Our new mining analyst Rania is making a non consensus call on Inco Indonesia (INCO IJ) with her SELL recommendation (re-initiating coverage) with TP of Rp4,200 or 11% lower than yesterday’s closing price. Her earnings forecast is 10% below consensus. CLSA foresees nickel price declining 11% to US$8.5/lb in 2011 from US$9.5/lb this year.
Reasons for the SELL call:
Strong earnings growth momentum is set to wither into FY11.
We expect average nickel price to soften by 11% yoy to US$8.5/lb on looming supply influx.
Nickel pig iron growth and significant nickel refinery supply growth (+300k tonnes) in 2011 and 2012 will pressure prices.
Production is set to fall by 6% yoy due to a 3-month repair at one of its furnaces in 1Q11.
INCO’s earnings sensitivity from nickel price movement is also far greater than that from costs and productions. A 10% movement in nickel price would positively move earnings by 22% (vs 13-15% for production and cost movement).
We expect oil price to increase 6.5% yoy on average next year.
Not much fat to burn anymore. Production cash cost could only fall by at most 8% yoy next year. Not enough to offset lower nickel price and production volumes.
Sales comment: the SELL call might be sound fundamentally but we would like to point out that it is difficult to swim against the tsunami of cash coming in to the market. In particular we are not keen to underweight resource sector on the back of massive money printing in the west. At the company specific level, INCO is globally competitive from cost point of view. The completion of Karebbe hydro power plant in August 2011 means INCO is going to be even more globally competitive. We expect cash cost to drop from US$3.5/lb to US$2.6/lb post hydro completion vs. global average of US$5/lb.
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