Pulp and Paper Cutting down pulp price assumption

We lower our pulp price assumption by 13%/16%
Shanghai softwood pulp price futures (KSP1 COMB Comdty) for June 2019 dropped by 10% (from Oct’18). INKP and TKIM sell slightly different kind of product which is hardwood pulp (only down by 2%). Historically, hardwood and softwood prices tend to move in the same direction. We think the softwood future price decline is due to the sentiment on China’s slower economy that leads to China’s lower pulp consumption. Hence, we lower our pulp price assumption by 13%/16% to USD700/650 per ton in 2019/20. It is in line with our coal price assumption that has similar declining trend going forward.

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Reducing earnings to reflect lower pulp price
We reduce our earnings estimates for INKP and TKIM by 26/49% and 29/39% in 2019/20 reflecting lower pulp price assumption. As a result, we expect INKP’s core earnings to decline by 20% next year. However, we assume TKIM to book 21% earnings growth next year supported by 22% higher production capacity from OKI (49% owned by TKIM).

De-rating already worse than global peers
INKP and TKIM share prices are down by 40/40% from their recent peak (in Jun18) vs global peers Fibria/Suzano/Klabin down 6/16/16% JCI +3% in the same period. In addition to concern over pulp and paper prices, INKP and TKIM de-rated more relative to its global peers due to perception on their disclosure, which has not improved post-inclusion into MSCI Indonesia.

Maintain BUY recommendation
We still have BUY recommendation for INKP and TKIM with DCF-based TP of IDR14,000 and IDR13,500. We maintain our TP for INKP as the lower pulp price assumption is being offset by the increase of cash level in 2019F (we rolled over our cash position from 2017 to 2019F). We reduce our TP for TKIM by 51% of which 36% contributed by lower EBITDA caused by lower pulp price assumption and 15% from higher beta in OKI’s DCF valuation. Our TP implies 10.6x and 8.7x 2019F PE and 6.9x and 8.2x 2019F EV/EBITDA for INKP and TKIM.

We prefer INKP over TKIM
We prefer INKP over TKIM for the following reasons: 1) Lower gearing (INKP 0.4x and TKIM 1.0x 2019F), 2) INKP has more straightforward business model compared to TKIM. Note that OKI (contributes c100% of TKIM’s net profit) is not consolidated in TKIM’s financials as it is accounted as income from associates, while INKP has full consolidation for its pulp and paper businesses. Key risks to our call are volatility in pulp prices and China’s lower demand for pulp and paper products.
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