PT Japfa Outlook Revised To Negative As Growth Aspirations Reduce Financial Headroom; 'BB-' Ratings Affirmed

  • PT Japfa's capital spending in 2019 substantially exceeded our earlier forecasts, leading to higher leverage and reduced financial headroom.
  • The company's growth aspirations could lead to persisting negative free operating cash flow, rising debt, and FFO interest coverage falling below 4.0x in 2020, amid rising economic headwinds in Indonesia and a weakening rupiah.
  • On March 24, 2020, S&P Global Ratings revised its outlook on the Indonesia-based integrated poultry producer to negative from stable. We also affirmed our long-term issuer credit rating on the company and the issue rating on its US$250 million senior unsecured notes maturing in 2022 at 'BB-'.
  • The negative outlook reflects the prospects of rising leverage and weakening interest coverage ratios over the next 12 months barring a slowdown in the company's expansion appetite and debt accumulation.
SINGAPORE (S&P Global Ratings) March 24, 2020--S&P Global Ratings today took the rating actions listed above. The negative outlook on PT Japfa Comfeed Indonesia Tbk. reflects the prospect of weaker cash flow adequacy and interest coverage ratios in 2020 and 2021 given steady capital spending, likely persisting negative free operating cash flow and rising debt.
Persisting capital spending in 2020 will steadily reduce PT Japfa's already weakened interest coverage and cash flow adequacy ratios. We believe the company remains keen to grow capacity in 2020 and 2021, to take advantage of favorable long-term demand patterns and consolidate its market share in Indonesia's poultry industry. Top-of-cycle profits in 2018 and 2019 to a lesser extent have also bolstered the company's ability to spend. Capital spending was about Indonesian rupiah (IDR) 3.1 trillion in 2019, more than 20% higher than we had anticipated as it expanded feed mill, breeding, downstream, as well as storage and packaging facilities. PT Japfa's discretionary cash flow was negative IDR3.4 trillion over 2018-2019. Expansion and investment in working capital led reported debt to increase to about IDR8.6 trillion as of Dec. 31, 2019, compared with about IDR6.1 trillion at the end of 2017. The company's coverage of its interest expense with funds from operations (FFO) reduced sharply to about 4.1x in 2019 compared with more than 7x in 2018. Its ratio of FFO to debt likewise weakened to about 26% in 2019 from more than 40% on average between 2016 and 2018.
We estimate that annual capital spending exceeding IDR2.5 trillion in 2020 and 2021 is likely to lead to persistently negative discretionary cash flow for PT Japfa. Besides requiring more debt to bridge the investment deficit, persisting investment in new capacity will also require growing working capital requirements, which the company has historically funded with working capital facilities. Debt is likely to top IDR10 trillion in 2020 and IDR11 trillion in 2021 under this spending scenario, leading to an FFO interest coverage ratio of 3.5x-3.8x and an FFO-to-debt ratio below 20%. Both levels would no longer be commensurate with a 'BB-' rating in light of PT Japfa's earnings quality.
PT Japfa's more leveraged balance sheet will make its credit ratios more sensitive to profitability headwinds. Rising debt at PT Japfa since 2016 has coincided with a period of buoyant industry conditions, with near multiyear-high in profit margins in Indonesia's integrated poultry sector in 2019. Reported EBITDA margins of 11.5% in 2019 were nearly 50% higher than the low of 7.5% in 2014.
The debt-funded expansion amid high margins increases downside risk to the company's cash flow adequacy and leverage ratios when industry margins normalizes, in our view. We believe downside risks to margins are more likely in 2020 and beyond, given the rapid expansion in domestic capacity and as the weaker Indonesian rupiah increases operating costs. While difficult to assess at this stage, demand headwinds from the COVID-19 outbreak may also lead to reduced volumes and margin compression in the near term, especially if the government enforces strict containment measures and reduces access to wet market and distribution channels. The extra costs to manage potential supply chain and logistics inconveniences, if not outright disruption, could also weigh on PT Japfa's cost structure in 2020. We estimate that PT Japfa's FFO interest coverage could fall to about 3.8x and its FFO-to-debt ratio to below 20% if EBITDA margins fall to 8% and if the company maintains annual capital spending of IDR2 trillion or more. Our base case currently assumes reported EBITDA margins at 9%-10% in 2020 and 2021.
Growth aspirations are reducing financial headroom and liquidity at majority shareholder Japfa Ltd. Japfa Ltd.'s cash flow adequacy and leverage ratios have weakened in line with those of PT Japfa, given capacity expansion and investments in working capital at the group level as well as in sister companies in Vietnam and China. We estimate that Japfa Ltd.'s FFO interest coverage shrank to 4.0x in 2019 on the consolidated level. The group's short-term debt--which includes working capital debt at raw material sourcing subsidiary Annona Pte. Ltd. and a US$253 million acquisition loan maturing in 2021--has also increased. Consolidated cash levels of about US$141 million, excluding PT Japfa, do not cover refinancing requirements over the next 12 months. As a result, we believe Japfa Ltd. might seek to accelerate receivables collection from PT Japfa or maintain dividends to reduce liquidity requirements.
We affirmed the 'BB-' rating to reflect PT Japfa's flexibility in capital spending and sound liquidity provided by the company's multiyear committed revolving working capital credit facility. While our base case assumes steady spending through 2020 and 2021, we recognize that PT Japfa has the flexibility to reduce or defer investments because most of them are related to smaller-size, brownfield projects. We estimate that the company's FFO interest coverage could stabilize above 4.0x and its FFO-to-debt ratio comfortably above 20% if capital spending in 2020 and 2021 stays between IDR1 trillion and IDR1.5 trillion. The company reduced investments to below IDR800 billion in 2015 and 2016 amid an oversupplied market, and managed at the time to rebuild its financial and liquidity buffer.
Our rating affirmation also reflects PT Japfa's multiyear committed syndicated revolving working capital credit facility of IDR3 trillion, amid reducing liquidity and currency volatility globally. We believe the credit line will act as a stabilizing liquidity source, given it matures in 2024. The company also obtained an IDR2 trillion five-year non-revolving club loan quota in the third quarter of 2019, which could help ease any liquidity pressure and mitigate risk from the increase in short-term working capital loans.
The negative outlook reflects the prospects of PT Japfa's rising leverage and weakening FFO interest coverage to below 4.0x over the next 12 months barring a slowdown in the company's expansion appetite and debt accumulation.
We may lower our rating on PT Japfa if the company's or its parent Japfa Ltd.'s cash interest coverage drops below 4x for an extended period of time. Given our EBITDA margin base case, we believe this could materialize if annual capital expenditure exceeds IDR2 trillion or working capital growth reduces annual operating cash flow to below IDR1 trillion sustainably. We could also lower the rating if the company's EBITDA margins fall below 8% with no prospects of recovery and if the company fails to adjust capital spending.
We may also lower the rating if the liquidity profile of PT Japfa or Japfa Ltd. weakens notably. This could materialize if an increase in raw material costs or a sharp depreciation in the Indonesian rupiah leads to much greater use of short-term debt, or if either company fails to proactively refinance large amortizing debt maturities.
We may revise the outlook to stable if both PT Japfa and Japfa Ltd. can sustain their FFO cash interest coverage materially above 4x. Given our margin assumptions, we believe this will likely stem from PT Japfa adopting a more cautious attitude towards capital expenditure, with capital spending of IDR1 trillion-IDR1.5 trillion in 2020.
We could also revise the outlook to stable if the company's EBITDA margins remain above 12% and the company generates positive discretionary cash flow. A revision of the outlook to stable will be contingent upon both PT Japfa and Japfa Ltd. maintaining adequate liquidity, Japfa Ltd.'s credit metrics being either commensurate or stronger than that of PT Japfa, and both companies proactively refinancing sizable amortizing debt maturities.
PT Japfa is a producer of animal feed and day-old chicks, and engages in commercial farming in Indonesia. It is the second-largest player in the poultry business, behind its largest competitor PT Charoen Pokphand Indonesia Tbk. (CPI). PT Japfa had a revenue of IDR37 trillion and reported EBITDA of about IDR4.1 trillion for the year ended Dec. 31, 2019. Poultry-related businesses constitute about 87% of the company's total revenues. PT Japfa was founded in 1971, is headquartered in Jakarta, and operates as a subsidiary of Singapore-listed Japfa Ltd.
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