Semen Gresik (SMGR-BUY-IDR9,800-TP:IDR11,700) Volume and margin enrichment - Bahana

Reiterating BUY with target price of IDR11,700
With additional 5.0m tons annual capacity coming from its 2 new mills in 2012, production constraint in Semen Gresik (SMGR) will no longer be an issue, poising to benefit from Indonesia’s continued growing cement demand. On top of pick up in volume (2012: +10%), we expect margins to gradually improve. Hence, despite higher interest expense arising from the bank borrowing to fund the development of these new mills, SMGR undoubtedly has promising medium-term earnings growth outlook given 2011-13 CAGR of 15%. Hence, we reiterate our Buy rating on SMGR with TP of IDR11,700, trading at implied 2011 P/E of 17.0x or 10% discount to market of 18.9x.

Gradual margin enhancement coming from Padang and Tonasa mills
Despite increased energy related costs (which account for approximately 38% of production costs), we expect SMGR to experience margin expansion toward end of 2011, not only due to the recent 2.5% ex-factory price increases, but also on the back improved production efficiency coming mainly from the Padang and Tonasa mills. These mills have carried EBITDA margins of 25% and 29% respectively, while Tuban has penciled EBITDA margin of 42%. The use lower calorific coal, improving infrastructure and higher efficiency of new mills would suggest better production cost structure. Looking ahead, the expected softening commodity prices and continued IDR strength would help produce positive impact to production efficiency. The management targets 2015 EBITDA margin of 38%, up from the current level of 34%.

Construction of Tuban IV (89.3%) and Tonasa (88.1%) in June 2011
As scheduled, construction of Tuban IV mill (East Java) with annual capacity of 2.5m tons has reached 89.3% in June and is expected to be completed in December. Although the progress of Tonasa V has moved slightly behind the schedule with 88.1% completion in June, it is likely to be ready for commercial production in early 2012. While waiting for the completion of the new 2x35MW power plant, which has reached 35.0% progress, supplies of electricity from PLN have been secured for the upcoming 12 month production. Note that this new power plant is destined to support Tonasa’s new mill (50MW) and to partially replace the less efficient old power generator (45MW).

In expansion mode to protect its dominance in the industry
On top of its 2 new mills, SMGR plans to continue expanding its capacity in order to defense its market share in this growing consumption. Concurrently, it creates barrier to entry for new players into this high margin lucrative industry. 3 new mills will be slated and located in Sumatra, Kalimantan and northern part of Java, with the following considerations namely, the availability of raw materials (i.e. limestone), easy access to coal supplies and strategically located along the transportation route. This strategic expansion would provide SMGR with its widest distribution network all over Indonesia. Note that it would take 3-4 years to build a new cement mill from green field.