CITI INCO Sell: Structurally Attractive, but Positive Expectations Priced In

Sell: Structurally Attractive, but Positive Expectations Priced In

v Maintain Sell — While structurally attractive production costs mean the company should survive long term, the stock’s current valuation suggests some positive expectations on nickel prices have already been priced in.Furthermore, we expect rising capex and funding needs to add to challenges for PT Inco. We cut our estimates; trim target to Rp1,975; maintain Sell (3L).

v 20% production cut — PT Inco is moving ahead with production cuts through shutting down diesel generators, hence relying solely on hydro power. This has started since end Oct-08, and we expect will continue until 2010.

v Commodity price revisions, earnings impact — Citi's commodities team recently slashed its '09-'10E Ni price forecast to US$4.5 and US$5.0/lb (from US$6/lb). Combined, the production cut and commodity price downgrades result in 14-61% reductions in our earnings estimates.

v Attractive cost structure — Along with the production cut, we expect production costs to fall to ~US$3.2/lb, made possible by the cheap operating cost of the hydro generators (hence the low cost should be sustainable).

v Unattractive valuation — PT Inco trades on 24x 12-months forward PE, slightly off the 25x, but a big jump from the low of 9x on trough earnings. This suggests downside risk if nickel price movements prove to be short-lived.

v Some near-term challenges — 1) Fund raising to plug major capex program. 2)Uncertainties surrounding the possible impact from the new mining law.