Dec 13, 2016 12:00:07

Indonesia Tobacco: December ex-factory price update: +1-3% m-m
Tobacco: Indonesia
Reiterating our preference for HMSP on its strong brand equity 
According to our analysis, HMSP should face less ASP adjustment than GGRM next year due to cost pressure. ASPs for HMSP’s A Mild (c.60-70% of its total clove machine-rolled cigarette volumes [SKM]) are up by IDR124/stick YTD, vs. cost inflation of c.IDR97/stick. Given that A Mild has high brand equity, HMSP has managed to only lose 3% market share, while having a 13.5% ASP increase YTD despite aggressive pricing by competitors RMBA (Lucky Strike Mild and Dunhill Mild) and GGRM (Surya Pro Mild). Also, RMBA is doing a year-end promotion: IDR400/pack discount for Dunhill Filter and Lucky Strike Mild 16 and IDR300/pack discount for Dunhill Mild 20/16 and Lucky Strike Mild 12. Previously, we had expected GGRM to regain its earnings growth momentum once the company starts to catch up on price adjustments for its Surya Pro Mild in 2017. However, we see competition remaining intense, forcing GGRM to keep Surya Pro Mild ASPs low. Hence, the cross subsidy that GGRM is doing right now should continue, leading to a drag on its earnings.

Sensitivity analysis: GGRM earnings more sensitive to ASP changes
In order to quantify the price adjustment’s impact on the bottom line, we have conducted a sensitivity analysis for every 1% change in ASP. As almost 90% of GGRM volumes are from SKM, the company is more sensitive to ASP changes than HMSP (exhibit 8). We note that Surya 16 contributes c.40-50% to GGRM’s SKM sales volume, International 12 30-35%, and Surya Pro Mild c.10-15%. In other words, each IDR10/stick of additional profit to Surya 16 or International 12 could be used to cross-subsidize Surya Pro Mild by IDR30-40/stick. On the other hand, HMSP’s A Mild contributes c.70% to total SKM volumes, with a 12-stick pack representing about a fifth of total A Mild volume, slightly lower than U Mild’s sales volumes. Thus, every additional IDR10/stick profit at A Mild 16 could be used to cross-subsidize A Mild 12 or U Mild by IDR20-25/stick.

December ASP update: up 1-3% m-m at GGRM, RMBA and Djarum
Unlike last year, GGRM is taking a more cautious pricing approach. Effective 19 December 2016, GGRM plans to raise its Surya 16 ASP by 2.2% (YTD: +6.4%) to IDR1,153/stick, International 12 by 1.4% (YTD: +6.8%) to IDR1,175/stick, Surya Pro Mild by 2.6% (YTD: +10.1%) to IDR750/stick, and GG Merah by 2% (YTD: +7.3%) to IDR854/stick. We calculate that GGRM would need to pass on another IDR83/stick next year to maintain its margins (exhibit 5). Note that Surya Pro Mild was previously selling at par with Lucky Strike Mild 16 (IDR731/stick). Effective 1 December 2016, RMBA increased its Lucky Strike Mild 16 ASP by 3.4% to IDR763/stick, the first time since it was launched in April 2016. However, RMBA is having a year-end promotion until 19 December 2016 to sell at November old prices (IDR300-400/pack discounts). Thus, from 19 December 2016 RMBA will then follow the new price schedule (exhibit 10). HMSP, on the other hand, has not announced an ASP hike in December 2016. However, YTD the company has increased its ASPs for A Mild 16 by 12.4% and Dji Sam Soe 12 by 5.1%, more than enough to offset cost inflation in 2016. In addition, Djarum recently announced ASP increases for a majority of its products, effective 19 December 2016, with the key products being Djarum Super 12 +1.1% (+9.2% ytd), LA Bold +1.3% (+23.7% ytd), and Djarum Coklat +1.5% (+10.3% ytd).
Recommendation: HMSP is our top pick on better margin preservation
As RMBA still offers huge promotions, we prefer HMSP given that it has a higher brand equity in the Mild segment than GGRM.  Thus, we reaffirm our BUY call on HMSP, but slightly lower our 12-month TP to IDR4,600 (from IDR4,700), based on an unchanged 2017F PER of 40x following the 2% reductions to our 2017-18F earnings.  However, we believe GGRM’s valuation gap over HMSP remains compelling at these levels, with the shares trading at a 2017F PER of 17x, a 10% discount to their past-5-year trading PER. Therefore, we reaffirm our BUY call on GGRM and maintain our 12-month target price of IDR81,000 based on a 2017F PER of 21x, a 20% premium to its past-5-year PER, as we see margin improvement ahead from ASP hikes (exhibit 5). The risk to our call on HMSP would be adverse government policy on excise and health awareness. The risk to our call on GGRM would be more pricing competition in the Mild segment, especially from RMBA for its Lucky Strike Mild and Dunhill Mild, making it more difficult for GGRM to increase its Surya Pro Mild’s ASP.