Danareksa Indofood Sukses Makmur (INDF IJ Rp 3,800 BUY) Reasons for optimism

BUY, TP of Rp4,500
We reinitiate coverage on INDF and rate the stock a BUY. Our TP of Rp4,500 - which is based on a SOTP valuation - implies 18.8-16.6x PER10-11F, a 20% discount to regional peers. Our optimism is grounded in a number of factors: 1) de-leveraging following the impending IPO of ICBP, 2) stable margins supported by the firm rupiah, improving purchasing power and lower wheat costs, and 3) a higher CPO price assumption (US$850/ton in FY10F) which suggests better performance of the plantations division and that more than offsets cost increases for noodles. At the current share price, the stock trades at 15.9x PER10F. However, we believe a re-rating is warranted given the visibility of the earnings, the strong CBP margins, and the healthier balance sheet.

De-leveraging post IPO of ICBP
After ICBP’s IPO, INDF’s EPS could be lifted by some 5.2-6.6% in FY10F due to a lower cost of debt, aside a stronger balance sheet. We estimate that ICBP’s listing should yield an equity value of around US$2.2-2.5bn, assuming the current regional valuation of 12.2-13.6x EV/EBITDA 2010F. If this turns out to be the case, it would be major value unlocked since the estimated equity value far exceeds ICBP’s current implied value of US$1.8bn (7.5x EV/EBITDA). But how likely is such a valuation? Well, we think it is quite possible given INDF’s strong brand equity and its competency in operating CBP businesses. Assuming a 20% stake is listed, we estimate that INDF will save around Rp200-250bn of interest costs whilst the net gearing shall fall to 0.5-0.6x from 0.8x currently. Please note that as the IPO of ICBP is likely to materialize in 2H10, we only assume a six months impact on earnings. But due to a lack of guidance from the company, we don’t yet incorporate the ICBP listing into our forecast. That’s upside potential!

Maintaining good margins
INDF’s operating margin shall remain firm at 13.5% in FY10F, supported by: 1) the stronger rupiah, 2) lower wheat costs, and 3) improving purchasing power. Plantations lead the way with a lofty 28.5% margin, followed by noodles and flour (10.9% and 9.6%, respectively). Despite surging crude oil and CPO prices, we are confident that noodle margins will be stable, thanks to lower wheat costs and selling price increases. As for Bogasari, we expect a stable operating margin of 9.6% in FY10F, down slightly from 9.9% in 2009, assuming no selling price increases this year because of lower wheat costs and fairly stiff competition. On the exchange rate, we take a conservative stance and assume an average exchange rate of Rp9,556/US$ compared to the current rate of Rp9,017/US$ and the ytd level of Rp9,212/US$. This offers further upside potential. Note that our sensitivity analysis suggests that for every 10% appreciation in the rupiah/USD exchange rate, earnings will increase by 13%, ceteris paribus.

Plantations – the largest contributor to EBIT
Given our bullishness on the outlook for the CPO price (we forecast a CPO price of US$850/ton in FY10F or up 15.7% in rupiah terms), INDF’s plantations arm is estimated to contribute 40.1% of EBIT in 2010 compared to 35.7% in 2009. However, there are risks since a 10% decline in the CPO price could reduce earnings by 4.3%. Other risks include unexpected rupiah depreciation and higher wheat costs.