CLSA Gudang Garam (GGRM IJ), a conviction call, the cheapest consumer stock in Asia

Reiterating BUY, TP Rp22,350 based on 11.7x 2010 CL PER

Swati maintains her conviction BUY call on turnaround story GGRM. We upgrade earnings by 20-30% for 2009-2011.

In this report, Swati is focusing more on VALUATION: GGRM is the cheapest amongst the 71 consumer companies that CLSA covers in Asia. The stock is trading at 8x 2010 CL PE, compared to 17x average for consumer companies in Asia. In term of P/B, GGRM is trading at 1.42x 2010 P/B, much lower than local peers like UNVR (21x) and INDF (2.57x).

We believe that re-rating should occur for GGRM, for the following reasons:

1. Cigarettes have an inelastic demand and offer stable earnings and cash flow. Indonesia has a regulatory light environment which is why 78% smokers start smoking before age of 19.

2. GGRM’ balance sheet has de-leveraged and the company will be in net cash situation this year.
3. Turnaround story: please see the table below on excise duty stamp purchase. Margins are improving as GGRM shifted product mix in favour of higher margin handmade kreteks and implemented a more targeted marketing approach (interesting to note that 9M09 marketing expenses actually fell by 17% YoY).

4. A sharp change in direction of the top management. Not only is the distribution being managed in house by newly hired, very respected and experienced people from the industry, the company is also hiring brand managers, marketing planners and trainers for the first time.