Danareksa International Nickel Indonesia Better Profitability

Headlines:

Helped by higher nickel-in-matte volume sales (up 7% QoQ to 18,653 tons in 3Q09) and an increase in ASP (up 51% QoQ to US$13,394/Mton in 3Q09), INCO’s revenues jumped 61% QoQ to US$250mn.

Gross profits per ton soared 269% QoQ to US$6,229 in 3Q09. As for the gross profit margin, it bounced back to 46.5% in 3Q09 from only 19% in the previous quarter thanks to both higher ASP and a lower COGS.

The net profit margin rose to 30.4% in 3Q09 from 11.2% in 2Q09. In 9M09, the net income reached US$110 mn or 72% of our full year forecast.

Comment:

INCO’s sales of nickel-in-matte have been steadily increasing since 1Q09 despite the weak nickel market, and the 9M09 sales of 50,687 Mtons (82% of our full year forecast) are slightly beyond our expectations. Hence, we remain confident that our FY09 sales forecast of 61,600 Mtons will be met despite the expected seasonal decline in sales which normally occurs in the fourth quarter of the year.

The company’s decision to restart some of its fossil-fuel power generators in 3Q09 has resulted in greater fuel consumption and consequently higher fuel costs (US$43mn in 3Q09 vs. US$34mn in 2Q09). However, we don’t believe this will jeopardize INCO’s profitability because the amount of fuel consumed was still lower than the amount consumed last year. Additionally, INCO’s average fuel cost in 3Q09 was only 59% of what it was in 3Q08 (US$61/barrel vs. US$104/barrel). This helped lift gross margins to 46.5% in 3Q09 from 21.9% in 3Q08.

The purchasing managers indices (PMI) of all major manufacturing countries were above 50 in October 2009, indicating the expansion of manufacturing activities worldwide. We are therefore convinced that demand for nickel will continue to grow. Underpinning our BUY call on INCO are the following:

INCO, by having restarted its fossil-fuel power generators, will be able to take advantage of higher nickel demand.

The amount of fuel consumed by INCO in 9M09 (and its associated cost) is still below our assumptions. Our COGS assumption for FY09 of US$7,666/Mton is therefore well within reach.

Despite the rising nickel inventory at the London Metal Exchange, market expectations of higher nickel demand in 2010 have so far kept the nickel price in the range ofUS$17,000-19,000/ton. We believe such prices are sustainable until the end of the year at least.

An increase in INCO’s COGS caused by higher fuel costs will be offset by higher ASP. Hence, our gross margin forecast of 30.9% for FY09 remains intact.

INCO’s shares now trade at a PE 10F/11F of 8.8x/9.7x, with 27% potential upside to our TP of Rp5,000.