INCO Bearish on nickel and firm’s growth strategy: Cut to U/P - BoAML

Downgrading from Buy to U/P, PO cut to Rp4,200
PT Inco has underperformed the IDX by 15% YTD and we believe the underperformance will continue. The stock is trading at 5% above our new, lowered PO of Rp4,200 (NPV-derived). We think nickel prices are peaking, due to substantial supply starting 2H11. Amid falling prices, we believe nickel stocks will find it tough to outperform. Moreover, we are not convinced with the firm’s growth strategy. The forecast dividend yield of about 7% for PT Inco deserves positive consideration but given the lack of implied share price upside, we do not think it covers the equity holding cost. We cut PT Inco rating from Buy to U/P.

…along with cuts to earnings estimates
The BofAML commodity team is cutting its nickel price forecast for 2011 by 10%, to US$10.9/lb, while retaining its 2012 forecast. We have lowered our 2011 earnings forecasts for PT Inco by 5%, and cut our PO to Rp4,900 from Rp4,200. We have increased the company’s WACC from 11% to 12% on higher RFR.

Bearish on nickel; stock moves in tandem with nickel prices
Our mining team estimates that primary nickel production can rise by 160Kt, equivalent to a massive 5.5mt of stainless steel output (i.e., post-crisis levels). This, when stainless steel output is already forecast to rise 7.6% in 2011, after the 26.2% achieved in 2010. We anticipate a small market surplus in 2011, with
fundamentals likely turning over in 2H11.

Bahudopi growth project not convincing
PT Inco seems to have plans to revive the Bahudopi project – apparently because the nickel ore is relatively high-grade. It also has an undertaking agreement to develop Bahudopi by 2010. But given the bleak outlook for nickel prices, expiration of contract of work in 2025 (already been extended in 1996) while extension seems uncertain if the undertaking agreement’s not fulfilled, and lack of cheap energy source nearby, we are not convinced about the project’s feasibility.

Commissioning of Karebbe dam already priced in
We could see modest share price impact when Karebbe dam is commissioned during 2H11, but it seems this is already priced-in and does not affect our bearish 12-month view on the stock. We think the stock price could move down from current levels and rate the stock Underperform.