Trimegah : GGRM
Double-edged leadership in SKM-FF
Cigarette levy is not an issue – raw material is
In our view, if the cigarette levy is not increased consistently at a rate twice as fast as the average minimum wage growth (12.1% in 2011), then the cost of smoking will be increasingly less. Our reasoning is based on GGRM’s 2011 cost structure, where cigarette levy is 70.3% (decreasing from 74.1% in 2007) of COGS (75.8% of sales in 2011). We believe raw material price increase is more alarming for GGRM’s leading products. Kretek cigarette industry is comprised of SKT (unﬁltered hand-rolled), SKM (ﬁltered machine-rolled), while SKM is divided into two sub-categories: full-ﬂavored (FF) and low-tar-low-nicotine (LTLN). In our view, consumers are shifting toward the latter, conﬁ rmed by Nielsen’s report that stated that 2011 SKM-LTLN sales volume has grown by 22% YoY, while SKT, SKM-FF, and white cigarettes (i.e. Marlboro) only grew by 4%, 2%, and 5%, respectively. GGRM has been the co-leader in SKM-FF (with Djarum, 2010-2011 ICSA survey) with its Surya, Professional, and International series.
Volatile raw materials prices will strangle GGRM
The nagging problem with SKM-FF segment is its raw material issues: Firstly, it is composed mostly of higher-nicotine and heavy-ﬂ avored tobaccos, which mainly grown in Indonesia (most notable: Temanggung and Madura), while for SKM-LTLN, lowernicotine and lighter-ﬂ avored tobaccos such as the Virginian and Turkish are mixed in.
Those kinds are mostly imported with stable supply and decreasing average price (-3% CAGR in 2009-2012). In contrast, Indonesia’s tobacco production has decreased from 204,329 tons (850kg/ha) in 2000 to 122,276 tons (630kg/ha) in 2010. Granted, that in 2011 estimated production reached 206,317 tons with 990 kg/ha yield (all-time high) which will reduce raw material cost in 2013 (assuming harvested in August and 1-1/2 years of drying and curing), but we expect production to reach normal level around 169,000 tons (about 810kg/ha) in 2012 and beyond with stable land area. Secondly, that albeit clove production has been increasing from 59,878 tons in 2000 to 110,316 tons in 2011 (Directorate General of Estate’s estimate), it also has been ﬂ uctuating in between (78,350 tons in 2005 to 61,408 tons in 2006, then to 80,405 in 2007). Furthermore, quality instabilities had caused prices to oscillate (average price: Rp60,000 in 2005 to Rp38,000 in 2006, and spiked to Rp110,000 in 2011). GGRM also produces several brands of SKM-LTLN, particularly the Surya Pro Mild. However, it is lagging behind Sampoerna’s A-mild, Djarum’s L.A. Lights, and Bentoel’s Star Mild. Hence, we expect GGRM will constantly be pressurized by undulating raw-material prices if it cannot establish a SKM-LTLN product that can compete with the market leaders.
Heavily exposed to raw material price volatility; downgrade to HOLD
We expect revenues to reach Rp46.8tr in 2012 (+11.8% YoY) and net income of Rp4.5tr (-8.3% YoY, 9.6% net margin), before further increasing to Rp6.1tr in 2013 (+35.7% YoY, 11.6% net margin). Beyond 2013, decreasing net margin shall occur due to GGRM’s inability to fully pass-on the increasing raw-material costs to its customers. Downgrade to HOLD with target price of Rp54,450, implying 2013 PE of 17.3x with 11.2% upside.