COFCO Joycome (1610 HK/HK$2.53, HOLD) hosted a conference call on 12 January to explain the rationale of the latest share placement to its largest shareholder COFCO Corporation.
　　Details of Transactions:
　　On 11 January 2023, COFCO Joycome has conditionally agreed to issue, and COFCO Corporation, the parent company, has conditionally agreed to subscribe for 680,000,000 shares at HK$2.30/share for a total cash consideration of HK$1,564m.The shares represent approximately 17.43% of the existing issued share capital of COFCO Joycome. If the transaction is approved and completed, the shareholding of COFCO Corporation will increase from 29.9% to 40.3%.
　　Uses of proceeds: (i) c.70% of the net proceeds (HK$1,086m) for expanding production capabilities and enhancing the branded fresh meat distribution; and (ii) c.30% of the net proceeds (HK$465m) for repaying the short term loan and replenishing the general working capital.
　　Rationale for the transaction: Management would like to expand the production capacity. Considering the impact of COVID-19 and the time needed, the management believed the share placement to the parent company, COFCO Corporation, would be most appropriate. COFCO Corporation would also like to increase the stake of COFCO Joycome in order to maintain food security.
　　Other Business Updates:
　　2022 financial performance: No details were discussed.
　　Hog production target for 2023: Management reiterated that COFCO Joyocme aims to increase the production capacity by at least 1m heads per year. If the share placement is completed, management would not rule out the possibility that the addition would accelerate. However, this would be subject to whether new production sites could be secured, subject to the criteria imposed by COFCO Corporation. While the production volume reached 4.1m heads in 2022, the exact production volume target for 2023-24 is not yet finalised.
　　In the long run, COFCO Joycome targets to achieve a production volume of 10m heads/year, which matches its slaughtering capacity.
　　Fresh pork business: The company targets the sales of linseed-fed pork would be more than doubled in 2023.
　　View on hog prices in 2023: COFCO Joycome does not have an official view on hog prices in 2023 and would not adjust its production based on hog prices. However, management personally believes if there is no major outbreak of African Swine Fever in China, hog prices may trend lower in 2023. This could be caused by higher hog production activities since June 2022, where the finishing hogs will be available after 11-12 months.
　　Hedging in 2023: COFCO Joycome would remain committed to hedging through hog futures in 2023. Management believes hedging would smoothen the company’s profits.
　　Our View:
　　We believe the transaction could be beneficial to the company’s long term development, as the HK$1.56bn raised could help accelerating the expansion of its upstream production facility. COFCO Corporation’s intention to increase its stake on COFCO Joycome also reflects its long-term bullish view on the industry.
　　However, we believe the short-term benefits for such deal would be limited, due to: (1) the near term EPS dilution of 17.43%, and (2) it takes time for the hog production to ramp up, which has to go through rigid process of site selection, construction, and more than 10 months of hog breeding cycle. It may also create higher depreciation, amortisation and fixed costs in the near term.
　　Meanwhile, the earnings visibility for 2023 could be limited, as hog prices are likely to stay volatile and create unpredictable hedging gains and losses. Still, we expect 2023’s profitability should be better than 2022 if no material hedging losses are involved. We believe more guidance on 2023, which may be disclosed in March 2023, would be needed for re-rating.
　　Valuation:
　　We have a HOLD rating on COFCO Joycome and a TP of HK$2.6, based on 4.5x 2023 P/E.
　　Key Risks for Rating
　　Key downside risks to our call included slower-than-expected recovery of hog cycle in China; sharp rise in feed cost; weak consumer demand, and unexpected hedging gains/losses. Key upside risks to our call included a rapid recovery of hog industry due to market consolidation and strong recovery of catering leading to strong demand for pork.