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8/6/2012 10:29:20 AM:

PT United Tractors Tbk

"PT United Tractors Tbk"

"We reduced our call on UNTR to UNDERWEIGHT on the backdrop of continuation of extremely gloomy outlook in the coal markets, intensified competition in the heavy equipment sector coupled with decreased investment by mining companies and lower-than-expected margin from mining contracting as weather has just improved in second half of May."

Ticker: UNTR.IJ
ANALYST: Wibowo Ng
Current Price (July 27th, 2012): IDR 20,850
Target Price 2012: IDR 20,400
PE 2012F: 12.8x
PE 2013F: 12.0x
PE 2014F: 9.4x
Construction Machinery
The firm managed to sell 4,231 units of Komatsu heavy equipment which is slightly below 50% of its revised new target of 8,500 units or 51.5% of our previous target of 8,215 units and down 2.4% yoy. The firm cites: (1) ongoing slumps in the coal markets and mineral exports taxes imposed on Nickel causing demands for heavy equipment (for expansion) to fall; (2) intensifying competition from other heavy equipment firms as the global partners reallocate assets from China to other countries including Indonesia. This blew Komatsu’s market share to 44% and the firm has taken proactive actions, as cited in our previous reports, to circumvent this issue and the initial results will be reflected in the 3Q12. 2Q2012 post-elimination gross profit margin of 23.2% exceeded our estimate of 17.0% which is due to increased portion of higher-margin Parts & Services division (+29.5% yoy) and the fact that the firm has increased its ASP early this year. Key concerns include: (1) Pricing war among other distributors intensified which will force UNTR to eventually reverse its price increase or even lower it to defend its market share despite the potential complications affecting the secondary market (used equipment market). Caterpillar (CAT US) and Hitachi Construction Machinery (6305 JP) have stated that China’s demands for construction/heavy equipment will remain weak and will allocate resources to other parts of APAC including Indonesia1, implying potential supply overflow in the coming half of 2012); (2) Further deterioration in the global economies and mining industry, especially intensification of EU crisis escalating to Greece leaving EMU or Spain and/or Italy requesting Sovereign bailout a la “Troika”, will prompt many companies to delay expansion to preserve cash as buffer for the next storms; (3) the firm’s Corporate Secretary has issued warning that company “may lower sales target as maintaining last year’s sales number won’t be easy” and should the condition deteriorates further, we should expect more earning cut.

To reflect these risks, we reduced our Komatsu 2012 sales volume to 7,869 (1H12 sales: 54% of our revised target) units from our previous 8,215 units and we estimate that the firm will reverse its ASP increase in the coming quarters to defend its market share as the competition intensified in the medium/small-sized heavy equipment. Increased in infrastructure investment and expansion by agriculture companies will offset the fall in heavy equipment demand but even then, we feel that the heavy equipment industry is way too dependent on mining sector (with mining made up of more than 60% of heavy equipment sales).

Mining Contracting
Unfavorable weather conditions in the 1Q2012 and one and a half month of 2Q2012 significantly depressed the gross margin of this division but, according to the firm, the weather has improved significantly and this allowed PAMA to operate at lower cost to meet its target. Post-elimination 2Q2012 margin fell to 17.3% (vs our estimate of 22.0%; up from 14.0% in 1Q2012) and we expect that with improving weather conditions, the firm should be able to register higher margin in the coming quarter and higher production and OB removal volumes. Total coal production increased to 45.1 mn tons (+12% yoy; 45.8% of 2012 target of 98 mn tons) while OB removal increased to 415.2 mn bcm (+13.3% yoy; 46.4% of out 2012 target of 894 mn bcm). These are slightly below our estimate which can be accounted for the seasonality of weather. However, with declining coal prices, we are concerned that mining companies will just want to meet the minimum volumes pre-specified at the contract in order to minimize losses incurred from operating above the cash cost. Furthermore, with 2 consecutive quarters of margin below our estimates, we revise 2012 gross margins downwards to 17.5% from our previous 18.5%.

Mining Division
Bloodbath in the coal markets has pushed its 2Q12 margin to 6.3% (post-elimination) vs our estimate of 14%. The declining coal prices and temporary breakdown in correlation between crude oil and coal prices have been cited to cause this margin compression. With the global markets turmoil denting investor’s confidence and slowing down Chinese economy, we expect this trend to persist unless: (1) colder than expected winter in 2H2012 driving up demands for energy; (2) Tensions in the middle east intensified escalating to the closure of Strait of Hormuz; (3) Better-than-expected Chinese economy growth as the results of strategic stimulus pumped into its economy triggering demands for energy; (4) EU achieved some form of feasible resolutions that do not trigger any market events. Despite these possible upside potentials, in near terms, we remain cautious and revise its 2012 gross margin downwards to 8.3% to account for the margin compression as the spread between coal ASP and cash cost narrows. With this scenario in place, we estimate that the mining division will barely break-even or even operating on net loss.

With the coal prices continue to be under pressure, we expect that the firm will seize the opportunity to acquire distressed mines at cheap/current valuation to boost its reserves for future operations and reduce its dependencies on heavy equipment sales (which is more leveraged to the coal/macroeconomic cycles).



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