OREANDA-NEWS. Fitch Ratings has revised Indonesia-based PT Japfa Comfeed Indonesia Tbk's (Japfa) Outlook to Negative from Stable. At the same time the agency has affirmed Japfa's Long-Term Issuer Default Rating at 'BB-'. Japfa's senior unsecured rating and the rating on its senior unsecured US dollar notes due in 2018 issued by Comfeed Finance B.V. have also been affirmed at 'BB-'.

Fitch has also affirmed Japfa's National Long-Term Rating at 'A+(idn)' and revised the Outlook to Negative from Stable. The rating on its IDR1.5trn bonds due in 2017 is affirmed at 'A+(idn)'.

The revision of Outlook to Negative reflects our view that Japfa's financial flexibility is under strain amid an uncertain market outlook. Weak demand growth and high supply led to thinner margins for Japfa in 2014. As a result, leverage (net debt/EBITDA) stood at 3.7x, exceeding the 2.5x threshold at which Fitch would consider negative rating action.

Fitch expects the poultry farmer and feed producer to deleverage to 2.5x by 2017, driven by earnings growth and underpinned by the robust long-term growth potential for the Indonesian poultry industry. However, prolonged weakness in demand and cost rises are risks that could exert further stress on Japfa's financial flexibility.

'A' National Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category.

KEY RATING DRIVERS

Outlook for Poultry Demand Uncertain: Growth in demand for chickens in Indonesia has been subdued over the last two years as economic growth decelerated. Although Fitch expects demand growth to improve in 2015-16, based on our forecasts for higher GDP growth, the pace of the uptick is unclear. Unless poultry demand growth in Indonesia picks up, a material improvement in Japfa's volumes and margins would be challenging.

Supply Response May Be Inadequate: Japfa's cost pass through ability appears to have been eroded by the increased supply over the last couple of years. We believe weak demand being faced currently can be partly offset by industry cuts in production capacity of day-old chicks (DOC) and further downstream. However, similar to demand growth, the outlook for the magnitude of supply response is not clear.

While demand for chicken meat has been weak for the past two years, a reduction in supply has only kicked in over the past six months or so. Japfa has cut DOC production capacity by about 15% this year, and the company believes smaller producers are also making similar capacity cuts. However, these cuts could be ineffectual if the industry leader Charoen Pokphand (with 40% of the total DOC capacity) does not respond with a similar cut in its production capacity.

Credit Metrics Could Worsen: Japfa's leverage stood at 3.7x at end-2014, much higher than our negative rating action guideline of 2.5x. We factor in a gradual improvement in demand, and estimate that leverage could improve to 2.5x by 2017. However, persistent weak demand conditions could derail the improvement in leverage. We also assume raw material costs that are mostly unchanged, based on market forecasts of steady international corn and soybean prices, and our expectations of a slowly strengthening Indonesian rupiah. A steep rise in global raw material prices or sustained rupiah weakness would inflate Japfa's costs, and present another significant risk to our estimates.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Japfa's animal feed sales volume to remain flat in 2015, and grow between 3%-5% in 2016-17.
- Sales volume of DOC and live poultry fall 10% in 2015, based on weak demand conditions and potential supply pressure from competitors. Thereafter, we assume a 3%-5% growth in DOC and live bird sales volumes in 2016-17.
- EBITDA margin of 7.4% in 2015 that will improve gradually to 8.5% in 2016 and 10% in 2017.
- Capex of IDR750bn in 2015 and IDR1bn thereafter.

RATING SENSITIVITIES

Positive developments that may, individually or collectively, lead to a revision in the Outlook to Stable include:
- Leverage (net debt/EBITDA) lowering to 2.5x or below by 2017
- Improvement in market fundamentals leading to a rise in EBITDA margin to 10% or more (2014: 7.1%).

Negative: Future developments that may, individually or collectively, lead to negative rating action include
- Continued weak market fundamentals that impair earnings, feedstock cost pressures or an aggressive capex plan, which could hurt Japfa's ability to reduce its leverage to below 2.5x by 2017.