United Tractors Passing the Ball to Pama

UNTR’s FY12 net profit came in at IDR5.78trn (-2% y-o-y), which was 4.5% above estimate and in line with our forecast. Its FY12 consolidated sales totaled IDR55.95trn (+2% y-o-y, +27% q-o-q), 2.1% above our estimate, which we deem in line. We are upgrading UNTR to NEUTRAL based on the following reasons: i) we see upside potential in Pama, its revenue mainstay, as world coal supply discipline improves, ii) UNTR’s balance sheet continues to rest on rock-solid fundamentals, and iii) street estimates have moved steadily to our fair value DCF-based TP.

No surprises in FY12 results
UNTR posted IDR5.78trn in net income for FY12 (down 2% y-o-y but up 29% q-o-q), beating our estimate by 4.5%. The company’s bottom-line recorded IDR55.95trn in consolidated revenue, which rose 2% y-o-y and 27% q-o-q — 2.1% above our estimate. Meanwhile, net income growth was flat on the back of higher operating expenses, which grew by a relatively high 15% y-o-y as selling expenses escalated amid declining heavy equipment demand and tightening competition.

Pama to be main revenue generator in 2013
Pama is now UNTR’s biggest source of revenue, contributing 50% of consolidated top-line. UNTR’s revenue dependence on Pama increases to ~70% if we include its revenue stake at the Machinery business unit. A planned 50% cutback in Pama’s capex in FY13 would continue to pressure machinery sales. Unofficial guidance from UNTR puts its Komatsu sales target at 5,000 units this year, down by another 19% from last year’s sales of 6,202 units. After a jittery year-end, UNTR is now seeing a green light to renew three of Pama’s expiring contracts.

UNTR expects Pama’s production to remain flat in FY13 at ~95 m tonnes. A decline in stripping ratio (which was recorded at a 9.2x average in 9M12 and fell to 8.3x by 4Q12) would continue in FY13 as concession-holders are keeping safe on the back the uncertain coal outlook. Despite a continued dour outlook for machinery sales, we see potential upside to Pama’s and TTA’s &PMM’s production as better supply discipline has led to a pick-up in coal prices.

Upgrade to NEUTRAL, TP stays at IDR19,700
We are upgrading UNTR to NEUTRAL given that: i) the company’s share price has been trading steadily at +/-10% of our TP, ii) its balance sheet continues to be propped up by rock-solid fundamentals, and iii) potential upside to coal production at Pama and UNTR’s coal mines.

FY12 Results review
FY12 results came in line with estimates, no surprises
United Tractors (UNTR) posted IDR5.78trn worth of net income for FY12 (down 2% y-o-y, up 29% q-o-q, 4.5% above our estimates). The bottom-line arrived preceded by an IDR55.95trn worth of consolidated revenue (up 2% y-o-y, 27% q-o-q, 2.1% above our estimates). Net income growth came flat on the back of higher operating expenses, which grew by a relatively high 15% y-o-y on the back of increased selling expenses. Operating expenses accounted for 120% of our FY12 numbers, with selling expenses alone arrived at a whopping 150% from our estimates.

Although notable, this steep increase was hardly surprising on the preceding days prior to the financial statement release (see our 9M12 Review for UNTR: Bracing for the Storm, 31 Oct 2012). UNTR has been known to engage in non-pricing strategy to counter mounting inventories (i.e. extended warranty, free services, among others). Weakening Rupiah posed another problem for the company, as it finally incurred IDR246.7bn worth of forex losses through the past year (4% of net profit) compared to IDR120bn gain in FY11. At close of FY12 book, IDR was recorded at IDR9,670/USD, a 6.3% decline from previous year’s close. Based on our calculation, each IDR100 weakening may impact UNTR’s top-line by ~2%.

Pama would be anchor to UNTR’s revenue
On the back of weak Construction Machinery sales, Mining Contracting arm Pamapersada Nusantara (Pama) has taken over to be UNTR’s largest source of revenue with 50% contribution to consolidated top-line. Construction Machinery and Coal Mining business units contributed 40% and 10% respectively. These results contrasted with FY11’s breakdown, when the business units contributed 41%, 49%, and 10% respectively. Driven by soft coal prices which fell as low as USD78/tonne in the past year (from a high of USD119/tonne recorded in February), Contruction Machinery business segment experienced a 21% y-o-y sales decrease to IDR22.2trn as mining companies retracted their capital expenditures (capex).

As these customers try to prolong the lifetimes of their machineries, 27% of the business unit’s sales volume was generated by spare parts & maintenance sales — which recorded an IDR5.89trn worth of revenue or 21% growth y-o-y. Spare parts & services contributed only 18% of the business unit’s sales in FY11. In contrast, Pama was mostly shielded from the industry downturn and recorded a 25% y-o-y growth and booked IDR27.99trn of FY12 revenue. We are not surprised at this finding, as Pama’s volume is largely contracted until the year is through.

TTA and PMM mines posted a mere 7% y-o-y revenue growth, compared to its 24% production volume growth – indicating a prominent reduction in average selling prices (ASP). The company has refrained to issue an official guidance for Construction Machinery sales for FY13, but the management confirmed that Pama’s capex would fall around USD250m – half of the company’s “regular” USD500m+ spend previous years.

Since Pama accounts for at least a quarter of all UNTR’s Machinery sales, the outlook for the Machinery business unit continues to be dour in the foreseeable future. We expect Pama to continue being the most prominent Mining Contracting player in Indonesia due to its scale and efficiency, and as Pama conducts mining activities for TTA & PMM as well, Pama’s health would dictate UNTR’s performance going forward.

Solid EOY Balance Sheet despite A Somber 2012
Cash position has declined significantly since 2011, mainly due to a jack-up in 2011 EOY cash from rights issuance and the 2012 acquisitions of new mining concession. Cash flow from operating activities was partially to blame for this decline, as depressed revenue growth had not been able to compensate for increased operational disbursements. Even so, UNTR showed an 18% D/E ratio and a 4% net gearing in FY12. UNTR continued to show stellar balance sheet performance at year end, considering the fact that net gearing has historically hovered around 7% even during the boom years 2009-2010.

Despite the industry downturn, the company managed to pull stable ROAE and ROAA numbers within the past year. As it happens, UNTR’s balance sheet continues to demonstrate rock-solid fundamentals– owing a negative earnings outlook solely because it came from a high point as the Heavy Equipment industry market leader (i.e. 43% market share as at end of FY12).

Construction Machinery sales to decline in 2013
54% of UNTR’s FY12 Construction Machinery sales were still dominated by sales to the mining sector, followed by agriculture (24%), constructions (16%), and forestry (6%). UNTR recorded negative growth for both the mining and forestry sector unit sales (at -41% and -27% respectively). Unit sales to the Construction sector posted a 17% growth, while sales to the agriculture sector stayed flat at +3% y-o-y. As customers prolong the lifetime of their machineries and avoid capex due to an uncertain coal outlook, UNTR’s spare-part and after-sales service recorded 21% growth y-o-y and thus, contributed 27% of the business unit’s revenue.

As we have stated earlier, a major part of Construction Machinery sales is generated from Pama. This year, Pama has allocated USD250m worth of capex solely for unit replacements (instead of unit additions). This number is half of the company’s “regular” USD500m+ capex in previous years. As Pama does not seem to require any fleet growth, the company has unofficially guided for 5,000 units of Komatsu sales in FY13, a further 19% decline from FY12 as accounted for within our model. Despite a pickup in January 2013 sales (at 410 units, up 95% m-o-m), it is too soon to be sanguine over the outlook of UNTR’s Construction Machinery division due to the “Pama factor”.

Pama’s fees and production volume to remain flat, expiring contracts are to be renewed
Pama has taken over to be UNTR’s most prominent source of revenue, with 50% contribution to the top-line (excluding its major contribution to the Construction Machinery sector, which would put UNTR’s dependency to Pama at ~70% of consolidated revenue). Pama posted IDR27.99trn worth of FY12 revenue (25% increase y-o-y) on the back of 8.8% growth in coal production and 7.4% growth in overburden removal. The slower growth pace of Pama’s overburden removal indicated a decline in stripping ratio – which fell from an average of 9.2x in FY11 to 9.0x by end of FY12. Pama’s stripping ratio for the last quarter in FY12 was recorded at 8.3x, much lower than the 9.2x average for 9M12.

UNTR has indicated that this trend is going to continue into 2013, affirming our stance about revising down UNTR’s projection back in October 2012. Even so, we are seeing a silver lining to the Pama story. Based on our last conversation with the company, Jembayan, Trubaindo, and Indominco (i.e. three clients whose contract expires in 2H13 and accounted for 27% of Pama’s total production in FY12) have indicated that they would continue their mining activities with Pama on the same production level.

At our base case scenario, Pama’s coal production volume and fees will remain flat this year, while overburden removal will continue to decline . Yet we are seeing an upside production potential for Pama; based on our house view, unannounced production cuts from smaller coal players in the market has led to a better supply discipline in the world market, proven by improving coal prices. Our coal analyst believes that improving fundamentals on the world coal market has made a strong case for three-digit (USD100/tonne average) coal prices in FY13.

PMM’s & TTA’s production expected to be flat, with upside risk
TTA and PMM mines posted a mere 7% y-o-y revenue growth, compared to its 24% volume growth – indicating a prominent reduction in average selling prices (ASP) throughout FY12. UNTR expects PMM’s & TTA’s production to remain flat this year, assuming a USD90/tonne average price. TTA and PPM by default have one of the highest cash cost for any coal producer in Indonesia (at USD70-75/ tonne) due to its high caloric value production (at ~6,700 kcal/kg GAR) and difficult terrain in Central Kalimantan (11x stripping ratio).

These UNTR’s mines generally operates and produce for a one-month forward contract, hence we have seen that their productions are directly correlated to but lagged from coal prices movement by one month. Although it is too early to confirm a pick-up for the rest of the year, we think that PMM & TTA may show production growth in the next couple of months (compared to the decline in 4Q12) as coal prices have picked up.

What’s New in 2013?
In summary, we think that UNTR would continue to face somber outlook within its Construction Machinery business segment, while outlook for the Mining Contracting and Coal Mining sector would stay flat with upside risks. We are also delighted to learn that UNTR’s fundamentals have remained solid despite a turbulent period in 2012. During our meeting last year with the management, UNTR has promised that the company would unfold a new product to dampen weaknesses in their Machinery business unit.

The promised product came in the form of PC200, an excavator with 20-tonne capacity that Komatsu claims to increase fuel efficiency by at least 10%. We have noted that 40% of UNTR’s Komatsu sales volume came from 20-tonne machineries, thus, the new product launch may provide a momentous potential for UNTR’s Construction Machinery sakes. In addition, this new product may better able to capture growth in Constructions customer segment — as its classification is better suited for construction works than larger products.

Upgrade to NEUTRAL, same TP at IDR19,700
The FY12 results and FY13 outlook for this year has affirmed our assumptions for the fair value of the share (derived by DCF-method). Following our SELL call in for UNTR in October when it traded around IDR22,000/share, the company’s share prices had declined by 20.1% to a low of IDR16,850 in December before rebounding to trade at a stable IDR19,000-IDR21,000/share ( a +/- 10% range from our TP of IDR19,700). As the market seemed to have followed trading within our acceptable range, we are upgrading UNTR to a NEUTRAL.