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INCO - Continues its shines
December 17, 2014 10:35

Despite short-term volatility in nickel prices on lower than expected nickel demand in 2014 and high inventory level, we believe nickel market is expected to turn into deficit in 2015 on recovery in nickel consumption growth and the continuation of Indonesia’s nickel ore export ban. This will put upward pressures on nickel prices going forward. Coupled with completion of CoW renegotiation to provide visible outlook for company’s business strategy in the long-run, as such, we maintain our BUY call with a Target Price of Rp4,700 based on DCF valuation (WACC: 12.2% and long-term growth of 3%). Our Target Price implies 21x 2015F PE.

Stable nickel production for 2015
With the company plans to postpone the upgrade of its electric furnace (EF) No. 1 from the beginning of 2015 to the second or third quarter of 2016 to reap the benefits of expected better nickel prices in 2015, we believe the company will fully utilize its current capacity and maintain its nickel-in-matte production at a maximum level of 80,000 tons in 2015 (2014F: 79,600 tons). Although the upgrading of EF No. 1 will lower the nickel-in-matte production by about 10% yoy to around 72,000 tons in 2016, the company plans to sustain the production through further improvements and de-bottlenecking. Following the EF#1 upgrade, the company is expected to increase nickel-in-matte production to about 90,000 tons.

Higher nickel prices and cost efficiencies to boost margins going forward
We foresee gross margins improvement to 32% in 2015 from an estimated 29% in 2014 with the cost of production expected to be maintained at around US$9,000/ton (9M14 COGS per ton: US$9,136/ton). This will be attributable to: a) better average nickel price to US$20,000/ton (+17.6% yoy) in 2015 with the expectation nickel market deficit and, b) lower energy costs going forward following the full operation of coal conversion project phase 1 for dryers (CCP1) at end-3Q13 to reduce the usage of High Sulphur Fuel Oil (HSFO) and further declines in the crude oil price will lower HSFO prices. 

Long-term capex of US$2bn to support business going forward
After renegotiation of the Contract of Work (CoW) with the government has been completed, the company plans to spend long-term capex of about US$2bn, consisting of US$1.5bn for Sorowako project developments and the remaining US$500mn for Bahodopi. In the first stage (2015 – 2017), US$500mn of capex will be used for a) EF #1 upgrade and b) further improvements and de-bottlenecking. This will increase nickel-in-matte production to 90,000 tons from 80,000 tons. In the second stage (2018 – 2020), the company plans to increase the nickel-in-matte production capacity further to 120,000 tons by adding the fifth furnace as well as its supporting facilities. Meanwhile, for Bahodopi, the company plans to build either a refinery or smelter, for which the ore-feed will come from Sorowako.