Danareksa International Nickel Indonesia (INCO IJ, Rp3,450 SELL) Dull times for nickel

Lackluster outlook for the nickel price
After booking a net loss in 4Q08, the company recorded a small net profit of US$17mn in 1Q09. Profit margins improved on the back of lower production costs. Nonetheless, significant profitability improvements will only come from higher nickel prices. For the gross margin to be maintained at last year’s level of 38%, the nickel price will have to reach around $16,000-17,000/ton this year. This is far higher than the current nickel price of $12,790/ton. And with inventories at the LME still well above 100,000 tons (which is much higher than last year’s average inventory of 51,474 tons), the outlook for the nickel price is rather lackluster we believe. At the current share price, INCO trades at a rich valuation of PE 09F/10F of 35.9x/27.0x. SELL recommendation maintained.

Planned projects postponed
INCO has postponed plans to construct a processing facility in Pomalaa, saying the plans were no longer feasible given the currently low nickel price. In addition, the company has also postponed plans to implement a fuel conversion project since it believes the project costs could not be justified at the current time. In our view the decision to postpone the construction of the processing facility makes sense given that INCO is currently running below capacity. However, postponement of the fuel conversion project could have a negative impact if crude oil prices rise significantly in the coming years. We believe that the project will be put back two years from 2010 to 2012. The full benefits of the project - i.e. lower cash production costs and higher net profits - will be felt in 2013.

TP raised only slightly to Rp2,000
To take into account the company’s change in plans, we make adjustments to our financial model. Basically, the postponed projects mean that capex will be shifted toward later years. The adjustments also include revisions to production costs and operating expenses in 2009F and 2010F due to lower expected royalties and lower expected management & technical assistance fees. Using the DCF approach, we arrive at a new target price of Rp2,000, a 4% increase from our previous TP of Rp1,915.