Strong fundamentals but stock is nearly fully-valued – downgrade to HOLD

Inoue Rubber (Thailand) Plc (IRC) reported 1Q03 earnings for the period ending December 31 of Bt43mn, up 237% yoy but down 27% qoq. IRC’s sales dipped 5.1% qoq to Bt555mn while gross margins narrowed to 13.3% versus 14.7% in the previous quarter.

After a recent analyst meeting at IRC, we have raised our sales and earnings forecasts by 23% and 14% to Bt2.75bn and Bt175.4mn respectively. However, IRC’s share price already reflects much of the strong growth, having more than doubled over the past four months.

Based on our revised forecasts, IRC is trading on a 2003 PER of 7.0x and EV/EBITDA of 4.8x. Despite its relatively low valuations, the stock is very close to our fair value estimate of Bt66/share (based on our DCF model). Accordingly, we are downgrading our recommendation from BUY to HOLD.

IRC's Income Statement

• IRC’s sales grew 19.8% yoy to Bt555.6mn but fell 5.1% qoq. The company’s performance was weak in comparison to the overall auto industry. According to central bank data, car production rose 4% qoq and 36.9% yoy to 174,966 units while motorcycle production grew to 443,430 units, up 16.9% qoq and 68.5% yoy.

• Gross margins narrowed to 13.3% versus 14.7% in 4Q02. This was due to higher polymer prices following the steady rise in oil prices. Polymer accounts for about 50% of raw material costs, which in turn represent about half the company’s total production expenses.

• Interest expenses fell 14.8% qoq and 38% yoy to Bt4.3mn in 1Q03, with IRC using its strong cash flow to trim debt levels. Total borrowings fell to Bt495mn in December compared with Bt586mn a year earlier. The company is in a strong financial position, with gearing of 0.76x last December.

• At last month’s analyst meeting, management indicated that sales would jump 33% this year to Bt2,750mn. As a result, we have revised up our net profit by 14% to Bt175.4mn (EPS of Bt8.77), 34.8% higher than 2002 earnings of Bt130.1mn. IRC’s management expects car and motorcycle production to grow by 20% and 26% respectively this year. Other factors supporting the company’s growth are: 1) improved operating efficiencies and lower rejection rates; 2) the relocation of many vehicle assemblers to Thailand; and 3) the marketing of new products such as RIM for Suzuki motorcycles and non-puncture tubes under the Tuff-Up brand name.

IRC’s sales breakdown and forecasting

• This year IRC will invest about Bt270mn at its Rangsit and Wangnoi plants in order to boost capacity of its industrial rubber business by 30% and its motorcycle tyre and inner tubes divisions by 15% each. The production increase is needed to meet a lengthy backlog of orders from major vehicle producers such as Toyota, Honda and Isuzu.

• IRC normally trades below a PER of 8x – a level it is rapidly approaching. On a DCF basis, we value the stock at Bt66 a share, indicating potential upside of just 7.3%. Despite its strong growth prospects this year, we are downgrading our recommendation from BUY to HOLD.