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News Analysis: Welcoming New Hope as strategic partner in China dairy business

  • New Hope to acquire 5% minority stake in Japfa’s China dairy business, along with raw milk supply contract 
  • Transaction amount of US$58.4m implies a 100% equity value of US$1.168bn for its China dairy business 
  • Japfa to remain as the single largest and controlling shareholder with a 62.5% stake
  • There would be dilution to our earnings estimate because of higher minority interests, but a positive move strategically in our view; maintain BUY
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What’s new?

Strategic investor and partnership with New Hope for dairy business in China. Japfa Ltd announced that it has entered into a conditional Sale and Purchase Agreement (SPA) with New Hope Dairy Co., Ltd (New Hope) for the sale of a 5% stake in AustAsia Investment Holdings (AIH). In connection with the transaction, AIH and New Hope will also enter into a contract to supply raw milk to New Hope on a 5-year rolling basis that will be renewed annually. This transaction will add New Hope as shareholder of AIH following Genki Forest, Honest Dairy and Meiji Group. Note that, in July 2020, Meiji came on board as a strategic partner with a 25% equity stake in AIH. While recently, on 30 August 2021, Japfa announced the agreements with Genki Forest and Honest Dairy, which acquired 5% and 2.5% respectively of the issued shares of AIH. After the closing of the transactions with Genki Forest, Honest Dairy and New Hope, Japfa will remain the single largest and controlling shareholder in AIH with a 62.5% stake and will continue to have control over the management of its farming operations in China.

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Rationale. Based on the company’s announcement, management believes that this transaction will allow it to build a strategic partnership with the Group’s growing dairy customer, with a view to build AIH to be the largest independent raw milk producer in China. Furthermore, the raw milk supply contract will provide a stable revenue stream for the company going forward. 

Transaction amounts to US$58.4m, subject to the satisfaction of conditions precedent. The consideration for the proposed transaction with New Hope amounts to US$58.4m, and “was arrived at on a willing-buyer, willing-seller basis”. Thus, the proposed aggregate sale of 12.5% of the issued shares of AIH to New Hope, Genki Forest and Honest Dairy will realise total cash proceeds of US$146m, which implies a 100% equity value of US$1.168bn for AIH (Japfa’s dairy business in China). Based on the aggregate consideration of US$146m and the book value of the aggregate sale shares of US$91.8m as at 30 June 2021, the estimated Group’s gain from the disposal of the aggregate sale shares to be recorded in the equity is US$54.2m. The cash proceeds will then be used for general working capital and corporate purposes.

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Our views

A positive development in our view. We see this transaction as a favourable move for Japfa Ltd, with the entry of a credible strategic investor coupled with supply contract. This would provide more certainty on the demand for its raw milk and future expansion, and at the same time enable the Group to leverage on New Hope, Genki Forest and Honest Dairy’s growth in China. 

Expect dilution to our earnings forecasts from higher minority interests. Based on proforma 1H21 figures shared in the announcement, the disposal of the 12.5% minority stake in AIH would lower Japfa’s 1H21 net profit by c.4%. Meanwhile, based on our calculation, the disposal of the 12.5% minority stake in its dairy business will lower our earnings forecasts for Japfa in FY21/22F by c.3%/7%, ceteris paribus. 

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Highlighting undervaluation of counter.  That said, the proposed transaction implies 100% equity value of AIH at US$1.168bn, which based on our calculation implied c.8-9x EV/EBITDA of its dairy business in FY21/22F. Meanwhile, in our sum-of-part valuation, we value the dairy business by using 6x EV/EBITDA in FY21/22F. Thus, this shows the undervaluation of the counter.

We have a BUY call with TP of S$1.05.