Gudang Garam - Pricing power may lead to higher dividends; raising TP - Deutsche

Pricing power and dividend potential being underappreciated
Gudang Garam has underperformed the JCI by 23% since September, even as it has proven its pricing power repeatedly, raising prices 19 times in the past 24 months by a total of 24%. In our view, this demonstration of pricing power warrants a further re-rating of the stock. We also believe there is room to increase the dividend payout ratio from the current 36% to 100% due to its strong free cash flow generation. We raise our target price to Rp62,000 (from Rp43,500), making GGRM our top pick in the Indonesia consumer space. Buy.

Positive excise changes on the horizon and superior operating environment
On top of the ongoing excise unification, the government plans to close a loophole in the excise system that allows lower excise for subsidiaries, which could affect 10-25% of industry volume. GGRM is the only major cigarette company without a production subsidiary. In addition, Indonesia is one of the few places in the world where volumes are still growing. The top 10% income bracket smokes c. 5x more (and 36% pricier) cigarettes than the bottom 10%, suggesting room for growth as GDP/capita rises. The price of a pack of Marlboro is 40% cheaper than in India even though income per capita is 2.5x more (i.e. room for price increases).

Low foreign ownership on overblown corporate governance concerns
In our view, the primary reason why foreigners have sold c. US$130m of GGRM shares since September is on unfounded concerns on Surya Air, which is now primarily for internal use, and KDM, the cigarette company being run by the son of the CEO, which does not compete directly with GGRM.

Trading at 24% discount to regional peers; raising target to Rp62,000
We rollover our DCF valuation to 2011 with a new target price of Rp62,000 (32% upside potential) implying 19.1x PE FY12F, in-line with valuations during its 1994- 98 growth phase. Despite minimal earnings revisions, our increase in TP is primarily due to rollover to 2011 and WACC decrease to 12.3% (from 13.4%). Risks: excise policy and regulation.