Sri Rejeki Isman (SRIL): Simply cheap
Retain BUY on low valuation, but cut TP on lower earnings
On the back of lower contribution from SRIL’s higher margin garment business, we lower our operating profit by 8-12% in 2016-17F. On the bottom line, SRIL’s recent USD350mn bond issuance (8.25% senior notes due 2021 by Golden Legacy, SRIL’s wholly-owned subsidiary), has us cutting earnings by 1-8% in 2016-17F. Given lower growth prospects this year, we have cut our target price from IDR400 to IDR340, reflecting a still cheap 2016F PE of 8.2x, 53% discount to the sector (exhibit 5). We still retain our BUY rating on SRIL and expect its recent market underperformance (exhibit 4) to reverse. Risks to our call would be expansion delays and a stronger IDR (10% appreciation in IDR = 100bps drop in gross margin).
- Focusing on finishing to help minimize margin decline: For 2016, given the volume growth constraints due to full capacity utilisation, SRIL is expecting higher contribution from its made-to-order divisions, in particular the higher-margin finishing division (exhibit 6) to support earnings. Note that the garment division, with the highest margin, has reached 100% production capacity, contributing just 10.6% to 1Q16 revenue, down 170bps compared to the same period last year. As a result, SRIL’s gross margin decreased by 20bps y-y and 270bps q-q. To offset the drop in garment sales, SRIL has improved its fabric (finishing) sales by 15% y-y leading to a higher contribution of 27% to the 1Q16 top line from 25% in 1Q15 (exhibit 7).
- Rising exports, 49% of 1Q16 top line, to provide growth support: Exports are becoming an important earnings source for SRIL. In 2014, 42% of SRIL’s sales consisted of exports, before rising to 48% in 2015 and 49% in 1Q16, implying nearly half of the company’s sales are generated from overseas markets (exhibit 12). SRIL started exporting its products in 1993, by supplying military uniforms to Germany. Since then, SRIL has gained recognition for its good-quality products, and exported to around 50 countries (13 of them military products) as of 1Q16. Export growth is expected to be sustainable with overseas sales of cotton and yarn to China (Marubeni, TEXHONG), weaving products to Turkey and finishing/garment (e.g. military uniforms) to Europe. Compared to China, SRIL’s products have a pricing advantage on cheaper raw materials like cotton (exhibit 14).
Product diversification to allow acceleration in 2017F top line growth
In 2016F, we expect revenue to reach USD672mn, up 8% y-y, on 3% volume growth and 5% ASP hike. Given SRIL’s business divisions are currently running at almost 100% production capacity: Spinning (90%), weaving (92%), Finishing (94%) and Garment (100%), we expect price toWbe the main supporter for top line growth instead of volumes this year. However, for 2017F, with additional production capacity, we expect sales growth to accelerate to 15% y-y, mainly supported by 10% volume expansion. In addition, we also expect contribution from its military uniform segment to increase to 60% of 2016F garment sales (2015: 55%), compensating for losses in the fashion business and at the same time, providing higher margins.