Deutsche Gudang Garam – Sustainable turnaround boosted by price increases

Aggressive pricing strategy continues with fourth price hike in 2010
GGRM plans to increase prices by c. 1.5% in mid-May, its fourth price increase in 2010. Year to date it has raised prices by 6.5%. Management has increased prices eight times since taking over in early 2009. Major competitors have tagged along on GGRM’s aggressive pricing strategy, thus minimizing the volume effect. The company needs to raise prices by a mere 2% to reach our full-year target. We reiterate our Buy rating, as every 1% price increase boosts net profit by 4.5%.

Management believes improved profitability is sustainable
Management stated that the positive effect of bringing distribution in-house last year was sustainable and not merely a one-off event, as “underlying improvement in profitability and cash flow is sustainable.” In line with our thesis, management said that the key reasons for profitability were its pricing strategy and the government’s favorable excise policy.

Investing in brand equity for future growth
GGRM was among the top ten TV adspenders in 1Q10, for the first time in the past few
years. In addition, we believe GGRM's profile will continue to rise, especially among the youth segment, as it will be the official broadcast sponsor for the World Cup in Indonesia.

Reiterate Buy, as GGRM trades at a 39% discount to regional tobacco peers
Trading at 12.3x FY10F PER, GGRM is our top pick in the Indonesian consumer space as a result of a sustainable turnaround, favorable excise policy and rising consumer purchasing power. Our target price is derived from DCF valuation, with WACC of 13.4% and a terminal growth rate of 5%. Risks: excise tax policy and the sustainability of internal restructuring.