May 09, 2016 16:41:27
Gudang Garam (GGRM): Still shining

Maintain BUY with higher TP
We continue to like GGRM for: 1) its solid branding 2) its exposure to mass market, 3) potential for lower leverage as the capex cycle has ended. Reiterate BUY with TP of IDR85,000, which implies 21x PER FY17F or +1SD above 3year historical mean. We upgraded our FY16-17F earnings forecasts by 9-10% to incorporate better than expected profitability from continuous ASP hikes and lower raw material costs.

Expect stable volume performance
We estimate -2 to 0% YoY volume for GGRM over 1Q16 vs. –6% YoY for the industry, implying some market share gain. We expect the volume performance to hold up through the rest 2016 on the back of a lower base and potential improvement in consumer confidence. In the longerrun, we expect consumers to continue to shift to machine roll cigarettes, which will lead to more intense competition in the segment. GGRM’s dominant position in the regular machine-rolled segment should support the company’s effort to expand to the ‘mild’ segment, in our view.

Pricing power to support margin
We expect major cigarette companies, including GGRM, to pass on cost increases to customers. With ~15% YoY excise tax increase for 2016F, we estimate ~10% YoY hike in ASP. The lower raw material price and potential for lower financing costs are expected to provide some support to net margin despite increase in opex. A&P costs are likely to rise after the soft performance of ‘mild’ brands last year and rising competition.

Better FCF after capex cycle ended
As the capex cycle appears to have ended in 2014, we expect FCF to improve and lead to deleveraging in the medium-term. With lower leverage and interest rate, we forecast lower financing costs for GGRM (- 9% YoY in FY16F and –10% YoY in FY17F) and this is likely to support the company’s net margins over FY16-17F.