GGRM:Smokin? hot - Mandiri

Gudang Garam posted FY10 net income of Rp4.1tn (+20.0%yoy, -7.5%qoq), which was in line with our and consensus estimates. Interestingly, despite the unfavorable sentiment of operating in a mature industry, the company was able to post a record double-digit growth in the revenue and profit margin since FY02, thanks to its stronger marketing arm. We view an extra spending in FY10 marketing expenses by 73.0%yoy will benefit its brand equity in the long term. We still believe in the company growth potential in FY11 as it is less impacted by rising raw material costs and it has bigger room for ASP increase relative to its competitors. We maintain Buy on GGRM.

FY10 results were inline with our and consensus estimates. GGRM posted FY10 revenue of Rp37.7tn (+14.3%yoy, 6.6%qoq) and net income of Rp4.1tn (+20.0%yoy, -7.5%qoq), which were in line with our and consensus estimates. We estimate the company’s FY10 sales volume grew by 5-6%yoy. Net income declined slightly qoq due to an increase in advertising expenses of 67.8%qoq, which was a cyclical effect.

Record revenue growth and profit margin. While people view cigarette industry has been mature, GGRM was able to post revenue growth of 14.3%yoy, which was the highest in 9 years. In addition to that, with at least 10 time of increases in ASP during 2010 leading to an estimated effective ASP increase of 8-9%yoy, the company’s gross margin expanded to 23.5% in FY10, which was also the highest level since FY02. We see this as a sign of stronger marketing arm and higher efficiency.

Positive outlook in FY11. We are still optimistic with the company’s FY11 outlook due to several reasons. Firstly, the company’s high inventory level will cushion it against raw material cost pressures. Secondly, the company’s ability to grow sales volume by 5-6%yoy while expanding its profit margin in FY10 proved the company’s strong marketing arm and reiterated GGRM’s growth potential. Thirdly, GGRM has more room to increase ASP because currently the margin it gives to distributors is higher than the other cigarette producers give to their distributors.

Maintain Buy. We maintain Buy on GGRM with TP of Rp48,000/share. Our TP is derived from DCF valuation with WACC of 12.7% and TG of 5.0%. At the current market price, the stock is trading at PER11-12F of 16.4-14.4x.