Gudang Garam, Set To Regain Glow In 2014

We believe GGRM’s fundamentals are firm given: i) its strong market share, which outpaced industry’s growth in 9M13, ii) its re-branding attempts to capture Indonesia’s young demographics, ii) the general election euphoria, which should offset the interest expense hike in its P&L due to large debt for revamping purposes. In view of the company’s solid outlook, we think the stock is mispriced and thus offers a BUY opportunity.

Re-branding for the better
Management reiterated that the sales volume disruption of its SKM regular brand – GG International (~20% of sales volume) – arising from its re-branding move is temporary, as only the packaging of the cigarettes (not the flavour) has been changed. We applaud GGRM’s rebranding efforts as we believe the old packaging was outdated and in need of refreshing in order to attract Indonesia’s young consumers.

9M13 sales outperform industry’s growth
GGRM’s 9M13 sales volume increased by 5% y-o-y (vs industry’s 2% y-o-y), backed by strong sales volume for its SKM regular (GGRM: +6.2% y-o-y; industry: +4.1% y-o-y) and SKM mild (GGRM: +33% y-o-y; industry:+5.3% y-o-y) segments, which offset a decline in SKT sales (GGRM: -16.2% y-o-y; industry: -6.6% y-o-y). This shows GGRM’s growing market share.

However, note that the company’s SKM mild volume expansion going forward may lead to gross margin compression as its volume growth is mainly derived from its SKM mild products (GG Surya Pro Mild and GG Mild), which have lower margins compared to its SKM regular products.

Upgrading 2014 earnings partly on election sentiment; BUY. Despite an increase in 9M13 net gearing to 42.9% (the highest since 9M05), we expect the upcoming election in 2014 to boost GGRM’s SKM cigarette demand. Hence, we upgrade our 2014 earnings by 5% to factor in the expected stronger demand during the election period. GGRM is currently trading at a 15x 2014 P/E coupled with 2014 PEG of less than 1x. We maintain our BUY call and IDR46,500 TP.

Fundamentals Remain Solid
Higher net gearing; but fundamentals still solid. We raise our 2014 revenue /net profit forecasts by 10.5%/5.4% respectively, mainly driven by higher sales volume growth. The revenue growth offsets our higher interest expense assumption for 2014, which should lead to a 17.6% y-o-y increase in 2014 net profit.

We expect interest expenses to increase by 60.8%/22.5% y-o-y for 2013/14, given GGRM’s higher leverage as reflected in its 9M13 balance sheet with a net gearing of 42.9%. We estimate 2013 net gearing at 38.9%, up from 26.0% in 2012. The company’s 9M13 capex of IDR4.4trn – which is the highest since its IPO in the early 1990s – drove its short-term debt to IDR13.5trn in 9M13. This lifted its net gearing to 44%, the highest since 9M05. The high capex was spurred by GGRM’s ongoing revamps across its business chain from warehouses to distribution system.