Deutsche Bank Indofood CBP : Pricing power offsets cost headwinds; initiating with Buy

Indofood CBP {Ticker: ICBP.JK, Closing Price: 4,650 IDR, Target Price: 7,000 IDR, Recommendation: Buy}

Indofood CBP’s pricing power underrated; initiating with Buy

ICBP’s ability to raise prices to protect margins is being misjudged in our view as it only needs to raise prices by 3% for each 10% hike in flour and CPO. We believe this is manageable as ICBP raised prices by c.60% during the last input surge in 2007-08 with minimal volume impact. Furthermore, the noodle-rice price gap is more than one standard deviation above historical average, encouraging a switch to noodles. ICBP continues to benefit from pricing power due to its market dominance, strong brands and favourable industry structure. Initiating with Buy.

Inflationary and rate hike concerns overblown

Recent concerns over lower disposable income and impact on consumption due to phased removal of the car fuel subsidy is not an issue as 85% of the population would be unaffected by the measure. The surge in the price of rice (+26% YtD) could lead to noodles becoming a favoured substitute. Similarly, potential rate hikes would have limited impact as less than 5% of households have mortgages.

Top consumer foods company with strong brands in a rising economy

ICBP is the market leader in Indonesia’s rapidly growing packaged-food industry, in which demand should remain robust amid a growing economy, urbanization and a rising middle class. The favourable noodle industry structure (ICBP has 73% market share) and low dairy consumption suggest a resilient earnings outlook. The competitive environment in noodles is benign as major competitors have followed ICBP’s price hikes and chose not to attack during the product recall in Taiwan.

Trading at 39% discount to regional peers; Rp7,000 target price (51% upside)

At our DCF-based target price (WACC of 12.1% and terminal growth of 5%), ICBP would trade at 22.4x PER FY11F (currently at 14.9x), which we believe fairly reflects its high earnings quality, dominant industry position, strong balance sheet, brand equity and excellent management. Key risks: commodity prices, USD/IDR exchange rate and related-party arrangements.