SGRO:Margin expansion - Mandiri

SGRO booked strong 1Q11 net income, beating our and consensus estimates. The main drivers were higher- than-expected CPO production volume and higher gross margin. Going forward, based on SGRO’s planting profile on nucleus and plasma (exhibit 3), we expect FFB contribution from nucleus to total processed FFB to exceed FFB contribution from plasma from 2013 (exhibit 5). Assuming CPO price stays the same, increasing FFB contribution from nucleus should keep margin expanding (exhibit 4). We maintain BUY recommendation on SGRO with a DCF-derived TP of Rp4,150/share, which implies PER FY11F and FY12F of 13.8x and 12.2x, respectively. We maintain SGRO as our top pick in the plantation sector as we expect its margin expansion to continue.

1Q11 results exceeded our and consensus estimates. 1Q11 net income beat our (39.6% of our FY11F) and consensus (36.8% of consensus FY11F) estimates. The main reasons were higher- than- expected production volume and higher- than expected gross margin.

CPO inventory of 35,000 tons would be an extra revenue booster. Although the 1Q11 net income has exceeded our and consensus, SGRO still has extra ammunition to boost its revenue in the next quarters, e.g. CPO inventory of 35,000 tons. Such size is quite a huge inventory, considering 1Q11 CPO sales volume of 72,131 tons.

As we have expected, higher nucleus leads to margin expansion. As we have forecasted in May 2010 (Our report “Improvement in cost structure ahead” on 12 May 2010), SGRO’s gross margin should improve because of higher FFB contribution from nucleus to total processed FFB. Using AALI as a benchmark, SGRO’s 1Q11 gross margin of 43.7% beats AALI’s 1Q11 gross margin of 38.9%.

Expect nucleus contribution higher than plasma contribution from 2013. Going forward, based on SGRO’s planting profile on nucleus and plasma (exhibit 3), we expect nucleus contribution to total processed FFB to keep improving and surpass plasma contribution from 2013 onward. We expect higher contribution of nucleus because the growth of FFB from nucleus is higher than the growth of FFB from plasma. Assuming CPO price stays the same, higher contribution from nucleus should keep gross margin expanding in the future.