Indopoly Swakarsa Industry New Products Save The Day
New products in the pipeline
In addition to Biaxially Oriented Polypropylene (BOPP) or plastic packaging film, the company is slated to launch three new products this year, which are: i) Biaxially Oriented Polyethylene Terephthalate (BOPET), or simply polyester-based packaging film, with an installed capacity of 20k tonnes/year. The equipment was commissioned this month; ii) metalizing value added line (two machines) with 2×4.9k tonnes/year target production capacity.
The first machine started commercial operation in 1Q11 and IPOL is already selling starting volumes of 273 tonnes; iii) thermal value added line with 5.7k tonnes/year capacity which started commercial operation in April 2011. The three new products are expected to bring in revenue of IDR381bn this year.
Earning to accelerate in FY12
We expect earnings to surge 43.4% in FY12 after the production of the three new products reach optimal capacity, but nearly flat in FY11 due to the lower margin from its existing product, BOPP. Historically, gross profit margin peaked at 33.1% in 2Q10 and has remained below 23% since 3Q10. The decline in 2H10 was attributed more to the cost in setting up new product lines amounting to ~IDR64bn, which is temporary. However, the low gross margin in 1Q11 was the result of raw material cost pressure.
We are taking a more conservative stance compared to FY10 and expect BOPP gross margin to average 22.1% for FY11. On a brighter note, considering that the estimated gross margins of BOPET, thermal and metalized products are higher than that from BOPP, we expect blended gross margin to reach 24.7% in FY11 and rise further to 27.1% in FY12 on higher capacity utilization.
Robust product demand
We are confident on the products’ long-term demand as they mainly serve big names in fine food packaging and cigarettes such as Indofood, Unilever Indonesia, Djarum, Gudang Garam and Philip Morris, considering i) the fact that the end-user’s products are mainly daily necessities, and ii) IPOL focuses on high quality products that attract long-term customers with strict requirements which are usually reluctant to change supplier once they make up their mind.
Cash flow improves
We take note of the improvement in the company’s operating cash flow in 1Q11 considering that it was quite tight on operating cash in 2010 as the result of preparations (setting up cost) for its new products as well as capacity expansion in 2009 which necessitated a looser selling policy in the early stages.
Safe long term demand
IPOL currently produces Biaxially Oriented Polypropylene (BOPP), or simply plastic packaging film, with total capacity of 80,000 tonnes per year. The product is mainly used in fine food packaging (45% of FY10 revenue), cigarettes (42%), and special needs products (13%). This year, IPOL will add a new product line, BOPET. We expect sustainable long-term demand for IPOL products considering that:
1) IPOL makes packaging products for basic necessities that are usually defensive in nature. For example, the fine food packaging segment comprises packaging for fruits, instant noodles, candies, bakery products, snacks, food seasonings and beverages. With two subsidiaries operating in China, IPOL mainly serves demand from Indonesia and China. It also exports to United States, Brazil, Argentina, Western and Eastern Europe, Australia and others.
Global demand for BOPP and BOPET are expected to increase by a ~6% CAGR from 2009-2014, based on data compiled by IPOL from PCI and AMI. Specifically, BOPP demand growth in Asean and China are envisaged to expand at a CAGR of 7% and 10% respectively from 2009-2014.
2) IPOL focuses on high quality products that appeal to long-term customers with strict requirements and which are usually reluctant to change supplier once they make up their mind. For example, the process towards becoming a supplier of Philip Morris, currently one of IPOL’s clients, takes about two years.
There are high barriers to entry in the high-end product industry, including high initial capital expenditure, a time-consuming learning curve, and about a two- or two-and-a-half years’ lag between ordering of machinery and their delivery.
Gross margin dynamics
IPOL gross margin fluctuated from a high of 33.1% in 1Q10 and 2Q10 to a lower 22.4%-19.9%-21.0% in 3Q10-4Q10-1Q11. The 3Q10 and 4Q10 gross margins were thinner mainly due to start-up costs for its new products totaling IDR27bn in 3Q10 (equal to ~7.1% 3Q10 gross margin) and IDR37bn in 4Q10 (equal to ~8.4% 4Q10 gross margin), which were only a temporary cost increase. However, as PP resin (BOPP raw material) price jumped 14% q-o-q in 1Q11 (adjusted with a 2-month lag), gross margin fell to 21.0%, even in the absence of the substantial start-up costs for 1Q11.
Other factors that also affect gross margins include a continuously changing product mix in the BOPP sub-segments and USD-IDR exchange rate movement. In the case of foreign exchange, a stronger IDR leads to lower sales, which partially are denominated in USD (approximately two thirds of sales). On the other hand, the cost of raw material (approximately four-fifth of manufacturing cost) will also come down. Considering that the proportion of revenue and COGS is almost the same, a 1% appreciation in the IDR will lead to a 0.1% dip in gross profit, although it will boost IPOL’s net profit by 1.2% as the company has net open positions on the liabilities side.
New products to the rescue
The biggest addition in this year was the installation of 20k tonnes of BOPET capacity, which is an entirely new production line. In general, BOPET film usage will be more or less the same with that for BOPP. The difference is BOPET has higher gas barrier properties, which makes it more suitable for packaging spices and other strongly flavored food products. We expect IPOL to begin commercial operation of BOPET this month and reach 54.0%-95.0% utilization in 2011-2012. We see gross margin reaching 36.2% to 38.0% over the same period.
Besides BOPET, we also expect the company to install new value added lines, including a metalizing value added line (two machines) with 2×4.9k tonnes/year capacity, and a thermal value added line with a 5.7k-tonne a year capacity. Notes that as a value product lines, these two lines do not increase total capacity but rather widen the margin of the basic product, which will be classified under an existing special needs sub-segment. The metalizing value added line could be applied to either BOPP or BOPET while the thermal line is dedicated only to BOPP.
We adopt a conservative position on existing BOPP products and project gross margin of 22.1% to 22.6% for FY11-FY12, while those of BOPET, thermal and metalized products are is expected to reach 36.2%, 32.2% and 39.1%, respectively, in FY11. On full capacity utilization, we expect gross margin of the three new products to widen to 38.0%, 38.0%, and 49.1% in FY12. Overall, gross margin is expected to reach 24.7% in FY11 and rise to 27.1% in FY12 on higher margin and revenue contribution from the new products. We expect total revenue to climb 26.0% and 14.6% in FY11 and FY12 respectively, but as gross margin dips in FY11, we expect net income to go up by only 8.6% in FY11 and then accelerate by 43.4% in FY12.
Cash flow improvement
Historically, the company’s operating cash flow was unsatisfying in FY07 and FY08 when it had yet to add its second production line and had not acquired its two subsidiaries, Yunnan Kunlene and Suzhou Kunlene, and was thus operating on a different scale back then. In the second half of 2009 and in 2010, its operational cash flow still diverged from its operating income, mostly due to a relaxation in its policy to selling new volumes as the company started second line in 2H09, lifting its total BOPP capacity to today’s level from about half previously.
In recent quarters, while digesting the setting-up costs incurred in 2H10 which were classified as operational cash out, IPOL’s operational cash flow started to trickle in. We expect operating cash flow to keep improving in the subsequent years, especially from FY12 onwards, considering that the company may need to relax its selling policy with regard to BOPET products for FY11.
COMPANY BACKGROUND
IPOL manufactures a wide range of biaxially oriented polypropylene (BOPP) films for the flexible packaging industry that are marketed worldwide under the registered brand name Ilene. The company was found in 1995 but operated its first production line the next year. In 2009, IPOL acquired its subsidiaries, Yunnan Kunlene and Suzhou Kunlene. In the same year, it also commissioned its BOPP second production line with 35,000 tonnes/ year capacity.
VALUATION
We value IPOL using a discounted cash flow (DCF) approach. We also apply cost of capital and cost of equity of 11.8 % and 13.9%, respectively which are based on the following assumptions:
a) Risk-free rate of 8.5%
b) Risk premium of 5.0%
c) Beta of 1.09.
d) Rupiah cost of debt of 13%
e) Income tax rate of 25%
f) Debt/Equity target of 50/50.
g) Terminal growth value of 3%
Fair value of IDR375 per share
Our valuation exercise suggests a fair value of IDR375 per share, which is based on the following underlying assumptions:
1) Oil price of USD95/barrel (2 months’ lag) from 2011 onwards. We expect resin price to move almost in tandem with oil price in the long term.
2) USD-IDR exchange rate at IDR8,750/USD for 2011 and thereafter
Using historical four quarters trailing PE, IPOL is currently traded at 10.4x PE, above industry average of 7.3x, while it’s ROE of 25.4% is nearly industry average of 26.2%. While seems traded at higher multiples on trailing basis, we must consider that IPOL’s 3Q10 and 4Q10 net profit is heavily affected by set up cost.
Sensitivity Analysis
Our sensitivity analysis on IPOL’s FY11 bottom-line is based on changes in oil price and USD-IDR exchange rate. We are assuming no cost pass through or change in pricing from the base case in the sensitivity analysis.
1. Oil Price
We use oil price as a proxy of raw materials. As raw materials make up 83% of manufacturing cost, a 1% uptick in oil price will drag gross profit and net profit down by 2.1% and 4.4%, respectively.
2. USD Exchange Rates
As discussed above, considering the proportion of sales in USD and proportion of USD-linked cost are almost the same, a 1% strengthening in IDR will only lower gross profit by 0.1%. However, as a chunk of IPOL’s debt is in USD, the same movement in USD will increase its net income by 1.2%.
Risk Factors
1. Raw material price hike
Although IPOL is able to pass on cost as its contracts are on a monthly basis, there is still a limitation on the quantum to be absorbed by the customer. Historically, hikes in raw material prices have cut into the company’s gross margin.
2. Delay in new products launch
Any factors that delay the timing of new products launching will result in lower-than-forecast sales and gross margin, which in turn will also lower the net income.
3. Foreign exchange rate fluctuations
Fluctuations in exchange rates affect the portion of sales that is denominated in foreign currency (CNY and USD) and also raw material prices (USD-linked). On the other hand, an open debt position may also result in a forex gain or loss.
