Volume is still growing strongly
The cigarette industry continued to show very strong volume growth in 4M09. Total YTD production (measured by excise ribbon purchase) was up 8% YoY to 81 billion sticks from 75 billion sticks in 4M08. We see that two things cause the sharp increase. Firstly, it was caused by heavy purchase of excise ribbons by cigarette producers anticipating another hike in excise ahead of the election. Secondly, we also see that the ”election-wealth” has prompted increased spending on small-ticket consumer goods items such as cigarettes.
Hand-rolled cigarettes grew by 35%, almost double that of the machine-made cigarettes at 18%. This phenomenon shows that purchasing power has not fully recovered from weakness, and that some smokers switched to cheaper products. Hand-rolled cigarettes, borne lower excise, are sold at lower prices
Gudang Garam showed high growth of 21% and was leading in production. The company’s volume growth is more than double that of the industry, which registered an 8% growth. The strong volume growth positioned Gudang Garam ahead of HM Sampoerna. Its market share in April was 24%, ahead of HM Sampoerna at 20%. Gudang Garam showed extraordinarily high growth in both machine-made cigarettes (up 18% YoY) and hand-rolled segment (up 35% YoY).
Better ways of doing business
The company shows significant changes from its old way of doing business. The Board of Directors and Board of Commissioners now consist of only two Wonowidjojo family members, from more than five in the past 10 years. We see that Gudang Garam also hired senior marketing people, hence, the sales growth and revamped branding. This is shown in 139% YoY increase in selling expenses for marketing employee compensation to Rp12.9b in 1Q09. The company managed to curb other expenses (such as repairs & maintenance) to control costs. Total operating expenses in 1Q09 were up only by 9% YoY, below the 11% revenue growth.
Excise may increase 10% next year
Director general of customs and excise was quoted as saying that the government may increase cigarette excise by 10% next year to raise state revenue. The government will not raise excise/tax on cigarettes this year as agreed between the industry and the government. The above excise hike is expected to put pressure on sales growth and profit margins next year. Separately, lawmakers are still deliberating the bill on regional tax and tax funds, which if passed will impose new regional taxes of 10%-25% of selling prices. We are on the opinion that the regional taxes are not likely to materialise as cigarette producers will fight relentlessly against the double taxing.
Room for upside remains
Bearing in mind the potential 10% excise hike next year, we downgraded our forecast for next year. We believe that net profit will come in flat (-0.1% YoY). Gudang Garam has the largest asset size compared to its peers. Its balance sheet and cash flow are healthy. Its ROE is attractive at 19%. The stock has seen significantly increasing liquidity and appetite since our report dated April 2009. We reiterate BUY with new target price at Rp13,000 (translates into 9.3x 2010F PER and 1.15x 2010F PBV). At the current price the stock is trading at 8.2x 2010F PER.
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