- Potential rebound in hog prices by 2H22-2023, plus gradual improvement in feed cost and operating efficiency point to a better margin outlook
- Accelerated industry consolidation should also favour players that would benefit from large-scale farming
- We upgrade COFCO Joycome from HOLD to BUY
Sequential improvement. While lower hog prices in China over the past months have put pressure on hog producers and accelerated market consolidation, we expect prices to gradually recover to RMB18-20/kg by 2H22 -2023 (Feb 2022: RMB14.7/kg) given the steady decline in sow inventory across the industry. The current breakeven hog price at about RMB15/kg also signals better profitability for upstream players during 2H22, in our view. Leading hog producers have also increasingly leveraged on hedging strategies to mitigate impact of the hog price cycle. Continual expansion of production scale could also further unlock the advantages of large-scale farming.
Sensitivity analysis.As prices of key feed components (e.g., soybean meal and corn) could stay high this year, government intervention might result in a more normalized feed supply to help moderate the cost impact going forward. Besides, some major hog producers are also proactively adjusting their feed composition with substitutes (e.g., wheat and paddy that have more stable price trends) to minimise the cost impact. COFCO Joycome may also benefit from the strong sourcing power of parent company COFCO. Based on our sensitivity analysis, every 1% drop in average feed costs points to a 3%/4% increase in gross/net profit of COFCO Joycome, suggesting an improving outlook in 6-12 months.
Large gets larger. The Top-6 players in China’s hog farming sector will account for an estimated 15%+ market share in 2022 (2021: 12.8%), and we see ample room for them to scale-up. We also expect efficiency improvement, brought about by expanding operating scale, and less volatile price cycles along with effective production planning by large-scale operators. Their strategic expansion towards feed sources as well as mid to downstream operations should also provide better growth opportunities, leading to stronger financial performance over the medium run.