Indofood CBP - Too much risk, not enough reward - Macquarie

Event
􀂃 We downgrade our ICBP rating to Underperform from Neutral and lower our TP to Rp4,900 from Rp5,700. We highlight the continuing growth of smaller noodle rivals such as Conscience Foods (CSF SP, Not Rated) that increased its market share to 5% from 3% in FY10A. We believe the growth of smaller rivals entails a greater risk to ICBP’s ongoing volume growth rate and operating margins than the market currently appreciates.

Impact
􀂃 Over the past two quarters, ICBP’s volume growth has slowed, whereas CSF’s growth rate has continued to accelerate (48.1% revenue growth in 1Q11A, driven mostly by volumes). We believe CSF’s accelerating growth trajectory indicates that ICBP has now raised prices and expanded the industry’s profit pool to a level that is allowing smaller rivals to profitably expand, which may already be beginning to impact ICBP’s market share.
􀂃 While CSF and other smaller players’ growth is unlikely to have a noticeable impact on ICBP’s leading market position (73% market share) any time soon, the implications are heavily influenced by the relative maturity of Indonesia’s noodle segment, which is only experiencing volume growth of 3–4% pa. This means that 40% growth by a small rival with 5% market share has the scope to monopolise half of the industry’s volume growth, potentially halving ICBP’s volume growth rate from 3–4% to say 1–2%. We believe this would be poorly received by the market, given ICBP’s relatively full multiples (FY11E PER 16.1x) and heavy reliance on noodles (which comprise 85% of earnings).
􀂃 In addition, we flag that ICBP’s pre-royalty noodle margins have already expanded materially from 0.7% to 17.9% during FY07–10A (regional industry averages are 5–15%). A reinvigoration of volume growth would likely require either tighter pricing and/or higher promotional spending, which could see margins begin to decline. We believe slowing volume growth and/or margin compression will render double digit earnings growth difficult to sustain.

Earnings and target price revision
􀂃 FY11E EPS –2.7%, FY12E EPS –11.1%. We are now forecasting 1.7% and 2.5% volume growth, 8.2% and 3.9% ASP growth, and 15.0% and 14.4% post-royalty noodle margins, for FY11E and FY12E respectively. Price target reduced from Rp5,700 to Rp4,900, in line with our revised SOTP valuation.

Price catalyst
􀂃 12-month price target: Rp4,900 based on a Sum of Parts methodology.
􀂃 Catalyst: 2Q11E result (expected in July/August).

Action and recommendation
􀂃 Downgrade to Underperform: We believe ICBP’s FY11E PER of 16.1x to be
full relative to trend revenue growth of just c10% pa. We also believe the risks posed by smaller rivals appear to be broadly unappreciated by the market, and given the undiversified nature of ICBP’s earnings, we view ICBP’s risk profile as being too high given its limited upside. For exposure to genuine pricing power, we much prefer GGRM (Rp43,300, Neutral, Rp43,000 PT).