SINGAPORE (Apr 30): Japfa CEO Tan Yong Nang was sanguine when he heard about the Covid-19 outbreak. A 10-year veteran at the Indonesia-based agri-food giant, he was used to preparing for and grappling with diseases that hit the company’s livestock. “Animals get diseases regularly, so we know how to deal with an outbreak when one occurs,” says Tan in an interview with The Edge Singapore.
Last year, Japfa had to grapple with a severe outbreak of African Swine Fever (ASF) which hurt its pig farms in Vietnam. It suffered an 83.1% drop in profit q-o-q for 2QFY2019 ended June 30, 2019, although there was a recovery in 4QFY2019, thanks to year-end seasonal demand.
“Using our industrialised approach coupled with strict biosecurity protocols, we were able to contain the impact of ASF better than many of our industry peers and capitalise on the rebound in livestock prices swiftly,” says Tan, whose business strategy emphasises nimbleness and building up economies of scale relative to its market competitors.
According to Tan, who was promoted to CEO in 2014, Japfa’s feed mills, farms and plants — several of which were located in China — were quickly placed on lockdown and under strict regulation once the Covid-19 virus began spreading. With most workers lodged in their dormitories on site, the firm was able to continue its operations while ensuring that its personnel were relatively insulated from infection.
“The situation in China is pretty good now, as the strict lockdown measures implemented have begun to take effect. Vietnam’s Covid-19 situation seems fairly well-controlled and the authorities have been running it very well. We are also currently watching very carefully the situation in Indonesia and India, which is more uncertain,” says Tan.
Weathering the storm
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Incidentally, with food and agriculture considered an essential service, Japfa has been allowed — even encouraged — to continue operations despite widespread lockdown measures. In addition, as Japfa’s focus is on the sale of staple proteins, overall demand is expected to be consistent despite reduced orders from commercial F&B outlets.
“While raw milk prices softened in the past months during the outbreak of Covid-19, [Japfa’s] supply chain and farm operations were not affected. It has also seen an increase in enquiries, which is an early indication of demand, particularly as China recovers from the outbreak,” comment DBS analysts Andy Sim and Alfie Yeo, who also note that February and March are traditionally low months for milk demand.
“As the Covid-19 outbreak recovery is under way in China, we are also seeing a corresponding recovery in the demand for raw milk and we believe that there should not be a major impact over the medium and long term. With the general shortage of raw milk in China, as an independent raw milk producer, we are poised to benefit in future,” adds Tan.
Demand for dairy products in Japfa’s business in China will also be further reinforced by the strategic partnership it announced in a US$254.4 million ($361 million) deal with Japanese dairy giant Meiji on April 15. In return for divesting 25% of its stake in AustAsia — its China-based subsidiary — the firm has inked a lucrative contract to supply raw milk to Meiji for the next five years effective from July 2020, which is likely to ensure a consistent flow of revenue amid the present economic uncertainty.
“This strategic and synergistic partnership will secure the supply of quality raw milk for Meiji’s downstream operations and provide a stable revenue stream for Japfa, enabling us to build AustAsia to become the largest independent raw milk producer in China,” says Tan.
Japfa’s strategy of building economies of scale and contesting market leadership has given the firm sufficient financial heft and market share in most of its business arms to weather the pandemic successfully. Besides being the second-largest integrated industrialised farming company by poultry feed and day-old-chick production in Indonesia, the firm is also a market leader in milk production there, as well as in Singapore, Malaysia, Brunei, mainland China, Hong Kong and the Philippines.
In the long run, Japfa’s regional value chains are likely to prove especially resilient in a world economy likely to be defined by growing economic nationalism. Tan Min Lan, head of the APAC investment office at the UBS Global Wealth Management Chief Investment Office, has warned that the combined effect of the Covid-19 pandemic and US-China trade war could see countries pursuing product localisation and reshoring strategic supplies to secure these against future global shocks.
This would result in significant supply chain redirection worldwide, warns NUS Business School Senior Fellow Alex Capri, as firms will increasingly look to “ring-fence” their global value chains within individual countries. Through its vertically-integrated business model, Japfa already keeps most of its production and sales local. It relies on local suppliers for raw materials like animal feed, reducing the need for further supply chain redirection while ensuring that the firm remain “shock-proof” from the early stage of the crisis.
“In general, the impact of Covid-19 on our logistics has been minimal. Should there be any changes, we are ready to make the necessary adjustments,” says Tan. “Even if governments intervene in the agri-food sector to encourage local buying, we would in fact benefit as we compete mostly with imported goods.”
For the most recent 4QFY2019, Japfa’s various divisions were able to report higher earnings. Overall, Japfa FY2019’s earnings of US$72.1 million were up approximately 170% y-o-y, on the back of 15.7% y-o-y growth in revenue to just over US$1 billion. Japfa’s share price was not able to reflect the better earnings. Year to date, it is down 6.28% to close at 53.5 cents on April 27, which values the company at 5.95 times historical earnings, making it a relatively cheap stock.
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Dancing with danger
One of Japfa’s main challenges is to turn around its loss-making consumer foods division. Despite being an established player in the Indonesian market with its So Good, So Nice and Real Good lines of frozen foods, revenue has declined 6.2% to US$190.7 million in FY2019 from US$203.3 million in the preceding year, as a result of increased market competition.
“Since 2019, the Group has been pushing forward with its strategy to lift the performance of the segment through ... brand rejuvenation and the expansion of its market position in ambient products, as well as implementing cost-efficiency measures in supply chain and distribution and refocusing advertising and promotion,” promised Japfa’s Annual Report for FY2019.
While the business has yet to turn a profit, improvements in earnings suggest some positive developments for consumer foods. While FY2019 recorded an operating loss of US$5.7 million, this was a marked 65.5% improvement from the US$16.6 million loss in FY2018.
Moreover, the Covid-19 pandemic has seen demand for consumer foods shoot up, as consumers begin to cook more often at home and seek out less perishable food items to minimise shopping trips. The firm has ramped up slaughter rates and increased direct selling in a bid to record a more significant increase in sales volume relative to FY2019.
Tan sees certain trends supporting the long-term growth of the consumer foods business, including the growing popularity of e-commerce. Many of its products such as frozen chicken nuggets and chicken wings can be found on Indonesia’s leading e-commerce market, Tokopedia.
“Many of the countries we operate in are in their early stages of development and thus [their consumers] tend to buy groceries from wet markets. Some part of that demand for groceries has increasingly shifted to e-commerce, especially in Indonesia. The pandemic may thus be a catalyst for long-term change in our distribution networks,” explains Tan.
According to a McKinsey report, online commerce sales in Indonesia will grow eightfold by 2022, with formal e-commerce reaching US$40 billion and social commerce US$25 billion. Around a third of this activity will involve new consumption that would not have occurred otherwise, presenting a god-sent opportunity for Japfa to capture emerging market share.
While still largely an urban phenomenon, firms like Tokopedia are increasingly looking to “go rural” — to enter untapped rural markets that are now better connected by Indonesia’s Palapa Ring 4G project. Japfa could gain a first-mover advantage from early adoption of rural e-commerce distribution networks, stealing a march on the competition in these new markets.
Still, Tan remains cautious about the fluidity of the pandemic situation in Indonesia. He anticipates that in the long run, the unprecedented economic impact of the pandemic and an extended lockdown could reduce overall purchasing power and as a result, affect demand for consumer products, potentially leading to stronger headwinds in the months ahead.
Another obstacle to Japfa’s ambitions, however, could stem from the rather high gearing ratio it is grappling with, at a time when firm cash flows may come under pressure from the Covid-19 economic shock. Japfa’s gearing ratio currently stands at 0.9 times after a rights issue in February 2020, though DBS predicts that this will fall to 0.7 times by the year’s end.
Japfa’s sale of a 25% downstream stake in its Chinese dairy subsidiary, AusAsia, to Meiji for a consideration of US$254.4 million, however, promises to strengthen the firm’s balance sheet. With AusAsia’s combined upstream and downstream operations valued at $700 million at point of acquisition, the 75% upstream stake retained by Japfa is valued at US$1 billion.
“Japfa will apply the proceeds of the transaction towards the repayment of the US$253 million term loan [used to acquire AusAsia]. This will improve the group’s consolidated leverage ratio and strengthen its balance sheet,” said a press release by the firm on April 15.
Despite the uncertainty and disruption of the Covid-19 pandemic, Tan sees little change to his business and is confident that the economy will return to normal. For now, he aims to stay flexible and adjust his operations as the situation develops, while further strengthening Japfa’s balance sheet.
“Our strategy is simple and we hope to continue with it in the coming years,” Tan concludes. “Our overall strategy of focusing on scale, industrialisation, strong biosecurity and diversification remains unchanged, and we look to tap the increasing regional protein consumption in the coming five to 10 years.”
