Valuing JAPFA

Rosesyrup Research

TARGET PRICE: $1

Upside: 25%

Valuing JAPFA

A number of blogs and articles have done a good job providing qualitative analysis on JAPFA. Rather than repeating their points all over again and risk being redundant here, I will just quickly summaries their points and provide the relevant link to their respective websites.

Instead I will add value by expressing my views on JAPFA and end off by providing my formal valuation.

Summary

As countries in ASEAN region become richer, there is a real growth potential for JAPFA business. The industry is also very fragmented in Indonesia and mostly run by families  with limited capital. Therefore, a publicly listed JAPFA with access to huge amount of funding has significant competitive advantage over private limited competitors. Thus being a market leader in a fast growing industry makes JAPFA business a very attractive investment opportunity. (You can read more about JAPFA's attractiveness from MR IPO BLOG).

However, JAPFA is highly leveraged with 60% of its asset financed with debt and some of its credit are charged as high as 16%. The fact that JAPFA is operating in Indonesia, a country faced with twin deficit problem raise extra concern. (Read more about credit risk from Motley Fool article).

My Opinion

Credit risk concern raised by Motley Fool might be overplayed a bit:

• 1.    Average interest rate of JAPFA stands at around 6-7%. The 16% interest rate is most probably cost of small amount of revolving credit, which typically much more expensive than line credit but necessary for every business's day to day operation.
• 2.    It is an agriculture industry's norm to have high leverage. For example, JAPFA debt to equity ratio stands at 1.4X while Chaoren Food (direct competitor) has a ratio of 1.7X.
• 3.    While I agree that the volatile interest rate and currencies in Indonesia post significant near term risk to JAPFA, a1997 Asian currencies crisis type of scenario is highly unlikely to happen due to the improved cooperation among Central Banks and currency pegging system.

In conclusion I think JAPFA is an attractive growth investment with correspondingly high risk. In order to quantify that risk and attractiveness, we will need to do a valuation on JAPFA.

Valuation by other websites and their flaws

Before we move on to the calculation, it is worthy to note that JAPFA has negative cashflow and does not pay dividend. This means that absolute valuation models are inapplicable. Even if I could extrapolate and assume JAPFA could achieve positive cashflow by X year, the assumption is highly unreliable due to the highly uncertain political environment in Indonesia.

Motley Fool therefore attempted to value JAPFA using P/E model (a relative valuation method comparing against competitors based in China), which I do not think is appropriate in JAPFA case due to the following 2 reasons:

1. 1.    Peers in China operate under a very very different business environment as compared to JAPFA. Some important differences are in the legal system and capital flow, which have great impact on valuation.
2. 2.    What P/E model really compares is the level of market confident in a company's ability to translate each cent of earning into ultimate returns to shareholders (usually through dividend policy). But as mentioned, JAPFA does not have any dividend policy as of yet.

My valuation

My valuation model entails using justified P/B ratio and only comparing against Thailand Chaoren Food which operates in environment much similar to that of JAPFA. I have attached a screenshot of my modeling as follow:

Things to Notes

• ·         I assume an ROE of 15.37% (average of past 3 years ROE) in FY 2014. Up to you to assess is this a realistic assumption.
• ·         Target price is $1 with 25% upside from IPO price.
• ·         Target price is just a maximum price an economic person is willing to pay for JAPFA's risk and reward, it does not mean that actual market price will move to 99.5cents due to reasons like market sentiments.
• ·         JAPFA is highly recommended for institutional investors looking to invest in counters that form growth portion of their portfolio.
• ·         JAPFA is NOT recommended for most individual investors, except high risk growth investors. Such individuals are also advised to limit their portfolio exposure to JAPFA.

Rosesyrup's Trading Strategy on first day of listing

Since JAPFA is too risky for the appetite of most value investors who supported the share price in the market, whether JAPFA float or sink on debut rest completely on whether institutional investors will come in and grab some shares in the open market.

Therefore my personal strategy is to wait for signal.

• ·         If price sink, I will wait till it stabilize before buying in to gain higher return. Matter of time institutional investors will come in, as it is indeed a very attractive stock to have in a large and diversified portfolio.
• ·         If price float with quick and large volume=> I would enter quickly and exit at target price + 10% ($1.10) (Institutional investors are armed with tools to do shrewd  valuation, better not to push my luck too far).

Goodluck to all.