United Tractors Notes

We attended United Tractors’  (UNTR IJ, SELL, TP IDR19,700) annual analyst meeting yesterday and witnessed an unusually pessimistic note from the largest player within the Indonesian heavy equipment market. Yet, we are delighted to learn that our new call and target price on UNTR found a firmer foundation as the company confirmed of our FY 13 outlook. Meanwhile, the below are some takeaways from the meeting:

Pama to reduce stripping ratio, but maintain production volume
As we have accounted for on our report, UNTR’s mining contracting arm Pamapersada Nusantara has received repeated requests from its mining clients to reduce production stripping ratio since August. Pama has recently completed contract negotiations with its largest mining client, Adaro, for whom it generated a total of 17.0m tonnes last year (20% of Pama’s total production). Other than tightening the belt for efficiencies, mining clients have not requested for fee cuts nor volume cuts.

Given overburden decrease as a proportion of revenue generating fees (currently stripping ratio stands at 9.3x bcm overburden for each tonne of coal production), Pama’s margins could potentially head southward without additional new businesses. However, we side with the company to be sanguine over Pama’s potential to generate new business volume due to its efficiency relative to competitors (e.g. Buma’s strip ratio currently stands at 10.1x).

In line with the company’s outlook, we have adjusted our assumptions to reflect a 0% y-o-y fee growth, reduction from strip ratio assumption from 9.0x to 8.8x, and 8% y-o-y increase on coal production for FY13. Yet, overburden reduction would translate to lower Heavy Equipment demand for FY13 as the bulk of machineries are actually used for overburden removal and transportation on the ground. In light of this trend, the company has confirmed that Pama would spend much less than the regular USD500m+ annual capital expenditure next year.

Second round of target sales cuts officially took place
Heavy Equipment sales would be lower in FY13. Driven by lower machinery demand from the Construction Machinery division’s mining clients (including Pama), the management finally officially announced a second round of target sales cut for Komatsu machineries. Earlier this year, UNTR has cut target Komatsu unit sales from 9,500 units to 8,500 units. The official guidance currently stands at 7,000 units. Even so, with two months left in FY12, the management has also stated that this target number “would not be an easy feat”.

As ~60% of UNTR”s machineries are sold to serve the mining sector, we have also cut our FY13 target unit sales by 23% to ~6,500 units, a 7% decline from the company’s official guidance for FY12 – lower than the stunning 15% y-o-y 9M unit sales drop between FY11 and FY12. Along with the company, we believe that growing demand from other sectors (especially constructions and agriculture) would provide a bumper for the downfall. Yet, Construction Machinery revenue is bound to decrease next year as larger proportion of small-medium sized machinery sales lead to lower ASP.  On our report, we have also tweaked the business unit’s performance to show 23% drop y-o-y at FY13 end.

Spare parts & services to take larger proportion of revenue, can cover for opex
According to the company, customers have lately chosen to prolong usage lifetime of its products rather than spending for capex purchasing new equipments. At 9M12, parts & services revenue contributed IDR6.7trn (30%) of Construction Machinery division revenue. At 24%-27% gross margin, profits from spare parts & services by itself covers for the whole UNTR’s operating expense, which for 9M12 stands at a “mere” IDR2.3trn. We are seeing revenue from parts & services would allows for at least 28% of the Construction Machinery division revenue in the near future, up from 23% last year.

Leaving no stones unturned on Construction Machinery sales
The company is going to launch new products in the beginning of FY13 to target non-mining client sectors. The company hinted that they would target agriculture client sector, where they see growth. In a desperate attempt to keep the Construction Machinery division afloat, UNTR is also looking to distribute more Scania and Nissan products for on-the-road usage, such as inter-city travels. We may be seeing more public transportation vehicles on UNTR’s portfolio in days to come.

UNTR to continue acquiring more mines to reach ASII’s 500m tonnes target reserves by FY15
The company acquired two new mining concessions this year in Central Kalimantan despite a very sheepish coal outlook. UNTR insisted that the company would continue acquire more coal mines in the future to serve its parent company ASII’s mandate for 500m tonnes reserves. At 6,300-6,700 CV, UNTR’s mines continue to receive contracted demand from Japan (for steam coal power plants), as well as world-name commodity traders such as Glencore.

UNTR is also looking to find a replacement for PMM mines, which has only 11 m tonnes of reserves left. We think that demand is much less elastic at this CV level, and have incorporated 8%-10% y-o-y production increase for UNTR mines, incorporating Asmin Bara mines that would start production next year.

Overall, we see that the analyst meeting only reaffirms our assumption and opinions on the strong headwinds ahead. Maintain SELL, TP IDR19,700.