AALI - Good yet not impressive - Ciptadana

We initiate a report of PT Astra Agro Lestari Tbk. (AALI) - with a target price of IDR25,400/share and our recommendation is HOLD. Our target price implies a CPO price assumption of RM3,300, 2% below the current price which is RM 3,366 We expect that CPO price will fluctuate and tend to decline in the short term, however as Deepavali and Ramadan event are coming, demand will cater price. Rising crude oil price will also support the upside risk in the CPO price. In our view, in the strong CPO price environment and better expected weather, AALI might not fully maximize the benefit due to production concern. AALI will be more dependable on CPO price catalysts compared to its peers, thus we see a higher risk in AALI share.

Aging plantation – Better expected weather should surge palm oil output in 2011, however we expect no surprising production for AALI. The plantation age for nucleus estate has reached 14years old, passing most optimal ages. Structural shift in AALI plantation might give downside pressure to the production. We project FFB and CPO productions of 3.4million tons and 1.1million tons, respectively, representing about 3% growth in production. We expect yield to slightly decline to 20.9tons/ha.

Increasing 3rd party purchase, lower margin – Triggered by shortfall growth on production, we believe that AALI should rely on 3rd party purchase to push CPO output in 2011. Margin will squeeze down as FFB purchase offers less margin of 10-15%, compared to FFB nucleus which could secure at least 30% margin with the current CPO price (above RM3,000/ton). We project a 2011 EBIT of IDR 3,838bn and EBIT margin of 36% - lower than 2007-08 which recorded margins above 41%.

Focus on upstream – Since 2009, AALI decided to focus on only upstream CPO business. Rubber and downstream CPO were being set aside starting 2009. CPO downstream output had been reduced significantly by 56% in 2009 and further 90% in 2010, and rubber business was also treated in a similar way. Strategy to become purer upstream player might increase AALI leverage to CPO price movement. AALI will fully benefit when CPO price spikes up and vice-versa. Although management is still exploring an opportunity to re-entry downstream business, we adjust a remote contribution from CPO upstream and rubber business as of 2011 in our model.

Valuation – AALI’s target price is derived from blended target prices from discounted cash flow (DCF) valuation, P/E, and EV/ha multipliers. Using simple average, we set our target price of IDR25,400/share. At our target price, AALI trades at 14.33x 2011P/E, 6.4% discount to average regional industry and 12.3% premium to average Indonesian industry. Shortfall production growth and more dependent to CPO price catalyst, compared to peers are our major concern in AALI. Risks to our call are unexpected weather, steep slump/surge movement in CPO price and crude oil and decreasing demand due to unavoidable catastrophes.