JPM PT International Nickel Indonesia - Decline and cap to volume; downgrade to UW and reduce PT to Rp3,700

Threat to FY11E volume and cap on maximum volume due to capacity: In the 1H10 results conference call, INCO stated that due to major maintenance on one of its four electric furnaces, FY11E volume is at risk of declining on a Y/Y basis as the furnace will be shut down for 13 weeks of shutdown plus 5-7 weeks of ramping up time. Currently, the maximum capacity at the processing plant is 79,000 tons of annual production. Despite Karebbe coming on-stream in 2H11E, which could increase the production ability to 90,000 tons p.a, the installed capacity at the processing plant could create a cap on maximum volume that can be delivered in the next few years.

• Flat nickel price assumption and rising cost: J.P. Morgan’s global metal analyst, Michael Jansen, is of the view that nickel supply and demand will swing from a deficit in FY10 to a surplus in FY11. As a result, he has a neutral view on nickel prices over the next 12 months, with potential downside risk. In addition, we expect the long-term cost to gradually rise (due to rising oil prices) until FY15, working against profitability.

• Investment drivers: We expect the following factors to cause the stock to underperform over the next 6-12 months: (1) threat to FY11E volume and cap on maximum volume to be delivered until FY15E; (2) flat or declining nickel prices; (3) long-term rise in production costs.

• Downgrade to UW; extend and cut PT from Rp5,300 to Rp3,700: We downgrade INCO from OW to UW, extend our PT to June-11, and cut our PT from Rp5,300 to Rp3,700. Risks: Rise in nickel price and higher grade ore input. We recommend that investors reduce positions in the stock on the back of a volume decline in FY11E and lack of volume growth going forward.