Earnings revised upward
We have altered our earnings forecast to take into account the 1Q09 results. We lower our sales volume estimate as demand was very slow in 1Q09 but raise both our selling price and production cost estimates. As a result of our higher selling price estimates, we raise our EPS estimates by 11.5% for FY09 and by 17.5% for FY10.
Making more money
High average selling prices (ASP) boosted Indocement’s profit margins and operating cash flow in 1Q09. Thus, despite the 25% y-o-y decline in sales volume in 1Q09 to 2.6mn tonnes, the EBITDA margin expanded to nearly 40%. In 1Q09, the ASP was around Rp836,000 per tonne. This was 42.7% higher y-o-y and 7.2% higher q-o-q. These figures show the importance of high selling prices in maintaining profitability when sales volumes decline. Nonetheless, in the long run the risk is that persistent declines in sales volumes will prompt cement producers to defend their market shares. This would put pressures on cement prices.
The most efficient producer
Indocement is the most efficient cement producer. Its production cost dropped 0.7% qoq to Rp450,000 per tonne in 1Q09. The lower sales volume worked to the company’s advantage as it was able to reduce its usage of expensive diesel oil in power generation. As it turned out, the electricity supplied by the state owned electricity company PLN was sufficient to meet Indocement’s needs as the company’s utilization rate was a low 50-60%. At the same time, the coal used from its inventory was still priced at last year’s contract of around US$45-50 per tonne. Going forward, Indocement will pin its hopes for cheap power generation on gas. Note that its new coal contracts will likely reflect the current coal price of around US$65 per tonne. As such, Indocement should fare better than some of its competitors who locked in the coal price in contracts at US$75-80 per tonne.
Dealing with high inventory levels
Falling demand - especially in Java - increased the company’s inventory from around 30 days to 50 days in 1Q09. Going forward, Indocement will want to reduce its inventory. If demand does not pick up, it has two main options to run down its inventory to normal levels. Firstly it can reduce production and fulfill demand from its inventory. This will hurt margins due to the contribution made by the fixed costs. Alternatively, the company can reduce selling prices in a bid to generate more sales – although this will put huge pressures on margins. As such, we believe the first option is the better one. Nonetheless, there are some signs that demand is picking up in the important Java market. This will benefit Indocement.
Our favorite stock in the sector, BUY
Indocement remains our top pick in the cement sector. It has an efficient cost structure and, furthermore, the company is well placed to benefit from a recovery in the cement market as it has a low utilization rate. Being cash positive, the company can focus its efforts on maintaining profitability. Our target price is Rp6,500. This translates into EV/tonne of US$120. BUY recommendation maintained.
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