Happy Friday. Our tireless and productive consumer analyst Swati upgrades her Gudang Garam (GGRM IJ) earnings forecasts and target price (attached). She raises her earnings forecasts by 5-11% on the back of higher selling prices. The new TP is Rp46,000 (previously Rp40k), based on 16x 2011 PER matching the 1992-96 valuation average. Maintain BUY.
GGRM has been a great call from Swati’s. Since her BUY recommendation in August 2009 (she actually started her unofficial positive call much earlier), the stock price has more than doubled.
It is just so tempting to take profits after the stock has a great run. Equally tempting for a stockbroker like ourselves to tell investors “You can’t go broke taking profits”.
However, we trust that investors hold on to GGRM a bit longer. GGRM’s ROE of the underlying business is still satisfactory (>20% and rising). The new management is competent and competition is easing. Two more important issues are consolidation in the sector and GGRM’s increased pricing power.
First, consolidation in the cigarette industry is a bigger story yet to fully play out. Smaller players (about 27% of total market share) who are currently protected by the government through lower excise taxes will have harder time competing with the big boys going forward. This year delayed tobacco harvest is another push that will accelerate consolidation in the industry. With consolidation comes pricing power, the second point we like to make.
GGRM has increased prices almost every month this year. Total price increases are 11.5% YoY for 1H10. Despite the government regularly increasing the excise tax for cigarette, the domestic cigarette industry is still growing 6% pa0020in the past 2004-2008 years (as a comparison, Indofood instant noodle is growing 2.5% pa during the same period of time). Cigarette is a resilient product with a relatively inelastic demand. It is also important to note that GGRM prices are about 5-7% discount to competitor prices to retailers. This gap will continue to decrease and completely diminish.
GGRM has consolidated its distributors and been trying to rebuild its image (promotion has improved significantly). The company is also making another attempt to penetrate the mild cigarette market.
The company is moving in the right direction. Quoting Warren Buffett “no matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant”.
We believe that investors’ patience will be rewarded. Don’t sell your GGRM stock. Not yet.
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