Nov 21, 2016 11:44:18

Indonesia Tobacco: Currency safe haven
Tobacco: Indonesia

Upgrading: safe haven, competition easing and lower excise hikes
At this stage of the cycle, we upgrade our rating on the Indonesian tobacco sector from Neutral to OVERWEIGHT due to 3 factors: (1) Its safe haven status due to low USD-linked costs (ie, packaging only c.2% of COGS); (2) Easing competition from value-proposition brands on substantial price hikes from Djarum and RMBA (exhibit 20); and (3) lower excise hike in 2017 (exhibit 25). In our view, all of these positive catalysts bode well for industry growth as we head into 2017. Besides the sector’s low USD content in COGS, both HMSP and GGRM have solid balance sheets with no USD-denominated debt. That said, we believe the tobacco sector, whose earnings move by just 0.1% with every 1% change in the IDR on our estimates, offers investors a shield against FX volatility (exhibit 24). OVERWEIGHT.

GGRM over HMSP: Faster earnings growth at attractive valuation gap
Post the 3Q16 results, we adjust our 2016-18F earnings, particularly as we are seeing margin improvement at GGRM on the back of its recent aggressive ASP hikes to catch up with other cigarette players. We see its margins improving over 2017-18F and higher earnings growth compared to HMSP. Moreover, we believe GGRM’s valuation gap over HMSP is too compelling to ignore at these levels, with the shares trading at a 2017F PER of 17x, a 10% discount to the past-5-year trading PER (exhibit 23). Nevertheless, we still like HMSP for its high brand equity and strong corporate governance. Thus, we reaffirm our BUY call on HMSP, but lower our 12-month TP to IDR4,400 (from IDR4,800), now based on a 2017F PER of 40x (from 42x) due to softer earnings-growth momentum ahead. On GGRM, we reaffirm our BUY call and raise our 12-month TP to IDR81,000 (from IDR72,300), now based on 2017F PER of 23x (from 21x), a 20% premium to its past-5-year PER, as we see margin improvement ahead from ASP hikes (exhibit 5). Risks for HMSP: Greater public ownership requirement from the IDX due to limited free float of 7.5%, management change and stiffer competition. Risks for GGRM: Lower product demand due to extreme weather adversely impacting farmer incomes and robust competition.