Kim Eng INCO: Within expectation, SELL

Net profit in line
Inco booked net profit of US$17m in 1Q09, a 88% YoY decline compared to US$140m in1Q08, in line with our expectation. Sales were down 68% YoY to US$121m mainly due to lower price of nickel. Inco reported average sales price (ASP) of US$3.8/lb (US$8,309/ton) or declined 61% YoY, pretty much in line with LME price.

Production in line, inventory level rose
The company produced 16,200 tons of nickel in matte in 1Q09 or down 19% from the same period last year, in line with management’s guidance to cut production by 20% in 2009. Sales volume was also down 18% YoY to 14,600 tons. However, inventory level rose meaningfully reflected by higher number of inventory days which rose to 104 days compared to 76 days in 1Q08 and the last five year historical average of 68 days. Note that an excessive amount of inventory on hand ties up cash and increases risks of obsolescence.

Lower cash cost as expected
As expected, cash cost fell 26.7% from US$4.0/lb (US$8,857/ton) to US$2.9/lb (US$6,492/ton), thanks to the management decision to shutdown all of its thermal generators. Although slightly higher than our cash cost estimate for FY09 of US$2.8/lb, we believe that our cash cost estimate for 2009 will still be achievable.

Signs of recovery?
INSG (International Nickel Study Group) recently estimates that primary nickel in 2009 will come to an oversupply of 80,000 tons, suggesting that nickel price will remain under pressure this year. Nonetheless, the recent economic data in China, in contrast is suggesting that the economy could have bottomed out. A number of economic figures come in better than expected. The purchasing manufacturing index (PMI), for example, has rebounded to over 50% since March, and further improved to 53.5% in April. Industrial production growth rebounded markedly in March. Fixed asset Investment (FAI) growth accelerated throughout 1Q09. It seems that government economic stimulus measure has gradually taken effect.


Raising nickel price assumption
In response to the better-than expected economic indicators in China, the world biggest nickel consumer, we have raised our nickel price assumption to US$5.2/lb and US$5.9/lb (from US$4.9/lb and US$5.7/lb), respectively.

Maintain SELL with higher TP
We raise our target price to Rp2,800 (from Rp1,700) which represents 50% premium of our DCF-over mine life valuation of Rp1,878 using 11.3% WACC. We believe that Inco deserves a premium valuation given its low cost structure. At current share price, SELL recommendation is maintained.