CLSA IndoNickelSector-19Oct09

Polishing nickel
We are revising up our nickel price assumptions as demand is improving, hence our sharp earnings revision for Indonesian nickel companies.

However, valuations are not particularly cheap, while mounting nickel inventory might limit upside risk on nickel price. We therefore view Indonesian nickel companies as more of a trade USD weakness and hence prefer the more defensive names, Inco Indonesia, over Antam.

Another look at nickel
􀂉 Stainless steel production was up by 24.5% QoQ in 2Q09 with sign of improvement on stainless steel price as well, positive for nickel usage.
􀂉 Austenitic grades stainless steel averaged 62% in 1H09, as compared 60% as of Dec08, suggesting growing nickel demand.
􀂉 However, LME nickel inventory have kept rising, breaching 121k, the highest level in the past 15 years, limiting further upside on price.
􀂉 Our nickel price assumptions were too low and we have raised them by 8% to 46%.

Our earnings revision
􀂉 We have raised our earnings estimates for Indonesian nickel companies by 70% to 420% over 2009 to 2011, coming from a low base.
􀂉 Our numbers are generally above consensus for Inco Indonesia and we believe consensus earnings estimates would need to be revised up following 3Q09 results.
􀂉 For Antam, our estimates are generally below consensus, largely reflecting different volume assumptions for nickel ore and cost structure on ferronickel.

How to play then?
􀂉 We think it is hard to see rally on nickel price given inventory risk, hence we do not expect a strong run up on Indonesian nickel names. Valuations are not particularly cheap either. Inco Indonesia and Antam are therefore mostly a trade on USD weakness, in our view.
􀂉 We think it is best to stay in a more defensive play, Inco Indonesia. The company
has low cost structure, strong balance sheet, while supported, financially and technically, by parent, Vale. Inco Indonesia’s USD based cost means its margin would not be affected by weak USD, unlike Antam or Australian nickel producers.
We raise our rating on Inco to BUY with target price set at Rp4,950.
􀂉 Antam valuations look stretch but downside would be supported by 1) the fact that
Antam is offering the sole gold exposure in Indonesia, and 2) potential M&A as the government could soon announce local parties that would entitle to buy stakes in gold and copper mine, Newmont Nusa Tenggara. We raised Antam rating to Outperform and set target price at Rp2,700.