Selamat Sempurna A Steady Dividend Stock

We initiate coverage on Selamat Sempurna (SMSM) with a BUY recommendation, based on: i) its high dividend yield; ii) high profitability; and iii) stable revenue growth prospects. We expect ROE to improve to 36.3% in 2013 from 29.6% in 2010, fuelled by higher utilization, and the stock’s dividend yield to jump to 10.7% from 7.1%. Our target price of IDR2,050 implies a 13.1x-11.5x PE on FY12-FY13 earnings. The counter is currently trading at 8.5x-7.5x FY12-FY13 earnings.

High dividend yield
SMSM’s high dividend payout ratio of 91% for 2010 earnings (its policy is a minimum 45% DPR if net income exceeds IDR30bn) makes the stock one of the best dividend payers, with a 7.1% dividend yield for 2010 earnings at the current price. We expect dividend yield to reach 7.9% for 2011 versus the average of 2.6% among other dividend paying stocks in the Jakarta Stock Exchange.

Stable topline growth
Sales have always been increasing every year in the last 18 years, with a CAGR of 13% in the last five years, which we believe would be the normal growth rate for the next three years. Growth will be supported by the penetration of new markets overseas and increasing domestic demand. Some 95% of SMSM’s sales are to the replacement market, which is naturally quite resilient.

Steady margin; high profitability
SMSM is good at maintaining margin even amid raw material price fluctuations. In the last five years, its gross margin has ranged from 22%-24%, which gave rise to a net income CAGR of 18%. We see stable margins of ~24% within the next three years, which will translate into a net income CAGR of 20%. The steady margin will be driven by solid inventory management and cost reduction measures, which in turn gradually lifted ROE from 15.4% in FY06 to 30.5% in 1H11. We expect ROE to reach 36.3% in FY13.

Ample room to grow even at low capex
SMSM increased its radiator and de-bottlenecked filter production capacity in the last two years to ramp up capacity by 33% and 63% respectively. As a result, its current utilized production capacity is only 48% for radiators and 56% for filters. Hence, we believe that the company does not need to spend high capex in the short term to support growth.

Risk
The main business risks are: i) raw material supply, ii) extreme movements in raw material prices, and iii) fluctuations in foreign currency.

INVESTMENT THESIS

Prominent dividend payers

Historically, SMSM has been adopting a high payout ratio in the last few years that has left it with a minimal cash balance, which shows the company’s good intention of distributing its income. In addition, we also like the fact that even given its high dividend payout ratio, SMSM is still be able to maintain low leverage.

We expect SMSM’s payout ratio to go down slightly as the first tranches of the company’s bonds started to mature from July, considering that it intends to maintain its bank loan at a low level. However, in terms of nominal value, we still expect its dividend to grow by 11%-19%-14% in 2011-2012-2013 respectively. The interim-final dividend timing also may differ from last year, with the final dividend comprising the major portion, as opposed to last year.

Stable Growth
SMSM produces filters under the Sakura brand and ADR brand radiators for the automotive and heavy equipment markets, with 95% of the products sold to replacement market. SMSM also serves OEM (original equipment manufacturers) of world-class brands such as Toyota and Mercedes Benz. Product wise, up to 1H11, filter sales accounted for 74% of revenue, radiator sales, 24%, and other products, 3%. In terms of destination, 1H11 domestic sales accounted for 26% of revenue and exports 74%, with Asia and United States as major destinations. SMSM currently exports to 105 countries.

Historically, annual revenue grew consistently from 1992 to 2010, even at the time of major crises such as 1998 and 2008, which was strong proof of resilient demand for its products, especially in the replacement market. In the last five years, revenue has been increasing by a CAGR of 13%, a level we see as its normal revenue growth rate in the mid-term.

Ample capacity to grow
In terms of volume, filter and radiator sales have been increasing by a CAGR of 7% and 12% respectively for the last five years. We expect a moderate ~10% CAGR for filter sales and radiator sales from 2011-2013. This year, the company just increased its filter production capacity to 96m units/year from 72m units/year initially through renewal and debottlenecking while its radiator production capacity stands at 1.95m units/year (1.5m in aluminum and 450k in copper brass).

In 1H11, the company manufactured 27m filters and 472k radiators (438k aluminum and 33k copper brass), an indication that there is ample capacity to grow, as its utilized production capacity is only 48% for radiators and 56% for filters

In the global market, SMSM products are positioned as high quality products at a lower price compared with first tier global brands. In the domestic market, Sakura is the market leader with a ~60% share and is also a price leader. SMSM considers itself a one-stop shop with the widest product line among international producers. The nature of its products shields it from the threat of price war from Chinese low-end producers as its product prices are relatively small compared to the price of the entire car while it holds an important role in keeping a car and machines running well.

Steady margin; high profitability
We like the fact that SMSM is able to maintain its gross margin within the 22%-24% range of in the last five years even in the face of volatile raw material prices. The main raw materials for filter are steel plates and paper. The raw materials for radiators are aluminum (for aluminum radiator), cooper, and brass (for cooper brass radiator).

The company has been achieving steady gross margins via active inventory management and cost reduction through optimizing machine efficiency. In the past one year, SMSM also been utilizing discount by accelerating payment to suppliers, but this also resulted in a tighter cash flow during that period.

Founded in 1976, Selamat Sempurna is a part of ADR Group and currently one of the largest filter and radiator manufacturers in the region. The Company manufactures filters, radiators, oil coolers, condensers, brake pipes, fuel pipes, fuel tanks, exhaust systems, and press parts. Currently, SMSM owns 70% of PT Panata Jaya Mandiri, a joint venture with Donaldson Inc. USA and also 15% in PT POSCO IJPC, a joint venture with Posco and Daewoo International Corporation from Korea. Below are examples of SMSM products.

Valuation
We value SMSM using a discounted cash flow (DCF) approach, with which we arrive at a fair value of IDR2,051 per share. As such, we are setting our one year target at IDR2,050. We use cost of capital and cost of equity of 12.1 % and 13.0% respectively on following assumptions below:
a) Risk-free rate of 8.5%
b) Risk premium of 5.0%
c) Beta of 0.9.
d) Rupiah cost of debt of 10.5%
e) Income tax rate of 25%
f) Debt/Equity target of 20/80.
g) Terminal growth value of 3%

SMSM is currently trading at a 10.9x trailing PE, or 10.1x FY11 PE, which is below the industry average at 11.7x and 11.2x. Its profitability is also higher than the industry average while its gearing is maintained at a relatively low level. In average, Indonesian auto parts companies’ profitability is quite high relative to their Chinese counterparts, but are trading at lower multiples. Compared to the rest, Indonesian auto parts stocks are slightly more expensive, although their profitability is more superior.

Business risks
The main business risks are:

1. Raw material supply
The availableness of raw material supply is crucial for the production continuity. Historically, raw material suppliers would not always be able to fulfill orders within short times. In order to manage such risk, the company usually stores up raw material inventory for two up to three months’ needs.

2. Extreme movement in raw material prices
Movements in raw material prices will affect production costs and margins. The company manages the risk through active inventory management and continuously implementing the cost reduction program.

3. Fluctuations in foreign currency
As a large portion of revenue and production cost are in foreign currency, fluctuations in forex will affect the company’s profitability. However this is not a major risk as a large part of the forex effect from revenue is being offset by the cost of goods sold portion.