• Maintain Outperform, albeit with lower target price of Rp55,000 (from Rp63,000), following our 4-7% earnings downgrade for FY10-12 as well as changes to our index target (to 14x from 16x). Our target price remains set at 20% above our market target. Our recent meetings with the company confirm that its fundamentals are intact. The company had raised selling prices for its machine-rolled cigarettes (MRC) by 1.3% in Jan 11 (4% excise tax in FY11). Nonetheless, given lower volume growth, we have reduced our volume-growth expectation for 2010 (from 4% to 2.5%) while maintaining margin estimates. Catalysts could include margin expansion, better-than-expected dividends as well as subsiding inflation fears, we believe.
• Second year of consolidation. Gudang Garam will be reinforcing its marketing efforts this year, together with
improving product availability and personnel competency. Following the latest excise tax for cigarettes, the company had gained market share, most likely from smaller players. With its better grip on pricing, we expect gross margins to improve further with the potential to return to pre-crisis levels of 25-30% from 9M10’s 23%.
• Dividends. With low major capex and a lack of inventory spending, we expect a higher dividend per share for FY10. We currently project Rp890 (40% payout), up from 2009’s Rp650 (36% payout), +37% yoy. The recent announcement of an interim dividend of Rp400/share, its first in eight years, has raised our confidence.
2011 outlook
No concern over economy. Gudang Garam is unfazed by higher-than-expected inflation, believing it may be seasonal rather than secular. It is more concerned with unexpected natural disasters that could hit demand or disrupt the supply of tobacco leaves, such as during the volcano eruptions of last year.
The 4Ps. 2011 will be a year for the company to reinforce its marketing efforts. Gudang Garam has been lagging in terms of distribution ownership, behind Sampoerna, Bentoel and Djarum.
No concern over economy. Gudang Garam is unfazed by higher-than-expected inflation, believing it may be seasonal rather than secular. It is more concerned with unexpected natural disasters that could hit demand or disrupt the supply of tobacco leaves, such as during the volcano eruptions of last year.
The 4Ps. 2011 will be a year for the company to reinforce its marketing efforts. Gudang Garam has been lagging in terms of distribution ownership, behind Sampoerna, Bentoel and Djarum.
• Products. Gudang Garam recognises the need to be in the mild segment which has seen the biggest growth in the market since 2004 particularly with limited upside for full flavoured machine-rolled and hand-rolled cigarettes. This is the reason it wants to continue improving its ‘Slim’ and Mild products and branding. Except for Surya Pro Mild, the other mild cigarette under the ‘Slim’ brand hasn’t picked up well.
• Pricing. One of the push factors for Gudang Garam to consolidate its distribution was a significant pricing gap between its cigarettes and peer cigarettes. After consolidation (in mid-2009), the company raised prices by 11% for hand-rolled and 16% for machine-rolled cigarettes. This has cut the pricing gap by half with one of its peers for hand/machine-rolled cigarettes.
• Placement. Control over distribution points and personnel has heightened over the past 1.5 years which has improved its ability to identify weaknesses in its marketing. It has been able to close its pricing gap with competition (at the distribution level). At the same time, it has gained market share from smaller players including white cigarette producers.
• Promotions. Supported by new distribution points opened last year, Gudang Garam may spend more on personnel this year. On top of that, it may spend more on advertising and promotions, particularly on ‘Slim’ cigarettes. Impact on margins. We reiterate that margin expansion will be one of the major catalysts for Gudang Garam. We believe that as the company improves its grip on pricing, of machine-rolled cigarettes in particular, there is a chance for its margins to return to pre-crisis levels. With banderol becoming a less significant benchmark for future cigarette
Valuation and recommendation
Gudang Garam was a clear outperformer in 2009-10, gaining as much as 347% and 100% vs. the JCI’s +85% and +50% respectively. Its stock peaked in early Oct 10 following fears of inflation, we believe. But the stock has shed as much as 30% since and continues to underperform the market although compared with Sampoerna and Bentoel, Gudang Garam has been quite defensive YTD.
Gudang Garam was a clear outperformer in 2009-10, gaining as much as 347% and 100% vs. the JCI’s +85% and +50% respectively. Its stock peaked in early Oct 10 following fears of inflation, we believe. But the stock has shed as much as 30% since and continues to underperform the market although compared with Sampoerna and Bentoel, Gudang Garam has been quite defensive YTD.
We maintain Outperform, albeit with a lower target price of Rp55,000, adjusted for ower earnings by 4-7% and a lower index target of 14x (from 16x), still valuing Gudang Garam at 20% above the market. Catalysts could include margin expansion, betterthan- expected dividend as well as easing inflation fears, we believe.
analysis by CIMB securities