Danareksa International Nickel Indonesia (INCO IJ, Rp4,375 BUY) A solid first-half

BUY maintained, TP of Rp5,000
We maintain our BUY call on INCO given the excellent 1H10 performance. In this period, INCO’s net profits surged 61% YoY to USD219mn, representing 51% of our full year forecast. The good profitability came on the back of both higher sales in 2Q10 and higher ASP. Margins also improved, with the net margin widening to 35% in 1H10 from 28% in 1H09 thanks to lower fuel consumption. Looking forward, we remain confident that our full year forecasts for the company will be met, since demand from stainless steel producers for restocking should be strong. INCO’s shares are currently trading at an attractive valuation of PE 10F/11F of 10.5x/12.2x, or less than the mining industry’s 13.6x/13.0x. With our TP of Rp5,000, the shares offer 14% upside potential.

Strong sales and good profit margins in 2Q10
INCO booked strong sales and higher profit margins in 1H10. The higher sales mainly owed to the 11% QoQ increase in sales volume in 2Q10, while the better profit margins resulted from increasing ASP in addition to lower fuel consumption due to a routine maintenance shutdown of a furnace for two weeks in April 2010. As a consequence, the 1H10 net profits were able to grow 61% YoY to USD219mn.

The nickel market has slowed but is still expanding
We are keeping our assumptions and forecasts intact for this year. Although nickel consumption has slowed a little bit, we believe that the slowdown is temporary and that restocking will begin by the end of 3Q10. Our conviction is based on the manufacturing activities of major manufacturing countries which still indicate expansion (see Exhibit 4 for worldwide purchasing manager indices that are still above 50). As such, nickel prices should hold up in the coming months, we believe.

Danareksa International Nickel Indonesia (INCO IJ, Rp3,450 SELL) Dull times for nickel

Lackluster outlook for the nickel price
After booking a net loss in 4Q08, the company recorded a small net profit of US$17mn in 1Q09. Profit margins improved on the back of lower production costs. Nonetheless, significant profitability improvements will only come from higher nickel prices. For the gross margin to be maintained at last year’s level of 38%, the nickel price will have to reach around $16,000-17,000/ton this year. This is far higher than the current nickel price of $12,790/ton. And with inventories at the LME still well above 100,000 tons (which is much higher than last year’s average inventory of 51,474 tons), the outlook for the nickel price is rather lackluster we believe. At the current share price, INCO trades at a rich valuation of PE 09F/10F of 35.9x/27.0x. SELL recommendation maintained.

Planned projects postponed
INCO has postponed plans to construct a processing facility in Pomalaa, saying the plans were no longer feasible given the currently low nickel price. In addition, the company has also postponed plans to implement a fuel conversion project since it believes the project costs could not be justified at the current time. In our view the decision to postpone the construction of the processing facility makes sense given that INCO is currently running below capacity. However, postponement of the fuel conversion project could have a negative impact if crude oil prices rise significantly in the coming years. We believe that the project will be put back two years from 2010 to 2012. The full benefits of the project - i.e. lower cash production costs and higher net profits - will be felt in 2013.

TP raised only slightly to Rp2,000
To take into account the company’s change in plans, we make adjustments to our financial model. Basically, the postponed projects mean that capex will be shifted toward later years. The adjustments also include revisions to production costs and operating expenses in 2009F and 2010F due to lower expected royalties and lower expected management & technical assistance fees. Using the DCF approach, we arrive at a new target price of Rp2,000, a 4% increase from our previous TP of Rp1,915.