We are upbeat on Gudang Garam. We believe that the market is overreacted on the worries on the excise tax hike and higher VAT. Stock has been underperforming the JCI this year by 17%. We believe that if this happens, GG will be able to pass it through as it has consistently done in the past.
Further being one of the largest player with strong brands and working capital capability, GG should in fact be able to gain market share as the increase in tax will squeezed out the smaller players.
Shift of consumer preference to machine made versus hand rolled, and majority of GG products are on machine. This resulting in a market share gain last year, and despite of a tough environment, which volume seen grew 5% YoY whilst industry reported a negative growth. Shift of preference to machine due to the aging profile of the handrolled smokers which are preferred among the oldies.
GG has demonstrate that it has pricing power. Its ASP has been risen faster than the increase in the excise costs. Because of the volume and the price increase, the company's profitability improves. Clove prices which is the major raw materials for kretek cigaretes is seen stable. At the same time, its labor cost also seen lower since its products are mostly machine made, so they are using less labor.
Completion of the expansion resulting in lower capex, which in turn it will see a positive free cash flow starting from this year onwards. The company has been spending massively on capex in the last three years on the machine and modernization.
As such, we revised up our earnings by around 7% for this year and next year. We believe that the stock's valuation is attractive, trading at less than 16x earnings this year and 14x earnings next year. The weighted average of global tobacco companies are trading on 20x this year earnings, with much lesser growth, and compared to the other Indonesia consumer names, this is the cheapest. While we also look at the relative P/E, GG is trading on its lowest of the five-year historical average. On the base of 20x earnings this year, our new target price is at Rp66,800 or at 26% upside from current price. We upgrade our rating to Outperform. GGRM