Consumer Staples: Indonesia
By Renaldy Effendy
Rating: NOT RATED
Share price (26-May-16): Rp396 per share
- Maintaining Tier II production level for SKM to avoid higher excise taxes:
The Indonesia tobacco industry is facing strong headwinds due to the implementation of higher excise taxes on all types of cigarettes (exhibit 5), particularly for some smaller players like Wismilak Inti Makmur (WIIM) as they curb volume expansions to remain in their existing excise tier. In this regard, WIIM, with around a 1% market share as of 2015, attempts to keep its machine-rolled cigarette (SKM) segment from moving to Tier I (production level: >2bn sticks) from Tier II (<2 billion sticks).
Currently, the company is producing 1.6 billion SKM sticks annually, planning to maintain flat volume growth with an average ASP hike of 10% to support revenue in 2016. In 1Q16, management raised the ASP three times by 1.5-2% each (4.5-6% ASP hike in total), resulting in a volume drop of 21% y-y to 310 million sticks and lower revenue of Rp 258.6 billion (-9.8% y-y). On top of that, SKM’s contribution to the company’s top line was lower than 1Q15.
- Shifting focus to SKT volume expansion for growth support: Considering some Rp400 billion surplus in COGS from excise duties if WIIM’s SKM production were to move to Tier I, management has decided to shift its focus to hand-rolled cigarettes (SKT) given its small market share of 0.3%, looking for increased growth where excise taxes are generally lower for SKTs.
The company targets to increase SKT volume by 20-25% and raise ASP by 7%, expecting SKT revenue to reach Rp600 billion by 2017. Stick sales would be derived from its new factory in Bojonegoro, which should provide additional annual capacity of 900 million sticks (current: 700 million) and is expected to begin operations in September 2016. Once the plant opens, WIIM plans to relocate its Surabaya and Kertosono SKT manufacturing plants to Bojonegoro, as minimum wage there (Rp 1.5 million/month) is around half of Surabaya’s.
The company plans to utilize the Surabaya warehouse to store tobacco, and would terminate its rental contract in Kertosono which essentially could lead to lower operating expenses. In 2016, WIIM expects to spend IDR70bn on capex for the new plant (c.Rp 25 billion) and for maintenance of its current production lines.
Small market cap + illiquidity = Single digit valuation
WIIM shares have under-performed the market ytd (exhibit 4), in line with its 1Q16 flat earnings of Rp 33 billion (+5% y-y) as a result of lower margins on higher promotional expenses (+77% y-y) to further deepen SKT market penetration. In spite of costly advertising and promotion expenses, 1Q16 cigarette sales volumes fell 4% y-y, resulting in minor overall top-line growth of 5% y-y to Rp 441 billion.
On valuation, with WIIM’s lack of brand equity, translating to difficulty in passing on higher excise tax through increased product prices, the stock is currently trading cheap on an annualized 2016F PE of 5.7x on consensus estimates, an 84% discount to the sector (exhibit 12). Other challenges is competition from bigger players (Sampoerna, Gudang Garam and Djarum), which may lead to sales-volume pressure for WIIM given its higher selling prices, particularly in the regular SKM and SKT segments (exhibit 9 & 11), amid a weak operating environment. (*)