Bahana Securities Indofood – (INDF-HOLD-IDR3,975-TP:IDR3,550) Food for thought

4Q09 gross margin compression = precursor of worse things to come

Indofood’s (INDF) 4Q09 results cement our view that margins for the company had peaked in 3Q09 as gross margin contracted to 26.9% in 4Q09 from 28.6% in 3Q09 on higher commodity prices. At the operating level, margin also fell to 14.3% in 4Q09 from 15% in 3Q09 while net margin dropped to 5.6% from 7.8% over the same period on less FX gain. Going forward, we expect margins to further decline on the back of two factors: 1) we expect cost of goods sold to rise, mainly for packaging (oil-based), CPO and sugar; 2) we believe INDF will have limited room to implement price increases due to tight competition. It is worth pointing out that INDF’s 2009 low noodle volume growth of 1.9% y-y suggests unlikely further price hikes.

Input costs trending up
We highlight that CPO prices have started to climb (exhibit 7), up from an average of USD680/ton in 3Q09 to USD692 in 4Q09 to USD772 in 1Q10 thus far. It is worth noting that CPO accounts for some 20% of the noodle division’s total COGS. Additionally, packaging costs, which tracks oil prices (exhibit 7), account for another 20% of total COGS. We note that oil prices had risen to an average USD76/bbl in 4Q09 from USD68 in 3Q09. Therefore, in 2010, we assume higher input costs causing lower gross margin of 24.6% in 2010 from 27.3% previously.

Flour: Lower prices on tighter competition
Our recent channel check to six local supermarkets and hypermarkets (exhibit 9) reveal that Bogasari’s flour prices have come off by an average of 8% in the past nine months. We believe this is caused by dumping from Turkey as well as the entry of Federal Flour Mill (FFM) of Malaysia into Indonesia. According to the Indonesian Flour Association (Aptindo), there will be at least 10 more new entrants into Indonesia’s flour milling industry in the near term with total investment of IDR2t (USD220m). With competition on the rise, Bogasari has been unable to benefit from wheat prices which decreased 23% q-q to USD208/ton in 3Q09 (exhibit 8). Testimony to this is the flour’s division 4Q09 operating margin of 12.6%, down from 13.6% in 3Q09.

Lower TP to IDR3,550 on less noodle contribution
With 2010 capex of nearly Rp4.3t (exhibit 10), we expect INDF to face tight cash flow. With 2009 net gearing of 126%, the listing of its CBP division would be the most viable cash raising exercise in our view. However, the impact of this on the listed INDF will not be positive given that investors can then buy directly into the CBP business and into LSIP directly for exposure on CPO, leaving only the unattractive and low margin business of the flour division within INDF itself. On valuation, INDF is not cheap on 2010 PE of 18.7x when compared to its regional peers (exhibit 11). We lower our target price based on SOTP (exhibit 12) to IDR3,550 from IDR3,800 on less noodle contribution. With 11% downside, we retain our HOLD rating on INDF.