RHB Indonesia Morning Cuppa - 21 November 2016 - (Indocement, Building Materials)

Good morning,

Indocement Tunggal Prakarsa: May Face Headwinds From Higher Coal Prices

Starting next year, Indocement is likely to face new challenges stemming from an increase in fuel costs. However, its new kiln, P14 – which consumes lower fuel–may likely partially offset the higher coal prices. To deal with rising competition, it recently launched its second-tier brand –Rajawali, which markets cement to selected areas – to strengthen market share. However, this would also incur a narrower EBIT margin. We lower our earnings estimates, while our new DCF-derived TP of IDR15,700 (from IDR17,900, 6% upside) is premised on 15x FY17F P/E.

¨ Higher coal prices. Indocement Tunggal Prakarsa (Indocement) is likely to face new challenges stemming from higher fuel costs from 1Q17 onwards. This year, it is still benefiting from relatively low fuel costs, as the majority of its coal purchases– which accounted for ~30% of 9M16 COGS – are made under 1- to 6-monthcontracts where prices are fixed. In addition, by running only its most efficient kilns and stopping production in old kilns that consume large amounts of coal, Indocement was able to reduce the proportion of its fuel and power costs to total manufacturing costs to 41% in 9M16 (9M15: 43%).

¨ New kiln to partially offset higher costs. Commencing operations of its new kiln, P14 – which is equipped with the latest technology and consumes less fuel – is likely to partially offset rising production costs caused by higher coal prices. Management said that P14 kiln’s cash cost is USD7-8/tonne (around IDR100,000/tonne) lower than that of its other kilns. Indocement’s 9M16 COGS was IDR550,000/tonne. P14 kiln’s production capacity is 4.4m tonnes pa, equivalent to 18% of its total production capacity.

¨ New second-tier brand, Rajawali. Rajawali was first launched in early October in Karawang, West Java. Going forward, it aims to sell Rajawali cement in other selected areas as well. Our ground checks suggest that Rajawali cement’s retail selling price is 15% lower than that of the Tiga Roda brand. This is to compete with cement produced by new cement makers which is selling at huge discounts. We think Indocement aims to increase its market share – even though this may lead to a narrower EBIT margin. Note that the company’s national market share declined to 25.8% in 3Q16 (from 26.2% in 3Q15).

¨ Lowering our earning estimates and TP. We cut our FY17F-18F earnings to IDR3.9trn-4.2trn (-13% and -12%) respectively, on the back of lower sales volumes and higher fuel prices. Our higher FY16F earnings are driven by tax benefits derived from asset valuations.

¨ We also reduced our dividend estimates since the company indicated that it will not be dishing out a special dividend in relation to its FY16F earnings. Indocement is now accumulating cash in preparation for acquisitions or expansion. We note that due to its strong balance sheet and operating cash flow, it paid a special dividend on FY15 earnings.

¨ Maintain NEUTRAL with a lower DCF-derived TP of IDR15,700 (from IDR17,900, 6% upside) implying 15x FY17F P/E. (Andrey Wijaya)

Link to report: to be sent out later

Link to Daily report: Indonesia Morning Cuppa - 211116

Company Highlights:

The government may announce gas tariff reduction for ceramic industry

Media reported that the government finally decided that gas tariff for three industries (petrochemicals, fertilizers and steel) should not exceed USD6 per mmbtu. This would be effective starting 1-Jan-17. The Minister of Energy and Mineral Resources, Ignasius Jonan said gas tariff reduction in other sectors – ie. ceramic and glass (which included in Presidential Decree No. 40/2016) – are likely to be determined in one week time. While, a ministerial regulation on the new gas tariff would be issued by next week.

Gas tariff reduction is positive for Arwana earnings. Arwana currently purchase gas at an average tariff of c. USD9.5 per mmbtu (upstream gas tariff + USD2 toll fee). According to Arwana, assuming industrial gas tariff were to declined by USD1/mmbtu, COGS would fall by IDR750/sqm, accounted for 3% of total COGS. In our back of the envelope calculation, Arwana earning should go up by around ~20% (assuming other factors remain same). The above presidential decree stated that new gas tariff would be implement retroactively since 1-Jan-16.

In our forecast, we assumed gas tariff reduction of USD1/mmbtu (c.10%) starting 2017. Our sensitivity analysis shows that Arwana’s fair value should range from IDR635 – IDR927/share (vs current share price of IDR535), assuming gas tariff cut of USD1-USD4/mmbtu starting 2017.

Maintain BUY on Arwana with DCF based IDR635 TP (20% upside), implying 25x/17x FY16/17F P/Es. (Andrey Wijaya)