Charoen Pokphand Foods

Charoen Pokphand Foods Plc (CPF)

Investment thesis: Following the 2Q12 preview meeting, we reiterate our view that 2Q12 core earnings will decline YoY but improve QoQ. We think the market has already priced in weak bottom-line expectations. The next focus will be on improved 2H12 numbers, brought about by better domestic meat operations and overseas operational turnarounds. We expect Thai chicken operators to resume exporting raw chicken to the EU by late 3Q12 (we earlier assumed July 2012). Our BUY rating stands, premised on stronger 2H12 earnings and the possibility of further acquisitions.  
Weak 2Q12 earnings estimate: We estimate a Bt3.84bn net profit for 2Q12—down by 21% YoY and 68% QoQ. Stripping out extra items, core earnings would have tumbled 34% YoY but risen 25% QoQ. The estimated YoY core profit plunge is due to: 1) weaker domestic meat and overseas operations, 2) a deeper realized livestock loss at CP Vietnam and 3) higher interest expenses. The QoQ rise is thanks to improved domestic meat operations. Overseas units, especially India, Malaysia and Turkey, are expected to post weaker YoY numbers.
Weaker chicken price in July: The fall in the domestic chicken price to Bt35/kg in July is attributable to chicken-dumping by Saha Farm, a major operator, because its plan to export to the EU was delayed by red tape. The EU lifted its ban on raw chicken imports from Thailand only for chickens hatched on July 1 or later. Given a 45- to 60-day raising cycle, chicken exports to the EU may resume in August-Sept.
Domestic chicken price rebound in 4Q12: We expect the domestic chicken price to rise to Bt40-43/kg in 4Q12 with the resumption of raw chicken exports to the EU in late 3Q12 and a meat consumption recovery in 2H12.
Overseas operations to bounce in 2H12: Management guides that offshore unit performances will improve on higher meat prices—especially in Turkey, Malaysia and India—starting 3Q12. 
FY12 net profit forecast slashed 23%: The cut reflects weaker assumptions for domestic chicken and pork prices. Our YE12 target price declines to Bt44.

Outlook
Weak 2Q12 earnings estimate: We expect a Bt3.84bn net profit for 2Q12—down by 21% YoY and 68% QoQ. Stripping out extra items (an Bt8.7bn in gain from a CP Vietnam asset revaluation and gains from divesting stakes in two insurance companies in 1Q12 and from trading CPALL stock), core earnings would have tumbled 34% YoY but risen 25% QoQ. The estimated YoY core profit plunge is due to: 1) weaker domestic meat and overseas operations, 2) a deeper realized livestock loss at CP Vietnam and 3) higher interest expenses. The QoQ rise is thanks to improved domestic meat operations.
All domestic meat prices dropped YoY in 2Q12 (chicken down 28% YoY, pork down 12%, eggs down 14% and shrimp down 17%). All prices except shrimp rose QoQ (chicken up 8% QoQ, pork up 16%, egg up 4% and shrimp down 17%). Domestic meat prices (especially chicken) peaked in 2Q11 and are unlikely to hit such high levels again in 2H12. The mean corn price edged up by 2% YoY and QoQ and the cost of soybean meal (SBM) jumped by 29% YoY and 8% QoQ on tighter global SBM supplies. CPF’s average SBM cost is typically 5-10% lower than the prevailing market price because the firm locks in prices through forward contracts. 
Most overseas units—especially Malaysia, India and Turkey—will post weaker YoY numbers for 2Q12. Meat prices in Turkey softened with chicken supply expansion. We estimate a Bt150m net loss in 2Q12 for the Turkish unit against a Bt300m net loss for 2Q11 and a Bt50m net profit for 1Q12. The Malaysian shrimp operation was hit by an outbreak of IMN virus, while chicken prices slumped in India during 2Q12. On a QoQ basis, we expect only flattish 2Q12 numbers for the Indian and Malaysian units. The Vietnamese operation would have been squeezed by a pork price decline during the quarter. The Russian unit, which is still in expansion phase, will post another net loss for 2Q12. CPP’s operation in China should report steady numbers for the quarter because its business is dominated by livestock feeds. 
Weaker chicken price in July on supply-dumping: The domestic chicken price declined from Bt40/kg in May to Bt37/kg in June, then slipped further to Bt35/kg during July 9-10, a 13% fall in two months. The domestic chicken price fall to Bt35/kg in July is attributable to chicken-dumping by Saha Farm, a major operator, because its plan to export to the EU was delayed by red tape. The EU lifted its ban on raw chicken imports from Thailand only for chickens hatched on July 1 or later. Given a 45- to 60-day raising cycle, chicken exports to the EU may resume in August-Sept. Saha Farm increased its capacity from 300-400K birds/day during early 2012 to 700K birds/day currently and plans to ramp it up to 1m birds/day by YE12.
On the demand side, management said domestic meat consumption has been stable since early this year. The firm expects domestic meat demand to rise gradually in 2H12, which should boost chicken and pork prices.
Domestic chicken price rebound in 4Q12: We expect the domestic chicken price to rebound to Bt40-43/kg in 4Q12 with the resumption of raw chicken exports to the EU in late 3Q12 and a meat consumption recovery in 2H12. We estimate the current chicken oversupply at 1m birds/week, assuming nationwide production of 24m birds/week. The industrywide excess was 1.5m birds/week at the start of 2012. We expect the oversupply to drop below 1m birds/week and the domestic price to recover.  
Overseas operations to bounce strongly in 2H12: Management believes that overseas units will rebound faster than Thai operations, led by higher meat prices—especially in Turkey, Malaysia and India—starting 3Q12.  

Recommendation and valuation
FY12 net profit forecast cut 23%: We have slashed our net profit forecasts by 23%, for FY12, 20% for FY13 and 10% for FY14 to reflect diminished expectations for domestic chicken and pork prices in FY12-14. We have revised down our assumed mean domestic FY12 chicken price by 16% to Bt38/kg and pork price by 12% to Bt60/kg. Moreover, we assume a Bt40/kg mean domestic chicken price and a Bt62/kg mean pork price in FY13 onward. Hence, our DDM-based YE12 target price declines to Bt44 from Bt48.    
Weak 2Q12 earnings priced in: Following the 2Q12 preview meeting, we reiterate our view that 2Q12 core earnings will decline YoY but improve QoQ. We think the market has already priced in weak bottom-line expectations. The next focus will be on improved 2H12 numbers, brought about by better domestic meat operations and overseas operational turnarounds. We expect Thai chicken operators to resume exporting raw chicken to the EU by late 3Q12 (we earlier assumed July 2012). Our BUY rating stands, premised on stronger 2H12 earnings and the possibility of further acquisitions.