus, change in estimates Sensitivity analysis EBIT EPS EPS FY16E FY17E Sensitivity to FY16E FY17E FY16E FY17E JPMe old na na +5% chg to hog prices 14.0% 23.0% 15.0% 25.0% JPMe new 0.2 0.2 +5% chg to corn prices -5.0% -6.0% -6.0% -7.0% % chg na na +5% chg to soybean prices -3.0% -4.0% -3.0% -4.0% Consensus na na Source: Bloomberg, Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates.
Comparative metrics CMP Mkt Cap P/E EV/EBITDA P/BV YTD LC $Mn FY16E FY17E FY16E FY17E FY16E FY17E Stock perf. WH GROUP LTD 6.3 12,014 12.6x 11.4x 6.9x 6.2x 1.9x 1.7x 51.2% GUANGDONG WENS-A 35.1 22,689 11.2x 11.6x 10.3x 13.3x 4.0x 3.2x -3.4% HENAN SHUAN-A 22.5 10,834 16.4x 14.8x 10.9x 9.6x 4.3x 4.0x 22.1% MUYUAN FOODSTU-A 24.8 3,776 12.2x 12.3x na na 3.9x 2.9x 7.5% CHUYING AGRO -A 5.3 2,396 15.0x 12.0x na na 3.0x 2.4x -6.1% Source: Bloomberg, Company and J.P. Morgan estimates.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Table of Contents Investment Positives...... 4 Near-term earnings benefits from cyclically high hog prices and benign input costs..4 Solid long-term growth drivers for volume and margins...... 8 Diversified shareholder structure and strong support from parent company likely to offer operational synergy...... 11 Investment Negatives and Risks...... 13 Earnings volatility due to hog price cycle and hog-to-corn ratio...... 13 China’s pork per-capita consumption already at high levels, risk to long-term growth ...... 16 Risk of increasing imports from US, which might cap pork prices in China...... 16 Food safety and regulatory risks ...... 17 Synergies not being achieved as planned, and key shareholder COFCO retreats...... 17 Third-party channel risk ...... 17 Preferential tax treatment may not continue ...... 17 Higher volatility in headline earnings due to biological asset revaluation and goodwill impairments...... 18 Impact of weather and outbreaks of diseases ...... 18 Valuation ...... 19 Overview of China’s Pork Industry ...... 23 China’s pork market size...... 23 China’s pork industry value chain...... 29 Hog price cycle and seasonality...... 30 Company Overview ...... 35 Company history and description...... 35 Operational Review ...... 38 Segment overview...... 38 Production capacity and expanded plan...... 40 Distribution network and customer profile ...... 45 Financials...... 46 Investment Thesis, Valuation and Risks ...... 50
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Investment Positives
Near-term earnings benefits from cyclically high hog prices and benign input costs Company description: China hog prices have been in an upcycle since mid-2015, reaching a cyclically COFCO Meat, a subsidiary of high level in mid-2016 COFCO Group and founded in China’s hog production cycle and thus hog prices have an inherent cycle that used to 2009, has an integrated model with be shorter, at around three years, and now is getting a bit longer (most recently four operations across the entire pork to five years). However, the most recent cycle was still relatively short compared to industry value chain, including those in some developed markets, such as the US. These cycles are due to the i) hog production (#4 market player), fragmented structure of the industry, where small farmers react to changes in hog ii) slaughtering and fresh pork (#8), prices too harshly by either culling sows or raising too many hogs. iii) processed meat production, sales and distribution (#9), China’s hog prices entered an upcycle in mid-2015, as explained below. China’s sow iv) international trade, importing and stock starting to decrease from early 2014, given lackluster hog prices in 2013 that led selling frozen meat and byproducts to the culling of sows and pushed small farmers out of the business. The declining sow in China (#2) stock led to a decline in hog production that has driven up hog prices since mid-2015. The company had hog production The sow stock did not pick up until Oct 2016, as the China government’s stricter capacity of 2.3m heads as of end- environmental protection rules have encouraged industry consolidation and restricted 2015 and plans to expand annual the expansion of smaller hog farms, causing the pork shortage to climb further in 2016, hog production capacity to 5.5m as per Ministry of Agriculture forecasts. There were also floods in China in June/July heads by 2020 that led to the death of several tens of thousands of sows or hogs and thus kept hog prices at elevated levels. Some smaller players hence had held back their volume in Jul- Sep in hope to sell at higher prices in later months. But given the continuing price correction during 3Q16 as several local governments increased their pork inventory releases to rein in the hog-corn-ratio, these smaller players suddenly changed their price outlook and put their stock to the market in Oct, therefore, driving a sharp price decline during the month. However, given the market is still running short of supply, the price stabilized in late Oct and picked up in Nov.
China’s hog prices were at cyclically high levels in 2Q16 and have started coming down since July, but the pace is moderate given that sow stock in China remains low. We expect hog prices to decline further in 2017, as sow stock is expected to increase gradually, although it still remains low until Oct-2016.
Figure 1: China hog price (Rmb/kg) 23 Peak 21 Peak 19 Peak 17 15 13 11 9 Trough 7 Trough Trough 5 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r r v c y v c y v c y v g n n p b g n n p b g n n p b g n n u c u c u c a p a p a p a o e a o e a o e a o u a u e e u a u e e u a u e e u a u J J J A O A O A O J J J J J J J J M F M F M F M A N S D A N S D A N S D A N M M M Source: NDRC.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Figure 2: The trend of sow stock and pig stock Figure 3: The trend of sow stock and hog prices 55,000 480,000 55,000 25
50,000 460,000 50,000 20
45,000 440,000 45,000 15
40,000 420,000 40,000 10
35,000 400,000 35,000 5 9 9 9 9 0 0 0 0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 9 0 0 0 0 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 0 1 1 1 1 1 1 1 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------r r r r r r r r l l l l l l l t t t t t t t t r r r r r r r c c c c c c c n p n p n p n p n p n p n p n p n n n n n n n a a a a a a a a c u c u c u c u c u c u c u c p p p p p p p e e e e e e e u e u e u e u e u e u e u e u e a a a a a a a J J J J J J J J J J J J J J J O A O A O A O A O A O A O A O M M M M M M M M J J J J J J J S D S D S D S D S D S D S D S Number of stock sow (LHS, '000 heads) Number of pig stock (RHS, '000 heads) Number of stock sow (LHS, '000 heads) Hog price (RHS, Rmb/kg)
Source: MoA. NDRC Source: MoA, NDRC
COFCO Meat derives 91% of its EBIT from hog production and is a beneficiary of hog price increases, especially when feed costs are benign. We expect a c18% increase in hog prices in China in FY16 and 25% growth for COFCO Meat’s hog production, given the company has some sales in higher-priced piglets in 2016, and thus we expect COFCO Meat to deliver strong earnings growth in 2016, with recurring net profit (excluding fair value adjustments in biological assets) of Rmb810m vs a 2015 net loss of Rmb22m. COFCO Meat delivered Rmb268m in net profit in 4M16, benefitting from surging hog prices. For headline net profit, which is impacted by fair value adjustments in biological assets, we expect COFCO Meat to post Rmb618m in FY16 vs Rmb210m in FY15.
We expect hog prices in China to come down c11% y/y (and down 10.5% y/y for COFCO Meat given still some more sales in higher-priced sows and piglets) in 2017. And with flat corn prices (which we explain in the next section), we expect c4% y/y growth in COFCO Meat’s recurring net profit in FY17 thanks to continuing volume growth and continuing efficiencies in the cost structure.
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Table 1: Results for four key segments FY15 FY16E FY17E FY18E COFCO Meat ASP, Rmb/kg Hog price (% chg. y/y) 16% 25% -11% -8% Corn price (% chg. y/y) -5% -10% 0% 0% Pork price (% chg. y/y) 13% 21% -10% -7%
Hog to corn ratio (JPM estimates) 6.3 8.7 7.8 7.2
Revenue (Rmb M, internal + external) Hog production 1,750 3,315 4,198 5,466 Fresh pork 2,107 3,222 3,710 4,451 Processed meat 330 351 352 376 International trade 1,950 2,145 2,360 2,596 Inter segment sales 1,081 1,795 2,257 2,921
Revenue (% chg. y/y) Hog production 41% 89% 27% 30% Fresh pork 40% 53% 15% 20% Processed meat 13% 7% 0% 7% International trade 22% 10% 10% 10%
OP per kg (Rmb) Hog production 1.2 5.6 4.1 2.9 Fresh pork (0.0) (0.1) (0.0) 0.0 Processed meat 0.4 (1.2) (0.5) 0.2 International trade (adjusted) (0.2) (0.0) 0.1 0.2
Recurring OPM Hog production 7.9% 30.4% 24.9% 19.3% Fresh pork -0.1% -0.6% -0.3% 0.1% Processed meat 1.2% -3.3% -1.4% 0.7% International trade (adjusted) -1.2% -0.2% 0.4% 0.8% Source: MoA, J.P. Morgan estimates, Company reports.
Input costs are benign, with corn prices down and the hog-to-corn ratio at a high level in 2016 Corn is typically the main feed for the hog-raising business. Therefore, the hog-price- to-corn-price ratio (which we refer as the hog-to-corn ratio in this report) is key to upstream profitability in the hog and pork business. Given that COFCO Meat derives 91% of EBIT from upstream production, the hog-to-corn ratio is the main parameter for profitability, in our view, until the downstream business reaches a scale that impacts overall earnings. China’s government launched a policy in 2007 to support the prices of some agriculture products (corn, soybean, cotton) by building up national reserves with targeted purchase prices and limits on the quantity of imports. This policy drove China’s domestic corn prices to over an 80% premium to the US initially, widening to over 100% in 2014 and 2015. In September 2015, the government revised down its purchase prices, the first decline since 2007, when the corn reserve policy was initiated, with an aim to clear the government’s corn reserve inventory and suppress domestic corn prices, which were the most expensive in the world. The change in reserve policy in 2015 was planned to reduce government’s reserve inventory and leave the market to determine its fair prices. Industries (feeds, ethanol) that use corn as an input cost and that had been making losses had been complaining about the policy distortion. The policy change was welcomed by these industry players. Corn prices have declined from Rmb2.5-2.6/kg in 2014 to around Rmb1.9/kg at current level, and the gap to the US is narrowing compared to 2014-15, though it is still over 80% higher than in the US. We expect corn prices to decline to cRmb2/kg for 2016 and stay stable in 2017.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Figure 4: China and US average corn price comparison (US$/kg) Figure 5: China’s corn prices (Rmb/kg) 0.45 2.7 0.39 0.40 0.40 0.37 0.35 0.33 2.5 0.35 0.30 0.30 0.28 2.3 0.24 0.25 0.27 0.27 2.1 0.20 0.23 0.15 1.9 0.17 0.16 0.15 0.15 0.10 0.14 1.7 0.05 1.5
- 9 9 0 0 1 1 2 2 3 3 4 4 5 5 6 6 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------
2009 2010 2011 2012 2013 2014 2015 YTD2016 y v y v y v y v y v y v y v y v a o a o a o a o a o a o a o a o N N N N N N N N China corn price (US$/kg) US corn price (US$/kg) M M M M M M M M Source: USDA, NDRC. Source: USDA, NDRC.
Based on historical data and our calculations, COFCO Meat was making losses at a hog-to-corn ratio of 5:1 during 2014. The hog production business turned profitable in 2015, when the hog-to-corn ratio was 6.3:1. We estimate the current breakeven hog-to-corn ratio at 6.0:1. For 2016, we expect the average hog-to-corn ratio to be at the cyclically high level of 8.7:1 and it will gradually trend down to 7.2:1 in 2018.
Figure 6: Recurring EBIT (with breakdown by segment) and its relationship to the hog-to-corn ratio (Rmb mn) 1,200 10
1,000 8.7 9 800 7.8 8 600 7.2 400 7 6.3 200 5.9 6 - 5.1 2013 2014 2015 2016E 2017E 2018E 5 (200)
(400) 4
Hog production EBIT (LHS) Fresh pork EBIT (LHS) Processed meat EBIT (LHS)
International trade EBIT (LHS) Other adjustments (LHS) Hog/Corn ratio (RHS)
Source: J.P. Morgan estimates, Company reports. Note: Other adjustments are those income/expenses booked under segments but not included in reported overall recurring EBIT
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Solid long-term growth drivers for volume and margins Leading player in a consolidating market, securing volume growth The Chinese government rolled out stringent amended laws/rules for environmental protection in 2014-2016. The new policies require breeding enterprises that would cause pollution to bear more costs for better environmental protection (see table below). This has driven some smaller players out of the market. We have seen small hog farms (<500 heads) shrink from 74% of total slaughtering capacity in 2007 to 57% in 2015 and the number of slaughtering houses decrease from 23,430 in 2010 to below 4,000 in 2015. We expect market consolidation to benefit the existing large players, such as COFCO Meat.
COFCO Meat has plans to increase capacity to 5.5m heads by 2020, with higher growth in 2016-17 and moderating growth in the later years. We expect capacity to grow to around 3.5m heads in 2016, 4.1m in 2017 and 4.6m in 2018. In terms of production volume (for finishing hogs only), we expect 1.7m heads in 2016, 2.3m heads in 2017 and 3.3m heads in 2018.
Figure 7: Pork production and consumption in China Figure 8: China’s pork shortage vs hog prices 60.0 1.4 20.0 18.0 1.2 57.0 16.0 1.0 14.0
54.0 0.8 12.0 10.0 0.6 51.0 8.0 0.4 6.0 48.0 4.0 0.2 2.0 45.0 - - 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Production (m tons) Consumption (m tons) Short of supply (LHS, m tons) Hog price (RHS, Rmb/kg)
Source: MoA, J.P. Morgan estimates. Source: MoA, J.P. Morgan estimates.
Figure 9: China’s hog production share by hog farm size (heads) Figure 10: Consolidating number of slaughtering houses in China 23,430 100% 4% 25,000 6% 7% 9% 10% 19,938 22% 26% 20,000 80% 29% 32% 33% 14,720 15,000 60% 10,000+ 9,985 500-10,000 10,000 40% 6,447 74% 1-500 68% 3,979 63% 59% 5,000 3,301 2,740 57% 2,235 1,933 1,785 20% - 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 0% 2007 2009 2011 2013 2015 Number of licensed slaughtering houses in China
Source: Frost & Sullivan. Source: Frost & Sullivan.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Table 2: Key government policies associated with environmental protection laws Law/rule Effective Content Administrative Measures on 8-May-01 Related companies are required to abide by various provisions regarding environmental protection and the prevention of the Prevention and Cure of pollution; to complete the environmental impact evaluation process prior to commencing a construction project; and to Pollution Caused by obtain discharge permits and pay discharge fees for the discharge of pollutants. Failure to comply with environmental Breeding of Livestock and protection laws and regulations is subject to a range of penalties, from warnings, fines and suspension of production or Poultry operations to other administrative sanctions, depending on the degree of damage or adverse consequences. Environmental Protection 1-Jan-15 Entities that cause environmental pollution and other public hazards must incorporate environmental protection work into Law their plans, establish an environmental protection responsibility system, and adopt effective measures to prevent and control pollution and other environmental harms caused to the environment by waste gases, wastewater, waste residues, dust, malodorous gases, radioactive substances, noise, vibration and electromagnetic radiation generated in the course of production, construction or other activities. Amended Law on 1-Jan-16 Enterprises that discharge water or air pollutants must pay discharge fees based on the types and volumes of the pollutants Prevention of Water discharged. The discharge fees are calculated by the local environmental protection authority, which will review and verify Pollution the types and volumes of pollutants discharged. Source: Company reports, governmental entities including MoA, NDRC, Ministry of Environmental Protection.
Further achievable cost savings via efficiency improvement COFCO Meat has continued to enhance its technology development and efficiency for better productivity: Its piglets weaned per sow per year (PSY) have increased from 21.6 heads in 2013 to 22.6 in 2015, and we expect this figure go up to 24 by 2018. The average finishing weight of hog per head also increased from 96.4 kg in 2013 to 101.8 kg in 2015, and we forecast it will achieve 110 kg by 2018.
Such efficiency improvements will lead to better profitability over the long run, in our view. If the above efficiencies were to be achieved now, the current breakeven hog-to-corn ratio of 6.0:1 could improve to 5.7:1, based on our estimates.
Figure 11: COFCO Meat’s productivity in hog production 24.5 115.0
24.0 110.0 23.5 110.1 109.0 23.0 105.0 22.5 105.9
22.0 101.8 100.0 21.5 97.8 21.0 96.4 95.0 2013 2014 2015 2016E 2017E 2018E Piglets weaned per sow per year (LHS) Average finishing weight (kg per head, RHS)
Source: J.P. Morgan estimates, Company reports.
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Longer hog price cycles at higher levels each time, with diminishing intervention in corn markets China’s hog price cycle has trended up over the past 16 years, which we believe is attributable to a combination of rising household income, rising labor costs and strong demand for pork products. Besides, with increasing market consolidation as smaller players, who are the source of price fluctuations, exit the market, the price cycle is gradually getting longer (from 3 years to 4-5 years). The government’s ceasing to intervene in corn prices in 2015 has relieved some pressure for upstream players on the cost side.
Figure 12: China’s hog price (Rmb/kg) 23 Peak 21 Peak 19 Peak 17 15 13 11
9 Trough 7 Trough Trough 5 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r r v c y v c y v c y v g n n p b g n n p b g n n p b g n n u c u c u c a a a a p p p a a a o e o e o e o u a u e e u a u e e u a u e e u a u J J J A O A O A O J J J J J J J J M F M F M F M A N S D A N S D A N S D A N M M M Source: NDRC.
Growing downstream business, given a strong brand and vertical integration COFCO Meat targets establishing a vertically integrated value chain in the long term, from upstream hog production to downstream processed meat sales, because: (1) this model can better ensure the quality and food safety of its products; and (2) an integrated platform can help it become more resilient to hog price volatility.
The chilled fresh pork business is accelerating in China, and COFCO Meat has more exposure to chilled products. Chilled fresh pork and frozen fresh pork comprised 10% and 12% of total pork consumption in 2010, respectively, and have grown to 25% and 20%, respectively, in 2015. We believe this trend is driven by demand for safer and higher-quality pork products and a stronger preference for the modern retail channel, given better hygiene and a more comfortable environment. We believe COFCO Meat, with its strong brand equity and expanding channel coverage, will reap the fruits of such a preference shift.
The downstream business was loss-making and accounted for -1% of EBIT as of 4M16. We expect this to improve gradually and break even by 2018. We also believe further growth is likely.
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Figure 13: China fresh pork consumption volume by category Figure 14: China fresh pork consumption volume by channel 100% 100% 3% 1% 14% 18% 80% 80% 9% 55% 17% Others 60% 77% 60% Warm fresh pork Hotels & restaurants Frozen fresh pork Modern retailers 40% 40% 68% 20% Chilled fresh pork 56% Wet markets Retail stores 20% 20% 12% 25% 10% 8% 0% 0% 6% 2010 2015 2010 2015
Source: Frost & Sullivan. Source: Frost & Sullivan.
Diversified shareholder structure and strong support from parent company likely to offer operational synergy COFCO Meat has a diversified shareholder structure, including strategic partners like MIY (Mitsubishi, Itoham and Yonekyu) and global investors like KKR, Baring, Temasek and Boyu. We believe such a shareholder profile can strengthen corporate governance and offer synergies, such as product innovation and technology upgrades, as these partners and shareholders have expertise in the field.
More importantly, parent company COFCO Group should be able to strengthen the company’s supply chain and build connections with global counterparts for its international businesses.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Figure 15: Shareholder structure before IPO
COFCO
100%
COFCO (HK)
100%
China Foods MIY (Holdings)
67% 33%
Mainfield KKR Baring Temasek Boyu
55.0% 20.0% 9.0% 8.2% 7.8%
COFCO Meat
Source: Company reports. Note: MIY indicates Mitsubishi, Itoham and Yonekyu.
Figure 16: Shareholder structure post IPO
COFCO
100%
COFCO (HK)
100%
China Foods (Holdings)
100%
Other Mainfield MIY KKR Baring Temasek Boyu shareholders
27.64% 13.61% 15.00% 6.75% 6.15% 5.85% 25.00%
COFCO Meat
Source: Company reports. Note: MIY indicates Mitsubishi, Itoham and Yonekyu.
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Investment Negatives and Risks
Earnings volatility due to hog price cycle and hog-to-corn ratio We highlight hog price changes as a risk for COFCO Meat, as the company’s business is currently tilted to upstream, leading to volatile earnings along with hog price changes and corn prices. Earnings are likely to be volatile in the near term until the long-term drivers we discussed above become more prominent.
Figure 17: Operating profit by segment (Rmb M) Figure 18: Total sales (internal + external) split by segment, 2015
200
150 29% 32% 100 Hog production Fresh pork 50 2013 2014 Processed meat products - 2015 International trading Hog production Fresh pork Processed meat International trade 5% (50)
(100) 34%
(150) Source: Company reports. Source: J.P. Morgan estimates, Company reports.
Risks to earnings estimates in FY17 With the company’s high exposure to hog production, changes in hog prices and feed costs have a substantial impact on profitability.
We expect COFCO Meat to deliver a c25% increase in hog prices in FY16 (4M16 up >50% y/y), above the China average increase of c18% that we estimate for FY16, as the company has been selling some high-value sows and piglets this year given the shortage in the market and already delivered an ASP increase above the China average in 4M16.
We expect China average hog prices to come down c11% in FY17, as we expect China hog production to see a 1.5% increase (with sow stock starting to go up in later FY16, helping hog production move up gradually in 2H17) and a further 3% increase in FY18. With demand growth estimated at 1% in FY17 and 2% in FY18, that leaves us with a pork supply shortage of 0.8m tons in FY17 and 0.2m tons in FY18. Given a supply shortage in China in FY17, we expect hog prices to go down only 11% on the back of increased production vs FY16 output.
Downside risks to our estimate come from better-than-expected demand or weather factors, or from hog production coming through better than expected. Upside risk to our estimate comes from sow stock numbers not continuing to increase as expected in 2H16. We expect COFCO Meat hog sales prices to decline 10.5% y/y in FY17 (vs the industry’s 11%) due to still some more sales of sows and piglets.
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Figure 19: Pork production and consumption in China Figure 20: China’s pork shortage vs hog prices 60.0 1.4 20.0 18.0 1.2 57.0 16.0 1.0 14.0 54.0 0.8 12.0 10.0 0.6 51.0 8.0 0.4 6.0 48.0 4.0 0.2 2.0 45.0 - - 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Production (m tons) Consumption (m tons) Short of supply (LHS, m tons) Hog price (RHS, Rmb/kg)
Source: MoA, J.P. Morgan estimates. Source: MoA, J.P. Morgan estimates.
The table below summarizes the impact on financials and the reference valuation range if hog price declines are worse than our estimate or less than our estimate.
For COFCO Meat, our assumptions for hog prices are +25% y/y in FY16 and -10.5% y/y in FY17; for corn prices are -10% y/y in FY16 and flat in FY17; and for soybean meal prices are -5% y/y in FY16 and flat in FY17.
Table 3: Sensitivity analysis to changes in hog, corn and soybean meal prices, FY17E (assumes all others unchanged) Base case To hog prices 0% -5% -10.5% -15% -20% Sales 8% 4% 0% -3% -7% Op profits excl. biological asset adj. 48% 25% 0% -21% -44% Recurring profits 53% 28% 0% -23% -48% Valuation reference (HKD bn) 10.8 10.0 9.2 8.4 7.6 Implied 2017E P/E 7.4 8.2 9.6 11.5 15.5 To corn prices -10% -5% 0% 5% 10% Sales 0% 0% 0% 0% 0% Op profits excl. biological asset adj. 12% 6% 0% -6% -12% Recurring profits 14% 7% 0% -7% -14% Valuation reference (HKD bn) 9.4 9.3 9.2 9.0 8.8 Implied 2017E P/E 8.7 9.1 9.6 10.2 10.8 To soybean meal prices -10% -5% 0% 5% 10% Sales 0% 0% 0% 0% 0% Op profits excl. biological asset adj. 8% 4% 0% -4% -8% Recurring profits 8% 4% 0% -4% -8% Valuation reference (HKD bn) 9.3 9.2 9.2 9.1 9.0 Implied 2017E P/E 9.0 9.3 9.6 9.9 10.3 Source: J.P. Morgan estimates.
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Table 4: Sensitivity analysis to changes in hog, corn and soybean meal prices, FY16E (assumes all others unchanged) Base case To hog prices 5% 15% 25% 35% 45% Sales -10% -5% 0% 5% 10% Op profits excl. biological asset adj. -55% -27% 0% 27% 55% Recurring profits -60% -30% 0% 30% 60% Valuation reference (HKD bn) 6.3 7.7 9.2 10.6 12.0 Implied 2016E P/E 16.9 12.0 10.0 8.9 8.2 To corn prices -2% -5% -10% -15% -18% Sales 0% 0% 0% 0% 0% Op profits excl. biological asset adj. -9% -5% 0% 5% 9% Recurring profits -9% -6% 0% 6% 9% Valuation reference (HKD bn) 8.8 8.9 9.2 9.3 9.5 Implied 2016E P/E 10.6 10.3 10.0 9.6 9.4 To soybean meal prices -1% -3% -5% -7% -9% Sales 0% 0% 0% 0% 0% Op profits excl. biological asset adj. -2% -1% 0% 1% 2% Recurring profits -3% -1% 0% 1% 3% Valuation reference (HKD bn) 9.0 9.1 9.2 9.2 9.2 Implied 2016E P/E 10.1 10.0 10.0 9.9 9.8 Source: J.P. Morgan estimates.
Our view of a sustainable hog-to-corn ratio COFCO Meat’s hog production business turned profitable in 2015, when the hog-to- corn ratio was 6.3:1, based on our calculations. For 2016, we expect the hog-to-corn ratio to be at its cyclically high level of 8.7:1, and gradually trend down to 7.2:1 in 2018.
China has a market stabilization mechanism in place that would like to see the hog- to-corn ratio in the range of 5.5-8.5:1, where the median is 7:1. At the same time, the last-16-year average hog-to-corn ratio is 6.5x. Therefore, we believe 6.5:1 should represent a sustainable long-term hog-to-corn ratio over the cycle.
Figure 21: China’s hog-to-corn ratio 12 11 10 9 8 7 6 5 4 0 0 0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 7 7 7 8 8 8 9 9 9 0 0 0 1 1 1 2 2 2 3 3 3 4 4 4 5 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l l l l l l l l l l l l l l l r r r r r r r r r r r r r r r r r v v v v v v v v v v v v v v v v v u u u u u u u u u u u u u u u u u a a a a a a a a a a a a a a a a a o o o o o o o o o o o o o o o o o J J J J J J J J J J J J J J J J J M M M M M M M M M M M M M M M M M N N N N N N N N N N N N N N N N N
Hog/corn ratio -1 Stdev +1 Stdev Mean
Source: NDRC.
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China’s pork per-capita consumption already at high levels, risk to long-term growth Per OECD data, China consumes 32kg per capita of pork per annum, which is a high level and beats the global average of 12kg and the US average of 23kg. While we believe the growth of pork consumption will stay stable in the medium term, there is a risk that the consumption may shift to other meats in the long term.
Figure 22: Meat consumption mix by country, 2015 Figure 23: Meat per-capita consumption, 2015 (kg)
100% 5% 0% 2% 0% 0% 100 5% 0
21% 30% 35% 80% 36% 80 45% 48% 0 48 2 60% Sheepmeat 60 Sheepmeat 23 39 Poultry Poultry 3 43% 15% 40% 38% 65% 24% 49% Pork 40 12 Pork 23 0 Beef 2 Beef 14 11 13 33 20% 37% 20 32 30% 12 25 15 24 22% 18% 22% 9% 6 11 7 0% - 4 World China US Europe Japan Brazil World China US Europe Japan Brazil
Source: OECD. Source: OECD.
Risk of increasing imports from US, which might cap pork prices in China Hog and pork price gaps between the US and China are substantial. With increasing China hog and pork prices, we believe imports could rise. Indeed, China’s frozen pork imports grew 130% y/y in 1H16 (though still accounting for a small portion of China frozen pork consumption, at 3%), driven partly by increasing hog/pork prices, in our view. While pork imports may have some limit, as only frozen pork can be imported, we believe imports may still serve as a stabilizer to press down hog/pork prices in China, which could limit the profitability of upstream players such as COFCO Meat.
Figure 24: China and US average hog price comparison (US$/kg) Figure 25: China and US average pork price comparison (US$/kg) 3.00 2.83 4.00 2.65 3.74 3.44 3.32 2.38 2.46 2.45 3.50 3.28 3.28 2.50 2.20 3.04 3.00 2.00 1.75 2.4x 2.31 1.64 3.1x 2.50 2.20 2.1x 2.4x 1.50 2.00 1.58 2.17 1.47 1.42 1.32 1.50 1.91 1.82 1.00 1.21 1.67 1.73 1.02 1.55 1.55 0.93 0.92 1.00 1.21 0.50 0.50 - - 2009 2010 2011 2012 2013 2014 2015 YTD2016 2009 2010 2011 2012 2013 2014 2015 YTD2016 China hog price (US$/kg) US hog price (US$/kg) China pork price (US$/kg) US pork price (US$/kg)
Source: USDA, NDRC. Source: USDA, NDRC.
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Food safety and regulatory risks Food safety incidents in China in recent years underscore the difficulties and challenges that food enterprises face in controlling the sources of their raw materials. The government therefore strengthened its enforcement in the field. From 2012 to 2015, the China Anti-Doping Agency conducted extensive sample testing of COFCO Meat’s products using international standards, and the company passed all tests 100%, according to the company. However, while COFCO Meat has good control of its upstream raw materials, any food safety incidents at peers could impact the company, given that Chinese customers are now sensitive to food safety. Although the government’s stringent regulations will result in higher costs to COFCO Meat in the near term, they will also drive smaller or unqualified players from the market and help market consolidation, in our view, which we believe are long-term positives.
Synergies not being achieved as planned, and key shareholder COFCO retreats While we believe there are potential synergies for the company’s vertically integrated model, which, in the medium and long term, can better counter the hog cycle, aided by expanding downstream businesses, there is a risk that proposed synergies might not materialize as planned. First, the company has a limited operating history as a vertically integrated company, with a short track record. Second, the establishment of downstream businesses may take longer than expected to expand channel coverage, build up brand names and improve logistics. Moreover, parent company COFCO offers some synergies for COFCO Meat, such as connections with suppliers and international business, so if COFCO were to sell its stake in COFCO Meat, there would be a risk of losing these benefits.
Third-party channel risk COFCO Meat relies on several channels for the distribution of its downstream products, including distributors. As of 30 April 2016, the company had 307 distributors across the country. Risks may arise if the company fails to renew agreements with existing distributors or is unable to add new ones, or if distributors fail to market the company’s products or keep them in sellable, good condition, which would tarnish the company’s brand name. There is also a risk that the company cannot broaden its distribution network as rapidly as it expects to match its upstream business expansion for vertical integration, because a strong downstream business can effectively cushion upstream hog price volatility.
Preferential tax treatment may not continue COFCO Meat has certain preferential tax terms for some operations, including hog production and fresh pork businesses, which are exempt from enterprise income tax. If such treatment were altered or terminated, there would be an impact on earnings, as the existing effective tax rate is low.
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Higher volatility in headline earnings due to biological asset revaluation and goodwill impairments The company has a significant amount of biological assets that are subject to fair value adjustment in each reporting period. While such changes have a limited impact from an operational perspective, they can substantially impact headline earnings and make them highly volatile. In addition, COFCO Meat had goodwill amounting to Rmb101m as of April 2016, and provision risk may arise if the company decides to impair it.
Impact of weather and outbreaks of diseases Unfavorable weather could impact the harvest of feeds such as corn and soybeans, dragging on costs. Extreme weather like the floods that occurred in June and July 2016 could also lead to reduced hog production. Finally, disease outbreaks would impact hog production and the average weight of finishing hogs.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Valuation
COFCO Meat is a pork company and operates a vertically integrated value chain, from feed production, hog production and slaughtering to the production, distribution and sale of fresh pork and processed meat products, and the import and sale of frozen meat products.
Given the earnings volatility related to hog price cycles and given that the peer group has a wide valuation multiple range, as it comprises different businesses and regions, we use DCF as the main valuation metric.
Table 5: DCF valuation range with key input assumptions Hog corn ratio 6.5 Terminal growth rate 2.0% Risk-free rate 3.5% Beta 0.8 Equity risk premium 10.0% Cost of equity 11.5% Cost of debt 5.0% Tax rate -5.0% WACC 9.7%
Long-term sales growth 6% Long-term EBITDA margin 9%
Equity value by DCF (Rmb mn) 8,139 Equity value by DCF (HK$ mn) 9,197 Source: J.P. Morgan estimates.
Using DCF valuation, we arrive at a valuation of total company at Rmb8.1bn, which can be translated into HK$9.2bn (or HK$1.9 per share) by using JPMorgan’s CNYHKD FX forecast rate of 1.13 in FY17. Our valuation represents a long-term hog-to-corn ratio of 6.5:1. For COFCO Meat, hog production represents c91% of EBIT, and hog production profitability is linked mainly to the hog-price-to-corn- price ratio, where the former represents ASP and the latter represents the main cost. We opt for a hog-to-corn ratio of 6.5:1 for our main DCF input as the 16-year average hog-to-corn ratio in China is 6.5:1 which we do not expect the long-term average over the cycle to fall below this level.
Our DCF valuation points to P/E of c10x for both 2016E and 2017E. This compares to:
Global protein players trading at a 2016E P/E range of 9-45x and 2017E P/E range of 6-22x. China pork players trading at a 2016E P/E range of 10-16x and 2017E P/E range of 9-15x. Chine F&B names trading at a 2016E P/E range of 15-48x and 2017E P/E range of 15-39x.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Table 6: Implied P/E of DCF valuation FY16E (x) FY17E (x) COFCO Meat valuation 10.0 9.6
Global protein players 9-45 6-22 China pork players 10-16 9-15 Chine F&B names 15-48 15-39 Source: J.P. Morgan estimates.
Table 7: Valuation comp sheet
Market Cap P/E EPS CAGR P/B EV/EBITDA ROE Company BBG Ticker (USDmn) FY15A FY16E FY17E FY18E 2014-16E FY15A FY16E FY17E FY18E FY15A FY16E FY17E FY18E FY15A FY16E FY17E FY18E China Staples Want Want 151 HK 7,783 15.9 15.9 15.8 15.5 -4.5% 3.9 4.1 3.6 3.2 10.2 10.5 10.7 10.7 26.6% 27.4% 24.3% 21.9% China Mengniu 2319 HK 6,547 23.0 24.1 19.7 17.7 4.2% 2.4 2.3 2.1 1.9 11.5 10.6 9.4 8.7 10.7% 9.8% 10.9% 11.2% Inner Mongolia Yili 600887 CH 16,937 27.3 22.2 19.8 17.1 10.2% 5.6 5.2 4.4 4.0 13.0 11.2 9.7 8.4 21.4% 24.6% 24.2% 24.8% Bright Dairy & Food 600597 CH 2,686 44.5 33.6 28.9 26.7 -4.8% 3.9 3.5 3.3 3.0 11.6 11.8 10.9 10.4 8.6% 10.8% 11.4% 11.6% Modern Dairy 1117 HK 697 10.6 na 18.3 14.6 -77.3% 1.3 1.3 1.2 1.2 7.8 10.4 8.0 7.1 7.1% 1.5% 5.6% 7.5% Huishan 6863 HK 5,297 26.8 47.7 38.4 31.8 -24.2% 2.6 2.9 2.7 2.5 21.5 27.6 20.3 17.7 10.2% 7.7% 7.1% 7.9% Tingyi 322 HK 4,845 26.4 36.0 26.4 22.9 -35.4% 2.1 2.1 2.0 1.9 7.7 8.6 7.9 7.4 8.1% 6.2% 7.8% 8.5% Uni-president China 220 HK 3,312 23.9 26.5 24.0 20.8 22.3% 1.8 1.7 1.6 1.5 9.9 11.3 10.0 9.2 7.9% 6.4% 7.0% 7.5% Tsingtao Brewery 168 HK 5,471 22.1 24.2 24.2 22.9 -13.5% 2.2 2.1 2.0 1.8 11.5 12.1 11.8 11.3 10.4% 9.0% 8.5% 8.4% CRB 291 HK 6,280 46.9 41.3 25.5 23.1 185.0% 2.9 2.5 2.4 2.3 11.7 11.4 10.6 9.9 3.5% 6.7% 9.4% 10.0% Yanjing Brew ery 000729 CH 3,150 29.7 37.8 35.4 33.6 -14.4% 1.7 1.6 1.6 1.5 11.7 13.4 12.8 11.9 5.3% 4.2% 4.4% 4.7% China Foods 506 HK 1,064 112.7 18.6 20.1 18.9 na 1.6 1.6 1.6 1.5 8.0 6.1 5.6 5.4 2.4% 8.6% 7.2% 7.5% Average 34.2 29.8 24.7 22.1 4.3% 2.7 2.6 2.4 2.2 11.3 12.1 10.6 9.8 10.2% 10.2% 10.7% 11.0% China pork related names Yurun 1068 HK 268 na na na na na na na na na na na na na na na na na WH Group 288 HK 11,535 16.6 12.8 11.5 10.4 4.1% 2.1 1.9 1.7 1.6 8.1 6.9 6.5 6.1 13.2% 15.8% 15.8% 15.7% Dahuangong 300498 CH 24,639 24.2 10.9 11.3 11.7 129.7% 6.5 3.9 3.1 2.6 20.3 10.4 13.4 17.7 29.3% 37.8% 28.8% 21.7% Shuanghui 000895 CH 12,206 17.9 16.4 14.8 13.5 3.2% 4.2 4.3 4.0 3.7 12.4 11.4 10.4 9.5 25.4% 26.2% 28.1% 29.4% New Hope 000876 CH 5,274 13.8 10.9 9.2 8.2 22.6% 1.8 1.6 1.4 1.3 na na na na 12.2% 15.3% 16.0% 16.0% Muyuan 002714 CH 4,200 42.5 12.2 12.3 9.6 386.2% 8.4 3.9 2.9 2.1 37.3 11.5 11.4 na 21.8% 38.1% 30.2% 23.2% Chuying 002477 CH 2,621 60.0 15.1 12.0 10.4 na 5.8 3.0 2.4 2.0 na na na na 7.5% 23.1% 22.9% 22.8% Average 29.2 13.0 11.8 10.6 109.2% 4.8 3.1 2.6 2.2 19.5 10.0 10.4 11.1 18.2% 26.1% 23.6% 21.5% Global protein players Hormel Foods HRL US 19,790 26.2 20.8 20.2 19.4 21.3% 4.7 4.2 3.8 2.9 16.5 13.7 13.2 12.7 18.3% 20.4% 18.9% 17.5% Tyson TSN US 29,620 17.8 12.4 11.8 11.4 27.1% 2.3 2.3 2.1 1.9 9.4 7.7 7.7 7.8 13.6% 18.6% 18.6% 16.8% JBS JBSS3 BZ 9,592 5.3 45.2 6.5 5.4 -40.4% 0.9 1.0 0.9 0.8 5.9 6.6 5.1 5.0 17.6% 0.3% 13.7% 15.6% BRF BRFS3 BZ 13,606 17.6 41.2 18.2 14.5 -26.9% 3.1 3.0 2.7 2.5 10.5 12.9 9.9 8.7 16.5% 8.0% 15.2% 17.9% Maple Leaf Foods Inc MFI CN 3,062 53.9 23.9 21.4 19.9 na 1.8 1.9 1.9 na 16.9 10.3 9.7 9.4 2.9% 8.2% 8.3% na CPF CPF TB 6,232 43.7 16.4 14.7 12.4 17.1% 1.7 1.6 1.5 1.5 22.3 11.8 11.1 10.3 6.7% 11.2% 11.5% 12.3% Pilgrim's Pride PPC US 5,917 6.4 9.5 8.6 9.0 -19.7% 3.4 4.5 4.0 na 5.1 6.9 6.4 6.7 na na na na Nippon Meat Packers 2282 JT 4,989 20.0 22.2 20.0 17.1 14.9% 1.7 1.6 1.6 1.5 8.5 8.6 7.9 7.4 9.1% 7.5% 8.3% 9.0% Sanderson Farms SAFM US 1,977 8.3 10.8 9.5 10.7 -16.9% 1.7 1.5 1.3 1.2 4.1 4.9 4.6 5.0 22.8% 15.1% 16.1% 13.9% Average 22.1 22.5 14.5 13.3 -2.9% 2.4 2.4 2.2 1.8 11.0 9.3 8.4 8.1 12.3% 12.5% 14.2% 14.7% Source: Bloomberg.
We also ran a sensitivity analysis on our DCF range based on various terminal growth rates and WACC. Below is the sensitivity analysis for the low and high ends of the DCF valuation range.
Table 8: Sensitivity of terminal growth rate and WACC for low end (HK$ bn) Terminal growth WACC 1% 2% (JPM assumption) 3% 8.5% 9.9 10.9 12.2 9.7% (JPM assumption) 8.5 9.2 10.0 10.5% 7.7 8.2 8.8 Source: J.P. Morgan estimates.
As we find a strong correlation between ROIC generation and the EV/IC ratio for global protein names (as seen in the chart below), we also compared implied EV/IC for our DCF valuation range with the EV/IC of global and Chinese protein names.
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
Figure 26: Global protein players’ EV/IC vs ROIC-WACC 60.0%
R² = 0.9051 Muyuan
50.0% Wens Foodstuffs
40.0%
30.0%
Shuanghui Pilgrim's Pride Chuying 20.0% Hormel Foods New Hope 10.0% WH Group Sanderson Farms Tyson Nippon Meat BRF 0.0% CPF Maple Leaf Foods JBS
-10.0% 0.0x 1.0x 2.0x 3.0x 4.0x 5.0x 6.0x 7.0x 8.0x 9.0x
Source: S&P Capital IQ consensus.
Global protein players with market caps above US$1bn trade in a 2016E EV/IC range of 1.3-5.0x. Our DCF valuation range implies a 2016E EV/IC of 1.6-2.0x for COFCO Meat.
According to our estimates, COFCO Meat is likely to generate a 16.8% ROIC in FY16 (using FY16 year-end IC for the calculation, rather than the average), ahead of the 14% average for major protein players. The main reason for this is high margins in China in FY16, as feed costs have been very favorable, given less intervention from the Chinese government, while hog prices are continuing an upcycle. We expect COFCO Meat’s ROIC to be around 14% in FY17 and to come down to 13% as of FY18, close to global protein names at 14%.
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Table 9: Protein industry players’ profitability, FY17E NOPAT/sales Sales/avg. assets Avg. assets/avg. IC ROIC Global players Hormel Foods HRL US 9.4% 1.5 1.6 22.9% Tyson TSN US 5.2% 1.6 1.5 12.7% JBS JBSS3 BZ 6.8% 1.0 1.6 10.5% BRF BRFS3 BZ 11.6% 0.8 1.7 15.8% Maple Leaf Foods MFI CN 5.9% 1.2 1.5 10.8% CPF CPF TB 4.7% 0.9 1.3 5.2% Pilgrim’s Pride PPC US 6.5% 2.6 1.8 29.7% Nippon Meat 2282 JT 3.1% 1.6 1.5 7.6% Sanderson Farms SAFM US 5.3% 2.2 1.5 17.4% Global average 6.5% 1.5 1.6 14.3% Chinese players WH Group 288 HK 6.1% 1.6 1.7 16.5% Wens Foodstuffs 300498 CH 32.1% 1.2 1.6 58.4% Shuanghui 000895 CH 10.9% 2.1 1.5 34.7% New Hope 000876 CH 7.6% 2.1 1.5 23.1% Muyuan 002714 CH 87.0% 0.4 2.0 63.9% Chuying 002477 CH 51.4% 0.3 2.2 32.1% Chinese average 11.6% 0.8 1.7 14.2% Total average 29.5% 1.2 1.7 34.7% Source: S&P Capital IQ consensus.
Table 10: China/global protein-related players’ business descriptions China pork-related names Yurun 1068 HK Meat product supplier offering a wide range of raw pork and processed meat products. Also operates distribution network in China. WH Group 288 HK Holding company through subsidiaries provides meat processing services, supplies chilled meat, meat products and related. Wens Foodstuffs 300498 CH Produces, processes and sells chicken, duck, pork and other related products. Also manufactures and markets cooked meat and frozen meat. Shuanghui 000895 CH Manufactures meat products and frozen food, provides processing and printing services. Also operates in commercial trading. New Hope 000876 CH Develops, produces and markets a variety of animal feeds. Also operates a commercial trading business, produces packing materials, chemicals and fish oil. Muyuan 002714 CH Breeds and sells boars and commodity pigs. Chuying 002477 CH Produces pork and poultry products, and engages in feed production, pig breeding, pig raising, chicken egg production and chick hatching. Global protein players Hormel Foods HRL US Manufactures and markets consumer branded meat and food products. Processes meat and poultry products and produces a variety of prepared foods, marketing under a variety of brands. Tyson TSN US Produces, distributes and markets chicken, beef, pork, prepared foods and related products. Products are marketed and sold to grocery retailers, wholesalers, meat distributors, etc. JBS JBSS3 BZ A processor of a range of meats, including beef, pork, lamb and chicken. Exports its products throughout the world. BRFS3 BZ BRFS3 BZ A food processor with a portfolio that includes established brands in Brazil and abroad (Sadia, Perdigao, Qualy, Chester, Perdix and Paty). Provides poultry and pork, foods processed of meat, pizzas, pastas and frozen vegetables. Maple Leaf MFI CN Manufactures and sells a variety of food products, including fresh and prepared meats, poultry, flours, fresh and frozen bakery Foods products, pasta, seafood and animal feeds. CPF CPF TB Produces a wide range of food products, including chicken, pork, shrimp, fish, eggs and duck. Pilgrim’s Pride PPC US Produces prepared and fresh chicken products in the US and Mexico. Through vertical integration, controls breeding, hatching and growing of chicken and the processing, preparation and packaging of its products. Nippon Meat 2282 JT Produces and sells ham, sausage and processed meat products. Also breeds and raises cattle through its subsidiary. Packers Sanderson Farms SAFM US Produces, processes, markets and distributes fresh and frozen chicken products, mostly under the Sanderson Farms brand name. Source: Company reports, Bloomberg.
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Overview of China’s Pork Industry
China’s pork market size China and the US are the world’s largest and second-largest pork consumption/ production countries Global pork consumption/production is estimated at 111mn/112m metric tons as of 2015 by the USDA and NBS. China accounts for c49% of total global production and c50% of total global consumption as of 2015. This translates into 55mn tons of production and 56mn tons of consumption per annum in China. The US accounts for c13% of total global production and c8% of total global consumption as of 2015. This translates into 15mn tons of production and 9mn tons of consumption per annum in the US. Figure 27: China’s pork consumption grew c9% during 2010-15 (vs Figure 28: China’s pork production grew c8% during 2010-15 (vs 9% 7% for ROW) (metric tonnes M) for ROW) (metric tonnes M) 120 120
100 100 45.9 41.9 38.5 80 42.9 80 ROW ROW 60 9.4 60 14.8 8.6 USA 13.6 USA China China 40 40
50.9 55.7 50.7 54.9 20 20
0 0 2010 2015 2010 2015
Source: USDA, NBS. Source: USDA, NBS.
China consumes more pork than other meats Per OECD data, pork accounts for 65% of China’s total meat consumption, compared to the world average of 38%. Per capita, China is higher than the EU, the US and Brazil, where more beef and poultry are consumed, based on OECD data. Although pork prices have risen over 20% YTD, we see limited product shift because the prices of beef and mutton are still twice as high as pork.
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Figure 29: Pork consumption per capita, 2015, kg 35
30
25
20
33 15 32
23 10 15 12 5 11
- World China US Europe Japan Brazil
Source: OECD.
Figure 30: Meat consumption mix by country, 2015 Figure 31: Per-capita meat consumption, 2015 (kg)
100% 0% 2% 0% 0% 100 5% 5% 0
21% 80% 30% 35% 80 36% 45% 48% 0 48 2 60% Sheepmeat 60 Sheepmeat 23 39 Poultry 3 Poultry 43% 15% 40% 38% 65% 24% 49% Pork 40 12 Pork 23 0 Beef 2 Beef 14 11 13 33 20% 37% 20 32 30% 12 25 15 24 22% 18% 22% 9% 6 11 7 0% - 4 World China US Europe Japan Brazil World China US Europe Japan Brazil
Source: OECD. Source: OECD.
Figure 32: China’s meat retail price trend (Rmb/kg) Figure 33: China’s meat retail price change y/y
80.0 50% 46% Meat retail price in China 70.0 Meat retail price chg y/y in China 40% 60.0 30% 50.0 30% 23% 40.0 21% 21% 20% 20% 20% 30.0 20% 10% 10% 20.0 8% 10% 7% 6% 10.0 4% 0% 1% 0% 0% - 0% -1% -1% 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
------2011 2012 2013 2014 2015 2016YTD - - - - - v y v y v y v y v y v b g b g b g b g b g o a o a o a o a o a o e u e u e u e u e u F F F F F
N A N A N A N A N A N -6% M M M M M -10% -8% -8% -8% Rmb/kg Pork Chicken Beef Mutton Pork Chicken Beef Mutton
Source: MoA. Source: MoA.
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China has been the largest driver of global growth over the past five years Per USDA and NBS data, the world’s pork production/consumption grew 8.5%/8.3% during 2010-15, with China contributing 48% of global production growth and 56% of global consumption growth. China’s pork consumption grew c9% during 2010-15 vs the rest of the world’s 7%, and its pork production grew c8% vs the rest of the world’s 9%.
Figure 34: China contributed 56% of global consumption growth Figure 35: China contributed 48% of global production growth during during 2010-15 (metric tonnes M) 2010-15 (metric tonnes M) 112 114 3.0 111 112 112 110 3.3 0.7 110 108 4.8 1.2 36% 108 4.2 106 8% 38% 106 14% 104 102 104 103 102 56% 102 48%
100 100
98 98 2010 China USA ROW 2015 2010 China USA ROW 2015
Source: USDA, NBS. Source: USDA, NBS.
China’s hog production fragmented vs US Per data compiled by Frost & Sullivan, China’s hog production market is fragmented, with only 10% of hog farms having herd sizes over 10,000 heads. While the percentage increased from 4% in 2007 to 10% in 2015, it is dwarfed by the US’s 75%. In China, the majority of hog farms are small-scale (herd sizes of 1-500), at 57%, but we believe this percentage will continue to decline, given the government’s encouragement of consolidation in service of environmental protection and quality control.
Figure 36: China’s hog production share by hog farm size (head) Figure 37: US hog production share by hog farm size (head)
100% 4% 100% 6% 7% 9% 10% 22% 26% 80% 29% 80% 32% 33% 67% 71% 72% 60% 60% 74% 75% 10,000+ 10,000+ 500-10,000 500-10,000 40% 40% 74% 1-500 1-500 68% 63% 59% 57% 20% 20% 28% 25% 25% 23% 22%
0% 0% 5% 4% 3% 3% 3% 2007 2009 2011 2013 2015 2004 2006 2008 2010 2012
Source: Frost & Sullivan. Source: Frost & Sullivan.
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China’s slaughterhouses are in consolidation China’s government has adopted a policy – based on the Outline of Development Plan of the National Hog Slaughter Industry (2011-2015 & 2016-2020) – to consolidate and reduce the number of licensed slaughterhouses to improve production efficiency and improve food safety. Smaller operators that are unable to bear the increasing costs of regulatory compliance such as environmental protection regulations are likely to close and leave the market, in our view. Indeed, the number of slaughterhouses in China decreased 80% between 2010 and 2015, from 23,000 to 4,000, and is expected to decline further, to below 2,000, before 2020, according to Frost & Sullivan’s forecasts.
Figure 38: Number of slaughtering houses is consolidating in China Figure 39: Processed meat products consumption breakdown in China 25,000 23,430 100% 19,938 34% 34% 35% 35% 36% 37% 20,000 80% 39% 41% 42% 43% 44% 14,720 15,000 60% 9,985 10,000 40% 6,447 66% 66% 65% 65% 64% 63% 61% 59% 58% 57% 56% 3,979 5,000 3,301 2,740 20% 2,235 1,933 1,785
- 0% 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E
Number of licensed slaughtering houses in China HTMP (ham sausage, canned pork) LTMP (hams, sausages, bacon)
Source: Frost & Sullivan. Source: Frost & Sullivan.
Growth opportunities differ across pork categories While China’s pork consumption appears to remain high relative to the rest of the world, we expect growth opportunities in China to differ across categories in the fresh pork segment.
Warm fresh pork sold through the wet market channel traditionally represented the majority. However, the growth of chilled fresh pork has accelerated, given continuing urbanization and rising awareness of food safety and hygiene requirements. Warm fresh pork comprised 78% of total fresh pork consumption in 2010 in China, but retreated to 55% in 2015, whereas chilled fresh pork and frozen fresh pork comprised 10% and 12% in 2010, respectively, and grew to 25% and 20% in 2015, respectively. We believe this trend was driven by demand for safer and higher-quality pork products and a stronger preference for the modern retail channel, given its better hygiene and more comfortable environment.
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Figure 40: China fresh pork consumption volume by category Figure 41: China fresh pork consumption volume by channel 100% 100% 3% 1% 14% 18% 80% 80% 9% 55% 17% Others 60% 78% 60% Warm fresh pork Hotels & restaurants Frozen fresh pork Modern retailers 40% 40% 68% 20% Chilled fresh pork 56% Wet markets Retail stores 20% 20% 12% 25% 10% 8% 0% 0% 6% 2010 2015 2010 2015
Source: Frost & Sullivan. Source: Frost & Sullivan.
Relatively stable “GP dollar” for fresh pork business Hog production prices and ex-factory pork prices tend to move in tandem in China and the US, implying the ability of fresh pork sellers to pass on hog price increases to consumers.
In China, “GP dollar” (defined by J.P. Morgan as ex-factory pork prices minus hog prices, ignoring labor and other production costs) increased from Rmb3/kg in 2000 to Rmb6/kg in Nov 2016. We believe this reflects a combination of rising household income, labor cost inflation and strong demand for pork products. “GP margin” (defined by J.P. Morgan as GP dollar over pork price) averaged 25-30% with relatively little volatility.
In the US, GP dollar increased from US$25/CWT in 2000 to US$40/CWT in Nov 2016, and GP margin is 30-40%, which we believe reflects higher profitability due to a greater market share concentration.
Figure 42: China hog price vs ex-factory pork prices (Rmb/kg) 30.0
25.0
20.0
15.0
10.0
5.0
- 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r r v c y v c y v c y v g p b g p b g p b g n n n n n n n n u c u c u c a p a p a p a o e a o e a o e a o u e u e u e u a u e a u e a u e a u J J J A O A O A O J J J J J J J J M M M M F F F A N S D A N S D A N S D A N M Hog Price Factory wholesale PorkM Price "GP" Dollar M
Source: NDRC, China MoA.
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Figure 43: US hog price vs ex-factory pork prices (US$/CWT) 140.00 120.00 100.00 80.00 60.00 40.00 20.00 - 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r v c y v c y v c y v n n p b g n n p b g n n p b g n n u c u c u c p a p a p a o e a o e a o e a o a u e e u a u e e u a u e e u a u J J J A O A O A O J J J J J J J J F M F M F M N S D A N S D A N S D A N M M M Hog Price Factory wholesale Pork Price "GP" Dollar
Source: NDRC, China MoA.
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China’s pork industry value chain Hog production The hog production cycle can be categorized into two periods: the preparation and construction period (one year) and the hog production cycle (10-12 months).
Figure 44: Development cycle of hog production
Source: Company reports.
The hog raising process takes 10-12 months and comprises four key stages: (1) breeding and gestation; (2) farrowing; (3) nursery; and (4) fattening.
Table 11: Average market hog’s life cycle Stage # 1: 15-16 weeks Breeding & gestation Breeding and maintenance of producing females Stage #2: 2-3 weeks Farrowing Sows nurse piglets Stage #3: 6-7 weeks Nursery After weaning until 25kg Stage #4: 16-20 weeks Fattening & finishing Feeding hogs until slaughter-ready (100-110kg) Source: USDA, University of Iowa and J.P. Morgan estimates.
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Stage 1: Once insemination is successful, sows will farrow (give birth) in approximately 16 weeks. Stage 2: The piglets are then nursed for two to three weeks by the sow until they are weaned at an average weight of 5-8kg. Stage 3: After the piglets are weaned, the sow can reproduce again, repeating the process slightly more than twice a year. The weaned pigs go to the nursery for about six to seven weeks, where they are fed varying protein rations until they grow to 25kg. Stage 4: The feeder pigs are ready to enter the finishing phase, an intense feeding period where they remain until they reach the desired slaughter weight (100- 110kg). Hog price cycle and seasonality Hog production/price cycles are a function of supply-demand responses to changing hog economic conditions in the hog business.
Early expansion: In early stages of increasing profitability, producers start to expand production to take advantage of the expected profit opportunity. Peak and the start of the downcycle: Expansion typically continues until larger supplies cause prices to drop to unprofitable levels for hog producers. Downcycle: Producers respond by reducing production or leaving the industry. The liquidation of sows adds to supply as the expansion phase of the cycle ends. Trough: As a smaller breeding herd is later reflected in smaller supplies of pork, prices trend higher again, profits improve, and the stage is set for another period of cyclical expansion. Apart from hog prices, production costs (in particular, feed costs) also determine profitability and contribute to cyclical production trends. China’s hog price cycle is more explicit and shorter than the US, as China’s hog farms’ market shares are fragmented, with much more smaller players. This is complicated by the fact that the biological cycle means it can take a year or more (from breeding, making a decision to expand a herd, etc.), a considerable time lag before hog producers begin to respond to changes in hog profitability until there are actual changes in the level of pork production. The trough and peak prices of each cycle are also climbing higher than in previous ones because, in our view, of rising household income and strong demand for pork products. While some portion of cost continues to rise, such as labor and environmental protection costs, we believe they can be offset by improved efficiency and productivity. More importantly, industry consolidation helps key players scale up, which can also effectively reduce their fixed costs. Seasonal variations in demand Hog prices and demand fluctuations follow a seasonal pattern in China in between cycles. As a general rule of thumb, hog prices are generally higher around major holiday periods (Chinese New Year, Mid Autumn). Hog prices also tend to follow a seasonal pattern of high summer prices and low fall prices. One reason for the seasonality is that hot summer temperatures suppress animals’ appetites, causing them to eat less. They thus require longer periods to reach market-ready weights (100-110kg), which temporarily restrains supply. Another reason is that farrowing performance is lower during the winter.
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Hop price expectations Hog prices have been in an upcycle since early 2015, as the market is running short of supply in both sows and hogs. Historically, a peak-to-peak cycle usually takes three years in China, but we believe the cycle will gradually extend to four to five years, as the supply-driven cycle is under consolidation due to the government’s environmental protection policy, which should impact smaller players that are unable to afford the incremental costs and will therefore eventually quit the market. Hog prices currently trade at around Rmb17/kg, and we expect them to remain stable till the end of 2016, for an average hog price of Rmb18.6/kg for China, +18% y/y. We expect hog prices to decline to Rmb16.5/kg levels in 2017 (-11% y/y), as we expect increased supply in both sows and hogs.
Figure 45: China hog price (Rmb/kg) 23 Peak 21 Peak 19 Peak 17 15 13 11
9 Trough 7 Trough Trough 5 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r r v c y v c y v c y v g n n p b g n n p b g n n p b g n n c c c u u u a a a a p p p o e a o e a o e a o u a u e e u a u e e u a u e e u a u J J J A O A O A O J J J J J J J J M F M F M F M A N S D A N S D A N S D A N M M M Source: NDRC.
Figure 46: US hog price (US$/CWT)
105 95 85 75 65 55 45 35 25 15 5 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 7 7 8 8 8 9 9 0 0 1 1 1 2 2 3 3 3 4 4 5 5 6 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l t t t r r r r r r r v c y v c y v c y v g n n p b g n n p b g n n p b g n n u c u c u c a a a a p p p a a a o e o e o e o u a u e e u a u e e u a u e e u a u J J J A O A O A O J J J J J J J J M F M F M F M A N S D A N S D A N S D A N M M M
Source: USDA.
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Figure 47: China’s hog farms are fragmented, output >10,000 heads Figure 48: US hog farms are highly concentrated, with output accounts for 10% of total >10,000 heads accounting for 75% of total
100% 4% 100% 6% 7% 9% 10% 22% 26% 80% 29% 80% 32% 33% 67% 71% 72% 60% 60% 74% 75% 10,000+ 10,000+ 500-10,000 500-10,000 40% 40% 74% 1-500 1-500 68% 63% 59% 57% 20% 20% 28% 25% 25% 23% 22%
0% 0% 5% 4% 3% 3% 3% 2007 2009 2011 2013 2015 2004 2006 2008 2010 2012
Source: Frost & Sullivan Source: Frost & Sullivan
Government hog price intervention mechanism Several government ministries, including NDRC, Ministry of Agriculture, Ministry of Finance and Ministry of Commerce, revised the “market stabilization” mechanism in October 2015 and aimed at stabilizing hog prices. The hog-to-corn ratio (a measure of short-term profitability in hog production) is used as a hog “price alert.”
The revised policy sets an ideal hog-to-corn price ratio at 5.5-8.5:1, which is categorized as the green zone. When the hog-to-corn price ratio rises to near 9:1 or falls to near 5:1, the government will intervene in the market in order to bring the ratio back to the desired range (either increase meat inventories to support market prices or release government inventories to drive down pork prices). See the table below for more details about the mechanism.
The hog-to-corn ratio has remained above 8:1 YTD and is currently at around 9:1. The ratio has already decreased from its cyclically high level of close to 10:1 in May/June because the NDRC required local governments to release their pork reserves and increase frozen pork imports.
Table 12: Major action points set by policy in China to stabilize hog prices amid hog price volatility Hog-to-corn price ratio Actions Green Zone: 5.5-8.5:1 Government will timely release information on hog production and market prices. Reserve of frozen pork is 10,000 tonnes, but this amount may be adjusted to supply and demand. Blue Zone: 8.5-9.0:1 or 5.0-5.5:1 NDRC will release early warnings for farmers to adjust their production. Yellow Zone: 9.0-9.5:1 or 4.5-5.0:1 If the ratio falls in the yellow zone for some time (typically one month), NDRC will hold a conference for a proposal of releasing/building up frozen pork reserves, and MoC will help implement. Red Zone: Higher than 9.5:1 or lower If the ratio falls in the yellow zone for some time (typically one month), NDRC will hold a conference for a proposal of than 4.5:1 releasing/building up frozen pork reserves, and MoC will help implement. If reserves hit 250,000 tonnes, government will restrict imports/exports. Other cases: hog price rises or drops N/A abnormally Source: NDRC, MoA, MoF, MoC.
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Figure 49: China’s hog-to-corn ratio 12 11 10 9 8 7 6 5 4 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 5 5 6 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l l l l l l l l l l l l l l l r r r r r r r r r r r r r r r r r v v v v v v v v v v v v v v v v v u u u u u u u u u u u u u u u u u a a a a a a a a a a a a a a a a a o o o o o o o o o o o o o o o o o J J J J J J J J J J J J J J J J J M M M M M M M M M M M M M M M M M N N N N N N N N N N N N N N N N N
Hog/corn ratio -1 Stdev +1 Stdev Mean
Source: NDRC.
China’s corn prices are in a downtrend China’s government launched a policy in 2007 to support the prices of some agriculture products (corn, soybean, cotton) by building up national reserves, with targeted purchase prices and limiting the quantity of imports. This policy has driven China’s domestic corn prices to over an 80% premium to the US and further widened to over 100% in 2014 and 2015. In September 2015, the government revised down its purchase prices, the first decline since 2007, when the corn reserve policy was initiated, with an aim to clear the government’s corn reserve inventory and suppress domestic corn prices, which were the most expensive in the world.
The change in reserve policy in 2015 was planned to reduce the government’s reserve inventory and leave the market to determine its fair price. Industries (feeds, ethanol) that use corn as input cost and make losses had been complaining about the policy distortion. The policy change was welcomed by these industry players. Corn prices have declined from Rmb2.5-2.6/kg in 2014 to around Rmb1.9/kg currently, and the gap to the US is narrowing, though it is still over 80% above that in the US.
We expect corn prices to decline to Rmb2/kg (-10% y/y) in 2016 and stay stable in 2017.
Figure 50: China and US average corn price comparison (US$/kg) Figure 51: China’s corn prices (Rmb/kg) 0.45 0.39 0.40 2.7 0.40 0.37 0.35 0.33 2.5 0.35 0.30 0.28 0.30 2.3 0.24 0.25 0.27 0.27 2.1 0.20 0.23 0.15 0.17 0.16 1.9 0.10 0.15 0.15 0.14 1.7 0.05 - 1.5
2009 2010 2011 2012 2013 2014 2015 YTD2016 9 9 0 0 1 1 2 2 3 3 4 4 5 5 6 6 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------y v y v y v y v y v y v y v y v
China corn price (US$/kg) US corn price (US$/kg) a o a o a o a o a o a o a o a o N N N N N N N N M M M M M M M M
Source: USDA, NDRC. Source: USDA, NDRC.
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Wide hog/pork price gaps between China and the US China’s hog prices were 2x higher than the US in 2015, and the gap has widened YTD. Pork prices are also widening from about 2.1x higher in 2015 to 2.4x YTD. Given that supply conditions in China improved a bit this year, we believe the gap may gradually narrow.
Given the price differential, China’s pork imports, mostly from the US, grew c130% y/y in 1H16, to 0.76m tons, which is around 3% of China’s total pork production volume of 24.73m tons during the period, per Ministry of Agriculture data. However, we believe there will be a limit for such imports, as only frozen pork can be imported. Further, consumers tend to prefer chilled fresh pork, and the demand for such products is increasing (up 150%+ over 2010-15).
Figure 52: China and US average hog price comparison (US$/kg) Figure 53: China and US average pork price comparison (US$/kg) 3.00 2.83 4.00 2.65 3.74 3.44 3.32 2.38 2.46 2.45 3.50 3.28 3.28 2.50 2.20 3.04 3.00 2.00 1.75 2.4x 2.31 1.64 3.1x 2.50 2.20 2.1x 2.4x 1.50 2.00 1.58 2.17 1.47 1.42 1.32 1.50 1.91 1.82 1.00 1.21 1.67 1.73 1.02 1.55 1.55 0.93 0.92 1.00 1.21 0.50 0.50 - - 2009 2010 2011 2012 2013 2014 2015 YTD2016 2009 2010 2011 2012 2013 2014 2015 YTD2016
China hog price (US$/kg) US hog price (US$/kg) China pork price (US$/kg) US pork price (US$/kg)
Source: USDA, NDRC. Source: USDA, NDRC.
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Company Overview
Company history and description COFCO Meat, a subsidiary of COFCO Group, was founded in 2009 with engagement in pork businesses. The company operates a vertically integrated value chain from feed production, hog production and slaughtering to the production, distribution and sale of fresh pork and processed meat products, and the import and sale of frozen meat products. COFCO Meat has 47 hog farms (24 new projects are under construction and are expected to be completed by end of 2016), two slaughtering plants and two processed meat plants.
In 2015, COFCO Meat ranked 4th in hog production by production volume of finishing hogs, 8th/9th in fresh pork/processed meat sales, and 2nd in meat imports by the volume of imports. In the short term, the company plans to expand its hog production capacity so it can control the quality of the source from upstream. In the long term, COFCO Meat plans to expand downstream to match the capacity of upstream, which will form an integrated platform that will become less cyclical.
The company had hog production capacity of 2.3m heads as of end-2015 and plans to expand annual hog production capacity to 5.5m heads by 2020.
In May 2014, COFCO Meat announced the formation of a strategic partnership with a consortium of investors composed of KKR, Baring, Hopu and Boyu, which held 20%, 9%, 8.2% and 7.8% of total issued shares, respectively. In September 2015, Hopu sold its entire stake in COFCO Meat to Temasek. After the IPO, the public will hold 25% of the outstanding shares while the pre-IPO shareholders’ stake will be decreased by 25% proportionally.
Figure 54: China hog production market share by production volume Figure 55: China’s fresh pork market share by sales revenue, 2015 of finishing hogs, 2015 3.0% 2.5% 2.6%
2.5% 2.0% 1.9%
2.0% 1.5% 1.2% 1.5% 1.0% 1.0% 0.5% 0.5% 0.5% 0.3% 0.2% 0.2% 0.2% 0.5% 0.3% 0.3% 0.1% 0.1% 0.2% 0.2% 0.0% 0.0% A B C D E F G COFCO I J A B C COFCO MEAT E MEAT
Source: Frost & Sullivan. Source: Frost & Sullivan.
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Fig 56: China’s processed meat market share by sales revenue, 2015 Fig 57: China’s meat imports market share by import volume, 2015 9.0% 8.5% 6.0% 8.0% 5.0% 5.0% 7.0%
6.0% 4.0% 5.0% 3.2% 4.0% 3.0% 2.2% 3.0% 2.1% 2.0% 2.3% 2.0% 2.0% 1.6% 1.0% 0.9% 0.8% 1.0% 1.0% 0.2% 0.1% 0.1% 0.1% 0.0% A B C D E F G H COFCO J 0.0% MEAT A COFCO MEAT C D E
Source: Frost & Sullivan. Source: Frost & Sullivan.
Figure 58: Shareholder structure before IPO
COFCO
100%
COFCO (HK)
100%
China Foods MIY (Holdings)
67% 33%
Mainfield KKR Baring Temasek Boyu
55.0% 20.0% 9.0% 8.2% 7.8%
COFCO Meat
Source: Company reports. Note: MIY is a consortium of Mitsubishi, Itoham and Yonekyu.
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Figure 59: Shareholder structure post IPO
COFCO
100%
COFCO (HK)
100%
China Foods (Holdings)
100%
Other Mainfield MIY KKR Baring Temasek Boyu shareholders
27.64% 13.61% 15.00% 6.75% 6.15% 5.85% 25.00%
COFCO Meat
Source: Company reports. Note: MIY indicates Mitsubishi, Itoham and Yonekyu.
Table 13: Management team Name Age Position Experience Ma Jianping 52 Chairman Mr Ma joined COFCO in 1986 and is currently vice president of COFCO. 马建平 XU Jianong 51 Managing Director & Mr Xu has more than 25 years of experience in agricultural commodities and foods processing in China. He 徐稼農 General Manager of joined COFCO in 1987 and has carried out managerial functions in several COFCO subsidiaries (such as COFCO Meat Head of brewing materials division of China Agri from Aug 2000 to Sep 2008). He joined COFCO Meat in 2013 SHEN Yunxiang 52 Deputy general manager of Mr Shen has more than 19 years of experience in the hog production industry. Before joining COFCO, Mr 沈雲祥 COFCO Meat & head of hog Shen served in Pig Improvement Co in 1997-2006 and Jilin Huazheng Agribusiness Development in 2006- production 2009. Mr Shen joined the group in 2009. ZHANG 53 Deputy general manager of Mr Zhang has more than 27 years of experience in the meat industry and has extensive experience in Changxin COFCO Meat & head of corporate management. He joined COFCO in 1989 and held a number of positions within the Group. 張昌新 fresh pork LI Lei 李雷 35 CFO Mr Li has over 10 years of experience in financial management and food and agriculture industries. He joined COFCO in 2004 and served as general manager of finance department of China Agri's brewing materials in 2007-2013. ZHANG Jinglei 41 Head of processed meat Mr Zhang joined COFCO in 1995 and has served several positions in different entities under COFCO Group. 張京雷 division LI Zhengfang 41 Deputy head of international Ms Li joined COFCO in 1997 and has served several positions in different entities under COFCO Group. 李正芳 trading division ZHANG Nan 35 Deputy head of strategy & Dr Zhang obtained a doctor's degree from Tsinghua University in 2008 and joined the Group since graduation. 張楠 joint company secretary Dr Zhang has extensive experience in meat industry research and strategy planning. Source: Company reports.
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Operational Review
Segment overview COFCO Meat has an integrated model, with operations across the entire pork industry value chain. This includes: (1) hog production (#4 market player), (2) slaughtering and fresh pork (#8), (3) processed meat production, sales and distribution (#9), (4) international trade, importing and selling frozen meat and byproducts in China (#2).
Figure 60: Overview of key business segments
Source: Company reports.
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Table 14: Sales and operating profit split by segment Rmb in millions 2013 2014 2015 2016E 2017E 2018E Revenue by product (external) Hog production 385 411 756 1,658 2,099 2,733 % chg. y/y 6.6% 84.1% 119.3% 26.6% 30.2% Fresh pork 1,426 1,443 2,027 3,093 3,562 4,273 % chg. y/y 1.2% 40.5% 52.6% 15.1% 20.0% Processed meat products 271 290 330 351 352 376 % chg. y/y 7.3% 13.6% 6.5% 0.2% 6.8% International trading 1,652 1,603 1,943 2,137 2,351 2,586 % chg. y/y -3.0% 21.2% 10.0% 10.0% 10.0% Total 3,734 3,746 5,056 7,239 8,363 9,967 % chg. y/y 0.3% 35.0% 43.2% 15.5% 19.2%
OP (Rmb per kg) Hog production 0.7 (1.2) 1.2 5.6 4.1 2.9 chg. y/y (1.9) 2.4 4.4 (1.5) (1.2) Fresh pork (0.1) (0.1) (0.0) (0.1) (0.0) 0.0 chg. y/y 0.0 0.1 (0.1) 0.1 0.1 Processed meat products (1.5) (0.1) 0.4 (1.2) (0.5) 0.2 chg. y/y 1.4 0.5 (1.6) 0.7 0.7 International trading 0.5 0.0 (0.2) (0.0) 0.1 0.2 chg. y/y (0.5) (0.3) 0.2 0.1 0.1
Operating profit (external+internal) Hog production 60 (120) 138 1,007 1,045 1,057 Fresh pork (10) (7) (1) (20) (10) 5 Processed meat products (11) (0) 4 (11) (5) 3 International trading 40 2 (74) 33 9 22 Oher adjustments (64) (50) 3 (66) (42) (50) Total 15 (176) 70 942 998 1,036
Recurring operating profit (external+internal) Hog production 60 (120) 138 1,007 1,045 1,057 Fresh pork (10) (7) (1) (20) (10) 5 Processed meat products (11) (0) 4 (11) (5) 3 International trading 40 2 (24) (4) 9 22 Oher adjustments (64) (50) 3 (66) (42) (50) Recurring operating profit excluding one-offs 15 (176) 120 905 998 1,036
Recurring OPM (based on external+internal sales) Hog production 4.7% -9.7% 7.9% 30.4% 24.9% 19.3% Fresh pork -0.6% -0.5% -0.1% -0.6% -0.3% 0.1% Processed meat products -4.1% -0.2% 1.2% -3.3% -1.4% 0.7% International trading 2.4% 0.1% -1.2% -0.2% 0.4% 0.8% Source: J.P. Morgan estimates, Company reports. Note: Other adjustments are those income/expenses booked under segments but not included in reported overall recurring EBIT.
Figure 61: Sales revenue breakdown by segment Figure 62: Sales volume breakdown by segment 100% 100%
27% 26% 29% 38% 80% 44% 43% 80% 3% 3% 3% 60% 7% International trading 60% International trading 8% 7% Processed meat products 36% 36% 35% Processed meat products 40% Fresh pork 40% Fresh pork 40% Hog production Hog production 38% 39% 20% 20% 34% 34% 33%
10% 11% 15% 0% 0% 2013 2014 2015 2013 2014 2015
Source: Company reports, J.P. Morgan. Source: Company reports, J.P. Morgan.
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Production capacity and expanded plan Figure 63: Location of production facilities
Source: Company reports.
Table 15: Capacity of production facilities
Hog farms Slaughtering facilities # of hog farms Capacity (000 heads) Capacity (000 heads) Existing projects Existing projects Chifeng, Inner Mongolia 10 500 Dongtai, Jiangsu 1,500 Songyuan, Jilin 5 250 Wuhan, Hubei 500 Zhangbei, Hebei 4 200 Total 2,000 Tianjin 2 100 Processed meat facilities Yancheng, Jiangsu 17 800 Location Capacity (000 metric tonnes) Wuhan, Hubei 9 440 Existing projects Total 47 2,290 Wuhan, Hubei 7 Heshan, Guangdong 10 New projects Total 17 Chifeng, Inner Mongolia 2 55 Feed mills Zhangbei, Hebei 6 331 New projects Guangshui, Hubei 4 219 Songyuan, Jilin 180 Zunhua, Hebei 6 344 Chifeng, Inner Mongolia 180 Songyuan, Jilin 6 300 Zhangbei, Hebei 180 Total 24 1,249 Guangshui, Hubei 180 Total 720 Source: Company reports.
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Segment Overview: Production Process, Capacity, Products And Brands
Hog production segment COFCO Meat had capacity of around 2.3m heads as of end-2015 and is expected to expand to over 3.5m heads by end-2016. The hog farms are largely located in Hubei, Jiangsu, Jilin and Inner Mongolia. Hog production is a fragmented market; the company’s market share was only 0.2% in 2015, or #4 in the year, compared to #1 at 2.6%, #2 at 0.3% and #3 at 0.3%. In 2015, 57% of the company’s hog production was supplied to internal slaughterhouses, while the remaining 43% was external sales by value. In the long term, the company plans to integrate the value chain, with a majority of its production supplies to its downstream businesses.
Figure 64: Hog production process
Source: Company reports.
Table 16: Hog production financial data and estimates 2013 2014 2015 2016E 2017E 2018E Sales (internal + external) (Rmb M) Hog production 1,285 1,237 1,750 3,315 4,198 5,466 y/y growth -3.7% 41.4% 89.5% 26.6% 30.2% Internal hog sales 900 827 994 1,658 2,099 2,733 y/y growth -8.1% 20.2% 66.8% 26.6% 30.2% as % of total 70% 67% 57% 50% 50% 50% External hog sales 385 411 756 1,658 2,099 2,733 y/y growth 6.6% 84.1% 119.3% 26.6% 30.2% as % of total 30% 33% 43% 50% 50% 50%
Sales volume (000 kg) 90,211 97,849 118,994 180,369 255,230 361,192 y/y growth 8.5% 21.6% 51.6% 41.5% 41.5% Average finishing weight (kg per head) 96.4 97.8 101.8 105.9 109.0 110.1 y/y growth 1.5% 4.1% 4.0% 3.0% 1.0%
ASP (Rmb per kg) 14.2 12.6 14.7 18.4 16.4 15.1 y/y growth -11.2% 16.3% 25.0% -10.5% -8.0% Hog/corn ratio (JPM estimates) 5.9 5.1 6.3 8.7 7.8 7.2
Capacity Hog production (000 heads) Hog production capacity 1,340 1,590 2,290 3,500 4,060 4,600 y/y growth 18.7% 44.0% 52.8% 16.0% 13.3% Hog production volume 936 1,001 1,169 1,704 2,341 3,279 y/y growth 6.9% 16.8% 45.7% 37.4% 40.1% Utilization rate* 69.8% 62.9% 51.0% 48.7% 57.6% 71.3%
Profitability (Rmb M) Operating profit 60 (120) 138 1,007 1,045 1,057 OPM 4.7% -9.7% 7.9% 30.4% 24.9% 19.3%
OP per kg 0.7 (1.2) 1.2 5.6 4.1 2.9 y/y chg. (1.9) 2.4 4.4 (1.5) (1.2) Source: J.P. Morgan estimates, Company reports. Note: Utilization rate calculated by finishing hogs (excluding those are not marketable yet) over capacity.
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Fresh pork segment COFCO Meat has two slaughterhouses in Dongtai, Jiangsu and Wuhan, Hubei, with a total capacity of 2m heads. Management highlights that slaughterhouse capacity should match production where it has hog raising businesses. The existing two slaughterhouses can gradually absorb the hog production in Hubei and Jiangsu. However, in northern China, it still lacks a slaughterhouse, which they plan to add. The fresh pork market is fragmented in China, with COFCO Meat holding only a 0.2% share (#8) and the top 10 players having c5%. In 2015, the fresh pork business supplied 4% of its production by value internally, and the majority was sold externally. Long-term, the company plans to increase the portion of internal sales.
Figure 65: Fresh pork production process
Source: Company reports.
Table 17: Fresh pork financial data and estimates 2013 2014 2015 2016E 2017E 2018E Sales (internal + external) (Rmb M) Fresh pork 1,484 1,506 2,107 3,222 3,710 4,451 y/y growth 1.5% 39.9% 52.9% 15.1% 20.0% Internal fresh pork sales 58 64 80 129 148 178 y/y growth 10.5% 24.3% 62.1% 15.1% 20.0% as % of total 4% 4% 4% 4% 4% 4% External fresh pork sales 1,426 1,443 2,027 3,093 3,562 4,273 y/y growth 1.2% 40.5% 52.6% 15.1% 20.0% as % of total 96% 96% 96% 96% 96% 96%
Capacity Fresh pork Slaughtering capacity (000 hogs) 2,000 2,000 2,000 2,000 2,600 2,800 Production volume (000 hogs) 966 1,087 1,263 1,571 1,961 2,510 Utilization rate 48.3% 54.3% 63.1% 78.5% 75.4% 89.6%
Sales volume (000 tons) 94.5 102.9 127.8 162.1 206.7 267.6 y/y growth 8.9% 24.2% 26.8% 27.5% 29.5%
ASP (Rmb per kg) 15.7 14.6 16.5 19.9 17.9 16.6 y/y growth -6.8% 12.6% 20.6% -9.7% -7.3% On top of hog production (Rmb per kg) 1.5 2.0 1.8 1.5 1.5 1.5
Profitability (Rmb M) Operating profit (10) (7) (1) (20) (10) 5 OPM -0.6% -0.5% -0.1% -0.6% -0.3% 0.1%
OP per kg (0.1) (0.1) (0.0) (0.1) (0.0) 0.0 y/y change 0.0 0.1 (0.1) 0.1 0.1 Source: J.P. Morgan estimates, Company reports.
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Processed meat segment COFCO Meat has two processed meat plants in Hubei and Guangdong with annual capacity of 17,000 tons. The business is still small, with only 0.1% market share in 2015 (#9), compared to the Top 3 players’ shares of 8.5%, 2.3% and 1.6%. In the long term, management plans to add more plants close its hog farms and slaughterhouses, as the company targets expanding the business from upstream to downstream, which can better ensure food safety and quality. The company’s processed meat products are under two core brands: Maverick (primarily in southern and eastern China) and Joycome (premium low-temperature products primarily in central, eastern, and northern China).
Figure 66: Processed meat production process
Source: Company reports.
Figure 67: Joycome-branded products Figure 68: Maverick-branded products
Source: Company reports. Source: Company reports.
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Table 18: Processed meat financial data and estimates 2013 2014 2015 2016E 2017E 2018E Sales (internal + external) (Rmb M) Processed meat 271.8 290.9 329.8 351.3 352.0 375.9 y/y growth 7.0% 13.4% 6.5% 0.2% 6.8% Internal processed meat sales 0.9 0.5 0.0 - - - y/y growth -48.0% -98.5% External processed meat sales 270.9 290.4 329.8 351.3 352.0 375.9 y/y growth 7.2% 13.6% 6.5% 0.2% 6.8%
Capacity Processed meat Annual production capacity (tons) 17,000 17,000 17,000 17,000 18,000 20,000 Annual production volume (tons) 7,913 8,623 9,974 10,200 10,800 12,000 Utilization rate 46.5% 50.7% 58.7% 60.0% 60.0% 60.0%
Sales volume (000 tons) 7.5 8.4 9.5 9.8 10.4 11.5 y/y growth 10.7% 14.2% 2.6% 5.9% 11.1% ASP (Rmb per kg) 36.0 34.8 34.5 35.9 33.9 32.6 y/y growth -3.3% -0.8% 3.9% -5.4% -3.9% On top of fresh pork (Rmb per kg) 20.3 20.2 18.1 16.0 16.0 16.0
Profitability (Rmb M) Operating profit (11) (0) 4 (11) (5) 3 OPM -4.1% -0.2% 1.2% -3.3% -1.4% 0.7%
OP per kg (1.5) (0.1) 0.4 (1.2) (0.5) 0.2 y/y change 1.4 0.5 (1.6) 0.7 0.7 Source: J.P. Morgan estimates, Company reports
International trade segment COFCO Meat had annual sales of 107,219 tons in 2015, with pork and its byproducts accounting for 56% of total sales volume. The company believes this business will have a stable growth rate, given solid demand.
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Table 19: International trade financial data and estimates 2013 2014 2015 2016E 2017E 2018E Sales (internal + external) (Rmb M) International trading 1,659 1,604 1,950 2,145 2,360 2,596 y/y growth -3.3% 21.6% 10.0% 10.0% 10.0% Internal sales 7 2 7 8 9 10 y/y growth -78.0% 352.5% 10.0% 10.0% 10.0% External sales 1,652 1,603 1,943 2,137 2,351 2,586 y/y growth -3.0% 21.2% 10.0% 10.0% 10.0%
Sales volume International Trading (000 tons) 72.8 75.1 107.2 118.0 129.1 140.4 y/y growth 3.2% 42.8% 10.1% 9.4% 8.8% Pork 21.0 23.9 60.3 65.1 69.0 73.1 y/y growth 13.8% 152.0% 8.0% 6.0% 6.0% Poultry 26.0 31.8 26.5 27.8 29.2 30.6 y/y growth 22.4% -16.8% 5.0% 5.0% 5.0% Beef 19.3 14.7 18.1 22.6 28.2 33.8 y/y growth -23.7% 22.6% 25.0% 25.0% 20.0% Mutton & Lamb 6.5 4.7 2.5 2.6 2.7 2.9 y/y growth -27.9% -47.4% 5.0% 5.0% 5.0%
ASP (Rmb per kg) 22.8 21.4 18.2 18.2 18.3 18.5 y/y growth -6.3% -14.8% 0.0% 0.6% 1.1%
Profitability (Rmb M) Operating profit 40 2 (74) 33 9 22 OPM 2.4% 0.1% -3.8% 1.5% 0.4% 0.8% Normalized operating profit (24) (4) 9 22 Adjusted OPM -1.2% -0.2% 0.4% 0.8% Source: J.P. Morgan estimates, Company reports.
Distribution network and customer profile Hog production: In 2015, COFCO Meat supplied c55% of its production internally, while the remaining c45% was supplied to slaughtering plants near its hog farms. External sales may include some piglets or sows to hog dealers or small-scale hog farms, but internal sales include only finishing hogs. Fresh meat: In 2015, only 4% of fresh pork was supplied to internal processed meat plants, given the small scale, and the majority (96%) of the output was sold primarily to wholesalers, distributors, food processors, hypermarkets and supermarkets, restaurants and canteens, Joycome-designated stores and also through the e- commence channel. As of 2015, COFCO Meat had 175 distributors across the country, with sales making up 31% of total sales. Processed meat: The company’s processed meat products are under two core brands: Maverick and Joycome. They are sold primarily to hypermarkets and supermarkets, retail stores, distributors, restaurants and canteens, Joycome-designated stores and through the e-commerce channel. While COFCO also operates some self-owned retail stores in Beijing, the scale is still small. As of 2015, the company had 133 distributors across the country, with sales accounting for 22% of the total. International trade: Meat imports are basically a B2B business, with most selling to internal meat processed plants, food processors, restaurants and canteens. Pork byproducts are the majority, accounting for over 50% of sales, poultry 25%, beef c17% and the remainder mutton.
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Financials
We expect COFCO Meat to deliver 43% y/y sales growth in FY16 thanks to a combination of higher capacity and increasing hog prices (up 25% y/y). We expect adjusted GPM (excluding fair value adjustment to biological assets) to increase to c19%, given rising hog prices and decreasing corn prices, with the hog-to-corn ratio at 8.7x in FY16E, based on our estimates. We expect the ratio to decline to 7.8x and 7.2x in FY17 and FY18, respectively.
Balance sheet and cash flow We expect inventory and biological assets to double in FY16 vs FY15, given the increasing capacity in hog raising, which may lengthen the cash cycle from around 30 days in FY15 to around 60 days in FY16-18, in our view. While the initial outlays for the capacity expansion may outpace profits in FY16, the proceeds from IPO have brought in an additional cRmb1.8b of cash inflow, which could help net cash flow remain positive for FY16. If excluding such proceeds, we expect the company to experience negative cash flow in FY16-17 and turn positive in FY18.
On profitability, we expect COFCO Meat to record a c21% ROE in FY16 (vs -1% in FY15), driven mainly by a significant increase in net margin and also sales growth. In 2017-18, we expect ROE to normalize at around low-to-mid teens.
Table 20: DuPont analysis 2013 2014 2015 2016E 2017E 2018E ROE -16.0% -19.3% -0.9% 20.9% 14.3% 12.7% Net margins -2.2% -7.6% -0.4% 11.2% 10.1% 9.1% Sales/assets 75% 58% 65% 84% 78% 82% Average assets/average equity 9.5 4.4 3.0 2.2 1.8 1.7 Source: J.P. Morgan estimates, Company reports.
Table 21: Cash conversion cycle 2013 2014 2015 2016E 2017E 2018E Inventory days 73 94 38 60 62 62 Account receivables days 15 19 12 15 20 23 Account payables days 18 28 18 20 23 25 Cash conversion cycle 70 84 32 55 59 60 Source: J.P. Morgan estimates, Company reports.
For free cash flow, we expect COFCO Meat to remain negative in FY16 and FY17 and turn positive in FY18, with FCF/EBITDA of 52% in FY18.
Table 22: Cash flow summary 2013 2014 2015 2016E 2017E 2018E Cash flow from operations (479) (370) 381 602 1,105 1,370 Cash flow from investing activities (390) (699) (1,252) (726) (1,200) (600) Cash flow from financing activities 790 2,903 (1,098) 1,707 (137) (137) Effects of foreign currency translation (6) 10 9 - - - Change in cash and cash equivalents (79) 1,833 (1,969) 1,584 (233) 633 Beginning cash 384 299 2,142 182 1,766 1,533 Ending cash 299 2,142 182 1,766 1,533 2,166
FCF (898) (1,054) (401) (698) (95) 770 FCF/EBITDA -439% -2106% -118% -54% -7% 52% Source: J.P. Morgan estimates, Company reports.
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Table 23: P&L statement Rmb in millions 2013 2014 2015 2016E 2017E 2018E Revenue 3,734 3,746 5,056 7,239 8,363 9,967 y/y growth 0.3% 35.0% 43.2% 15.5% 19.2% Cost of sales (3,549) (3,626) (4,938) (6,870) (6,993) (8,448)
Gross profit 185 120 118 369 1,370 1,520 Gross margin 5.0% 3.2% 2.3% 5.1% 16.4% 15.2%
Gross profits excl. biological asset adj. 363 194 472 1,369 1,470 1,570 Adjusted GPM 9.7% 5.2% 9.3% 18.9% 17.6% 15.7% Improvement y/y (bps) 9.6% -1.3% -1.8%
Selling expenses (174) (195) (223) (246) (280) (334) as % of sales -4.7% -5.2% -4.4% -3.4% -3.3% -3.4% General and administrative expenses (174) (174) (179) (181) (192) (199) as % of sales -4.6% -4.7% -3.5% -2.5% -2.3% -2.0% Total opex (348) (369) (402) (427) (472) (533) as % of sales -9.3% -9.9% -7.9% -5.9% -5.6% -5.4%
Operating profit (163) (249) (284) (58) 898 986 y/y growth na na na na 9.9% Operating margin -4.4% -6.7% -5.6% -0.8% 10.7% 9.9%
Operating profits excl. biological asset adj. 15 (176) 70 942 998 1,036 y/y growth na na 1236.8% 5.9% 3.9% Adjusted OPM 0.4% -4.7% 1.4% 13.0% 11.9% 10.4% Improvement y/y (bps) -1.1% -1.5%
OP excl. biological asset and one-offs 15 (176) 120 905 998 1,036 y/y growth na na 652.1% 10.2% 3.9%
Other income 29 39 58 38 60 69 Other gains and losses (2) (24) (128) (1) (0) (0) Gain/(loss) arising from agricultural produce 23 (78) 250 600 (100) (50) Gain arising from changes in fair value 152 105 456 209 873 267 Finance costs (105) (138) (133) (137) (137) (137)
PBT (65) (346) 220 651 1,593 1,135 Tax expense (15.0) (3.6) (10.0) (32.5) (79.6) (56.8) Tax rate 23.2% 1.0% -4.5% -5.0% -5.0% -5.0%
Net profit (80) (349) 210 618 1,513 1,078 Net margin -2.1% -9.3% 4.1% 8.5% 18.1% 10.8% y/y growth 195.0% 144.7% -28.7%
One-off gains/losses 6.6 (16.1) (119.7) (1.1) - - Fair value changes in biological assets (2.3) (47.5) 351.7 (190.9) 672.5 167.3
Recurring profits (84) (286) (22) 810 841 911 y/y growth na na na 3.7% 8.4%
Discontinued operations (162) (62) (59) Total reported profits (242) (411) 151
EBITDA 205 50 341 1,288 1,416 1,491 y/y growth -75.5% 580.4% 278.1% 9.9% 5.3% Adjusted EBITDA margin 5.5% 1.3% 6.7% 17.8% 16.9% 15.0% D&A 189 226 270 346 418 455 Source: J.P. Morgan estimates, Company reports.
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Table 24: Balance sheet Rmb in millions 2013 2014 2015 2016E 2017E 2018E Current assets Inventories 710 933 519 1,129 1,188 1,435 Biological assets 541 603 936 1,121 1,819 2,033 Accounts receivable 153 190 165 297 458 628 Other receivables 186 204 178 178 178 178 Financial assets at fair value - - 500 500 500 500 Cash and equivalents 303 2,175 216 1,766 1,533 2,166 Others 6 2 997 45 45 44 Total current assets 1,900 4,108 3,511 5,036 5,721 6,984
Goodwill 101 101 101 101 101 101 Property and equipment, net 2,710 3,391 3,418 4,322 5,054 5,149 Biological assets 156 158 256 280 455 508 Prepaid lease payments 103 112 108 111 115 118 Others 30 159 43 43 43 43 Total non-current assets 3,099 3,921 3,926 4,858 5,767 5,919
Total assets 4,999 8,029 7,438 9,894 11,488 12,904
Current liabilities Accounts and bills payables 177 280 244 376 441 579 Other payables 438 710 661 941 958 1,157 Borrowings 1,754 3,200 2,053 2,053 2,053 2,053 Loans from holding company 814 6 907 907 907 907 Others 994 1,075 496 77 77 77 Total current liabilities 4,177 5,270 4,362 4,355 4,437 4,774
Non-current liabilities Long-term borrowings 266 283 370 370 370 370 Deferred income 30 38 61 61 61 61 Total non-current liabilities 296 322 431 431 431 431
Total liabilities 4,473 5,592 4,794 4,787 4,868 5,205
Shareholders’ equity Share capital & reserves 389 2,325 2,644 5,107 6,620 7,699
Minority interest 137 111 - - - - Total shareholders’ equity 526 2,437 2,644 5,107 6,620 7,699
Total liabilities and equity 4,999 8,029 7,438 9,894 11,488 12,904 Source: J.P. Morgan estimates, Company reports.
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Table 25: Cash flow statement Rmb in millions 2013 2014 2015 2016E 2017E 2018E Profit/loss for the year (242) (411) 151 618 1,513 1,078 Income tax expenses 19 5 11 33 80 57 Interest income (6) (8) (15) (3) (12) (13) Finance costs 124 154 141 137 137 137 Depreciation 133 156 175 346 418 455 Amortization 6 7 8 (3) (3) (3) Others (125) (119) (468) 14 (18) 6 Op cash flows before WC chg. (90) (216) 4 1,142 2,116 1,717
Increase in A/R (19) (38) (23) (132) (161) (170) Decrease/(increase) in inventories (347) (231) 279 (611) (59) (247) Decrease in biological assets 103 47 4 (209) (873) (267) Increase/(decrease) in A/P (131) 103 70 132 64 138 Others 11 (17) 54 280 17 199 Cash generated from/(used in) operations (474) (351) 387 602 1,105 1,370 Income tax paid (5) (20) (6) Cash flow from operations (479) (370) 381 602 1,105 1,370
Cash flow from investing activities Property, plant and equipment (419) (684) (782) (1,300) (1,200) (600) Others 29 (15) (470) 574 - - Cash flow from investing activities (390) (699) (1,252) (726) (1,200) (600)
Financing activities Interest paid (128) (161) (132) (137) (137) (137) New borrowings 760 1,462 (933) - - - Issue of new shares - 1,671 59 1,845 - - Others 158 (71) (92) - - - Cash flow from financing activities 790 2,903 (1,098) 1,707 (137) (137)
Effects of foreign currency translation (6) 10 9 - - - Change in cash and cash equivalents (79) 1,833 (1,969) 1,584 (233) 633
Beginning cash 384 299 2,142 182 1,766 1,533 Ending cash 299 2,142 182 1,766 1,533 2,166 Source: J.P. Morgan estimates, Company reports
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Investment Thesis, Valuation and Risks
COFCO Meat Holdings (Neutral; Price Target: HK$1.90) Investment Thesis We initiate coverage of COFCO Meat with a Neutral rating and a Dec-17 price target of HK$1.90. A subsidiary of the COFCO Group, COFCO Meat operates a vertically integrated value chain including feed & hog production, slaughtering, production and sale of fresh pork and processed meat products. Near-term earnings benefits from high hog prices and benign input costs (we expect COFCO Meat to post profit in FY16E vs a loss in FY15), and ongoing market share gains given the fragmented market should sustain strong volumes. But the company is likely to face some earnings volatility over the next two years as profits are very sensitive to hog prices, which peaked in 1H16. Although we see 15% potential upside to our price target, we are concerned about downside risks to estimates should hog prices soften beyond our base estimates.
Valuation Given the earnings volatility we use a DCF valuation and arrive at a valuation of HK$9.2b and a Dec-17E PT of HK$1.9, based on hog-to-corn ratio of 6.5:1 (which is the 16-year average hog-to-corn ratio in China). This equates to a 2017E P/E of 9.6x vs China pork names trading in a range of 9-15x.
Risks to Rating and Price Target Downside risks to our rating and price target include: (1) continuing earnings volatility due to hog price in a downcycle; (2) rising corn prices, (3) rising US imports, which could cap the price of pork in China and (4) food safety and regulatory risks.
Upside risks include: (1) better-than-expected hog price, (2) deeper corn price corrections, and faster-than-expected efficiency improvements.
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COFCO Meat Holdings: Summary of Financials Income Statement Cash flow statement Rmb in millions, year end Dec FY14 FY15 FY16E FY17E FY18E Rmb in millions, year end Dec FY14 FY15 FY16E FY17E FY18E Revenues 3,746 5,056 7,239 8,363 9,967 PBT (346) 220 651 1,593 1,135 % change Y/Y 0.3% 35.0% 43.2% 15.5% 19.2% Depr. & amortization 163 183 343 415 452 Gross Profit 120 118 369 1,370 1,520 Change in working capital (135) 384 (540) (1,011) (347) % change Y/Y (35.2%) (1.5%) 212.7% 271.2% 10.9% Tax & Other 69 73 167 205 182 Gross margin 3.2% 2.3% 5.1% 16.4% 15.2% Cash flow from operations (370) 381 602 1,105 1,370 Other operating income 226 270 346 418 455 EBITDA (24) (14) 288 1,316 1,441 Capex (684) (782) (1,300) (1,200) (600) % change Y/Y (75.5%) 580.4% 278.1% 9.9% 5.3% Sale of assets 7 1 0 0 0 EBITDA Margin 1.3% 6.7% 17.8% 16.9% 15.0% Acquisition of subsidiaries/intangibles - - - - - EBIT (249) (284) (58) 898 986 Other (22) (472) 0 0 0 % change Y/Y 53.4% 13.8% (79.6%) (1653.4%) 9.9% Cash flow from investing (699) (1,252) (726) (1,200) (600) EBIT Margin (4.7%) 1.4% 13.0% 11.9% 10.4% Net Interest (138) (133) (137) (137) (137) Equity raised/(repaid) 1,671 59 1,845 0 0 Share of JVs - - - - - Debt raised/(repaid) 654 (933) 0 0 0 Other non operating income 65 765 848 833 286 Dividends paid - - - - - Earnings before tax (346) 220 651 1,593 1,135 Other 577 (224) (137) (137) (137) % change Y/Y 435.2% (163.5%) 196.4% 144.7% (28.7%) Cash flow from financing 2,903 (1,098) 1,707 (137) (137) Tax (4) (10) (33) (80) (57) as % of EBT (1.0%) 4.5% 5.0% 5.0% 5.0% FX gain/(loss) 10 9 0 0 0 Minorities - - - - - Net change in cash 1,844 (1,960) 1,584 (233) 633 Net income (reported) (349) 210 618 1,513 1,078 Ending cash 2,142 182 1,766 1,533 2,166 % change Y/Y 338.8% (160.0%) 195.0% 144.7% (28.7%) DPS - - - - - Recurring Net Income (286) (22) 810 841 911 % change Y/Y 240.5% (92.2%) (3729.9%) 3.7% 8.4% EPS (reported) (0.09) 0.05 0.13 0.31 0.22 % change Y/Y 338.8% (160.0%) 136.0% 144.7% (28.7%) Recurring EPS (0.07) (0.01) 0.17 0.17 0.19 % change Y/Y 240.5% (92.2%) (3003.9%) 3.7% 8.4% Balance sheet Ratio Analysis Rmb in millions, year end Dec FY14 FY15 FY16E FY17E FY18E Rmb in millions, year end Dec FY14 FY15 FY16E FY17E FY18E Cash and cash equivalents 2,142 176 1,766 1,533 2,166 Gross margin 3.2% 2.3% 5.1% 16.4% 15.2% Accounts receivable 190 165 297 458 628 EBITDA margin 1.3% 6.7% 17.8% 16.9% 15.0% Inventories 933 519 1,129 1,188 1,435 Operating Margin (4.7%) 1.4% 13.0% 11.9% 10.4% Others 842 2,651 1,844 2,542 2,755 Net margin (7.6%) (0.4%) 11.2% 10.1% 9.1% Current assets 4,108 3,511 5,036 5,721 6,984 Recurring net profit margin (7.6%) (0.4%) 11.2% 10.1% 9.1% Goodwill 101 101 101 101 101 Sales growth 0.3% 35.0% 43.2% 15.5% 19.2% Intangible assets 4 2 2 2 2 Net profit growth 338.8% (160.0%) 195.0% 144.7% (28.7%) Long term investments - - - - - Recurring net profit growth 240.5% (92.2%) (3729.9%) 3.7% 8.4% Net fixed assets 3,391 3,418 4,322 5,054 5,149 EPS growth 338.8% (160.0%) 136.0% 144.7% (28.7%) Other assets 310 405 433 611 667 Total Assets 8,029 7,438 9,894 11,488 12,904 Interest coverage (x) 0.4 2.6 9.4 10.3 10.9 Net debt to equity 55.0% 85.0% 12.9% 13.5% 3.3% Liabilities Sales/assets 0.6 0.7 0.8 0.8 0.8 Short-term loans 3,200 2,053 2,053 2,053 2,053 Assets/equity 480.0% 311.2% 223.6% 182.3% 170.3% Trade & other payables 280 244 376 441 579 ROE (21.1%) (0.9%) 20.9% 14.3% 12.7% Others 1,791 2,065 1,926 1,943 2,142 ROCE (4.3%) 1.3% 14.7% 11.5% 10.3% Total current liabilities 5,270 4,362 4,355 4,437 4,774 Long-term debt 283 370 370 370 370 Others 38 61 61 61 61 Total Liabilities 5,592 4,794 4,787 4,868 5,205 Minorities 111 0 0 0 0 Shareholders' equity 2,325 2,644 5,107 6,620 7,699 BVPS 0.60 0.68 1.05 1.36 1.58 Source: Company reports and J.P. Morgan estimates.
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Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention. Important Disclosures
Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for COFCO Meat Holdings within the past 12 months. Client: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as clients: COFCO Meat Holdings. Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as investment banking clients: COFCO Meat Holdings. Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation for investment banking services from COFCO Meat Holdings. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from COFCO Meat Holdings. Other Significant Financial Interests: J.P. Morgan owns a position of 1 million USD or more in the debt securities of COFCO Meat Holdings. Company-Specific Disclosures: Important disclosures, including price charts and credit opinion history tables, are available for compendium reports and all J.P. Morgan–covered companies by visiting https://jpmm.com/research/disclosures, calling 1-800-477-0406, or e-mailing [email protected] with your request. J.P. Morgan’s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477- 0406 or e-mail [email protected].
COFCO Meat Holdings (1610.HK, 1610 HK) Price Chart
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Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.
The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings or designations: OW = Overweight, N= Neutral, UW = Underweight, NR = Not Rated Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the
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average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stock’s expected total return is compared to the expected total return of a benchmark country market index, not to those analysts’ coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analyst’s coverage universe can be found on J.P. Morgan’s research website, www.jpmorganmarkets.com. Coverage Universe: Sener Kurumlu, Ebru: Ajisen China Holdings Ltd (0538.HK), Beijing Yanjing Brewery - A (000729.SS), Belle International Holdings Ltd. (1880.HK), China Foods Ltd (0506.HK), China Mengniu Dairy Co. Ltd. (2319.HK), China Resources Beer (0291.HK), Chow Tai Fook Jewellery Company Ltd. (1929.HK), Esprit Holdings (0330.HK), Golden Eagle Retail Group Ltd (3308.HK), Hengan International Group Ltd (1044.HK), Inner Mongolia Yili Industrial Group - A (600887.SS), Li & Fung (0494.HK), Lifestyle International Holdings (1212.HK), Shanghai Jahwa - A (600315.SS), Tibet Water Resources Ltd (1115.HK), Tingyi (Cayman Islands) Holding Corp (0322.HK), Tsingtao Brewery - A (600600.SS), Tsingtao Brewery - H (0168.HK), Uni-President China Holdings Ltd (0220.HK), Want Want China Holdings Ltd (0151.HK)
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{[{QZ]*Owksv*O*|o}J l}}nsm8myw*:@9;<9<:;@}]} Ebru Sener Kurumlu Asia Pacific Equity Research (852) 2800-8521 05 December 2016 [email protected]
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"Other Disclosures" last revised October 8, 2016. Copyright 2016 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan. #$J&098$#*P
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