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Wednesday, July 20, 2011

Downgrade Semen Gresik to Hold from Buy

by Deutsche Bank

We downgrade our rating due to 1) limited upside potential to our 12-month target price, (5%, after the stock rebounded by 28% from its low in January, 2) slower earnings growth due to limited pricing flexibility, and 3) at par with the regional average, trading at 7.7x EV/EBITDA in 2012F. We believe aggressive capacity build-out presents a major risk on pricing flexibility and hence, earnings outlook.

Increasing threat from new entrants

We see a big jump in our base case new capacity assumption from 14m tons p.a. to c. 38m tons p.a. in the next five years following investment realization by new entrants such as Conch Cement and China National Building Materials. We believe this condition could worsen the competitive landscape and further supress current weak pricing flexibility and hence, profitability.

Possible excess supply situation in the next ten years

We expect the current capacity constraint of the sector to dissipate starting next year following the completion of Semen Gresik’s (SMGR) two brownfield projects totaling 5m tons p.a. Based on an annual demand growth of 6-7% and combined planned expansion of 38m tons p.a. by existing and foreign players, we estimate the industry to experience excess supply condition until at least 2020-21.

Maintaining target price of Rp10,250

Our target price is based on a ten-year DCF valuation using a WACC of 13.8% and a TG rate of 5%. Downside risks are SMGR’s inability to increase price or even price competition, and failure to increase synergies within the group. Upside risks include a greater pricing flexibility and faster completion of new capacity.
Our target price is based on a ten-year DCF valuation using a WACC of 13.8% and a TG rate of 5%. Downside risks are SMGR’s inability to increase price or even price competition, and failure to increase synergies within the group. Upside risks include a greater pricing flexibility and faster completion of new capacity.

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