CLSA GGRM upgrade, conviction BUY, TP Rp40,000

Swati raised her TP for Gudang Garam (GGRM IJ) from Rp31,300 to Rp40,000 and reiterates conviction BUY.

Swati met an industry contact and learned that Gudang Garam Surya (regular) which makes up 50% of its sales is doing very well. The other product GGRM International (30% of sales) have seen volumes stabilizing. Mild is picking up gradually.

Swati also highlights that there is significant difference in pricing to the retailers between GGRM and competitor products which are sold at similar pricing to the end customer. Correcting this difference could translate into additional Rp1.25tn of profit or 31% of our 2010 forecasts. In fact GGRM is already increasing prices in steps. They seem to have realized that lower price strategy simply failed as innovativeness, taste, and branding proved to be more important than price.

But the bigger story yet to be played out is industry consolidation. Top five cigarette makers control 77% of the market. We think the government will gradually phase out the middle layers by creating more equal playing field via excise tax mechanism. This will benefit the big players such as GGRM.

CLSA INDF, re-initiating coverage, conviction BUY, TP Rp2,550

Our consumer analyst Swati has just written a very interesting (non consensus) report on Indofood (INDF IJ) . This is a re-initiation report. Swati has Rp2,550 TP and a conviction BUY call. She arrives at this target price by applying a multiple of 13x 2010 CL PE, which is also the 10 year average P/B of 2.2x. Regional consumer peers trade at 13.5x 2010 PE.

Consumer or plantation play?
Contrary to the popular perception, INDF is not really a plantation play (anymore). Consumer-related operations will contribute 70% to net income this year. While agribusiness will contribute 30% to net profits AFTER eliminating inter-segment sales, interest expense related to acquisition and amortization of goodwill and minority interests. See the charts below:

Noodle recovery and potential, the key driver to group earnings in the years ahead
For the first time in 5 years, INDF’s noodle operations are showing signs of recovery. EBIT margins have recovered from all time lows, no doubt helped by lower CPO and wheat prices.

Despite being the largest market in the world, Indo’s noodle market still has great potential. Euromonitor predicts Indo’s noodle market will grow by 11.2% pa for the next 5 years, second only to Vietnam.

Key points from the report:
· We reinitiate coverage on INDF with a conviction Buy call.
· INDF is one of the world’s largest producers of instant noodles and is a proxy to Indonesia’s growing domestic consumption with a market share of about 72% in instant noodles.
· We see a turnaround in noodle margins this year as market share stabilize, price war subsides and input costs fall.
· We argue that INDF is a consumer related company as consumer related operations will contribute 70% to net income this year.
· INDF’s margins on flour segment will suffer this year as competition increases. Indofood emphasize market share and therefore we conservatively forecast 5% ebit margins this year vs 8-11% historically.
· Indolakto we believe will be earnings accretive from 2013 onwards.
· We derive fair value of Rp2550/sh. A blue sky multiple would lift this higher.