BAHANA

Securities April 29, 2003

BAHANA FOCUS
RECOMMENDATION

BUY
INCO
JAKARTA COMPOSITE INDEX

430.8 1Q03 Results – A sign of things to come?

SHARE PRICE First quarter results were buoyed by high nickel prices and net profit of
US$15.0mn was the highest quarterly total in two years. A scheduled
Rp6,250 furnace rebuild that occurred over 4Q02-1Q03 is now complete and min-
COMPANY INFORMATION ing efficiency continues to improve. Although we expect nickel prices to
Issued shares 248mn soften in the short-term due to the SARS affect on Chinese nickel de-
Market capitalization US$175mn mand, Inco still represents a compelling long-term investment opportu-
Free float (%) 21.2 nity. A FY02 dividend of US$0.01 is insignificant but dividends should
Average daily turnover US$0.04mn rise to US$0.20 per share in 2006. Our 12-month target price of Rp7,750
Bloomberg Code INCO IJ is 25% above the current share price. BUY

ECONOMIC DATA (US$ mn) 2001A 2002F 2003F 2004F

Revenue 296 321 371 386
2003F 2004F
Change (%) (26.2) 8.3 15.6 4.0
Economic growth 3.5 3.5 EBITDA 115 125 164 182
Inflation, year-end 8.5 9.0 Ebitda Growth (49.7) 8.4 31.3 11.5
IDR avg 9,000 9,200 Net Profit 9.3 30.3 56.2 69.4
IDR year-end 9,200 9,500 Change (%) (88.5) 226.8 85.5 23.5
EPS 0.04 0.12 0.23 0.28
SBI 1m year-end 10.5 11.0
Change (%) (88.5) 226.8 85.5 23.5
SHARES PERFORMANCE(%) PER (x) 19.2 5.9 3.2 2.6
EV/Ebitda (x) 3.4 3.2 2.4 2.2
 

Ebitda / Gross Int. Exp. (x) 4.1 10.1 17.7 26.3


Net Debt / Equity (%) 41.2 32.0 14.4 (0.8)

Current Ratio (x) 1.2 1.2 1.6 2.1

ROE (%) 1.3 4.0 7.0 8.1





l The investment case for Inco is based upon the company’s free cash
flow, which can surpass US$100mn after capital expenditures in good


 
years versus a market cap of US$175mn. This cash flow goes to-
wards yearly principal repayments of US$77mn currently but will be
      

-&,5+6 ,1&2/+6

Source: Bloomberg used for dividends in future years.

PRICE CHANGES (%) l The share price could come under pressure in the near-term as the
1Wk:-3.0 1M:-7.5 3M:+18.1 affect of SARS on Chinese demand for nickel is a major concern. The
LME spot price is currently US$3.55/lb versus a high of US$4.10/lb in
February and our FY03 assumption of US$3.40/lb. However, further
decreases in oil prices could partially offset the effects of a lower
nickel price.

l Inco is a long-term investment opportunity but our 12-month target of

Rp7,750 is still 25% above the current share price. The share is up
Paul Dammkoehler 70% from its lows in November and has outperformed the index by
paul@bahana.co.id 62% YTD. BUY
(62-21) 250-5080 ext 2620

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 BAHANA
Securities
Investment Case

Cash flow and debt reduc- Our investment case for Inco centers around the free cash the com-
tion is the key pany is able to generate, the de-leveraging of the balance sheet, and
the future dividend stream, particularly after debt is fully retired in 1Q06.
At that time we anticipate the major shareholders will favor a maxi-
mum payout policy and maximize the return of capital from Inco after
having to finance the company’s expansion in the past. In the interim
the de-leveraging of the balance sheet will also translate into gains in
the value of equity irregardless of dividend payouts.

Principal repayments Inco currently pays off US$77mn in debt per year and in 2003 a total
US$77mn per year of US$86mn will go towards principal and interest payments but even-
tually this cash flow will be used for substantial dividends. A dividend
of US$0.20 per totals only US$50mn and results in a yield of over 25%
based on the current share price. We estimate operating cash flow
will reach US$150mn in 2003. The company unexpectedly paid a
US$0.01 dividend out of FY02 net profit and this could rise to US$0.05
this year if nickel prices remain at current levels (7% yield).

Before a 50% capacity expansion (1997-2000) and taking on of

US$600mn in debt, Inco typically paid a dividend of US$0.10 per share.
Under the terms with lenders Inco is allowed to pay this “normal”
US$0.10 dividend before debt is fully retired, but a dividend in excess
of US$0.10 would require the deposit of the next scheduled principal
payment (US$38mn). The share is up 68% from its lows but our 12-
month price target is still 25% above current levels. BUY

EV / EBITDA
  [

  [
( 9 ( % , 7 ' $

  [

  [

  [

  [

  [

  [

  [

  [

  [

4 4 4 4 4 4 4 4  4

Source: Bahana Estimates

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 BAHANA
Securities
Review of 1Q03 Financial Results & Operations

Summary First quarter net profit of US$15.0mn was up 160% QoQ and over 800%
YoY primarily due to better nickel prices. The average price realized for
Inco’s nickel matte product increased 15.1% QoQ and 41.0% YoY to
US$2.82 per pound and the gross margin rose to 28% versus only 13%
and 7% in the prior periods respectively. During the quarter maintenance
on one of the company’s four furnaces was completed and the unit is
now fully operational. Inco also paid off US$38mn in debt and declared a
US$0.01 per share dividend.

INCO PROFIT AND LOSS

(US$) 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 QoQ YoY

Sales 55.9 71.4 95.3 81.6 72.6 87.1 20.0% 22.0%
Cost of goods sold 66.8 65.6 76.8 61.1 62.0 62.7
Gross Profit (10.9) 5.8 18.6 20.5 10.7 24.4 128.8% 321.2%
margin -19.4% 8.1% 19.5% 25.1% 14.7% 28.0%

S,G,&A 0.8 0.5 0.3 0.5 1.1 0.5

Operating Profit (11.6) 5.3 18.3 20.1 9.5 23.9 151.1% 3 5 4 . 3 %
margin -20.8% 7.4% 19.2% 24.6% 13.1% 27.5%

EBITDA 9.1 24.1 37.2 38.9 24.3 39.9 64.6% 65.4%

margin 16.2% 33.8% 39.1% 47.6% 33.4% 45.8%

Other Income 0.2 (3.0) (2.4) (2.9) (1.3) (2.5)

Interest expense (3.3) (3.2) (2.8) (2.9) (2.3) (2.2)
Other 3.5 0.2 0.4 0.1 1.0 (0.3)

Earnings before taxes (11.5) 2.3 15.9 17.2 8.3 21.5 159.4% 841.6%
Income taxes 3.5 (0.7) (4.8) (5.4) (2.5) (6.5)
Net Profit (8.0) 1.6 11.2 11.8 5.7 15.0 160.1% 838.0%
margin -14.3% 2.2% 11.7% 14.4% 7.9% 17.2%
EPS (0.03) 0.01 0.04 0.05 0.02 0.06 160.1% 838.0%

Source: Company

Revenue

Average realized nickel price
increases to US$2.82/lb
Revenue rose 20.0% QoQ and 22% YoY to US$87.1mn due to a 15.1%
QoQ and 41.0% YoY increase in the average nickel price received to
US$2.82/lb. This price translates into an average LME spot price of
US$3.61 per pound versus US$3.55 currently. It is likely that 1Q03 will
mark the high for the year despite resiliency in nickel prices as the
nickel demand story that centered around Chinese economic growth
has been altered due to the affect of SARS. Our nickel price assumption
for FY03 is for a realized price of US$2.67/lb or spot price of roughly
US$3.40/lb (US$7,500/ton). Nickel matte deliveries of 30.5mn lbs were
up 4.1% QoQ but down 13.4% YoY due to scheduled maintenance on
one of the company’s four furnaces (see discussion below).

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 BAHANA
Securities
NICKEL INVENTORY AND PRICE
 





 









 





 
- 0 0 $ 2 ' 0 0 - 6 ' ) 0 - 6 ' ) 0 - 6 ' )

Source: Bloomberg

Inco’s realized price is equal to 78% of the previous month’s average

spot nickel price on the London Metals Exchange (LME) because the
nickel matte product that Inco sells is 78% contained nickel. All of
Inco’s production is exported to Japan under long-term contracts with
the two major shareholders - Inco Canada (59%) & Sumitomo Metal
Mining (20%). Nickel matte is an intermediate product that is refined
further in Japan before shipping to stainless steel producers in Japan,
Korea and China.

INCO OPERATIONAL DATA

 






















1LFNHOPDWWHSURGXFWLRQPQOEV

1LFNHOPDWWHGHOLYHULHVPQOEV 


$YHUDJHUHDOLVHGSULFHSHUOE

$YHUDJHUHDOLVHG&2*6SHUOE




 

4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4

Source: Company

Furnace maintenance completed
in 1Q03.
Production in the first quarter was still affected by a scheduled rebuild
of one of Inco’s four furnaces that began in 4Q02 and was completed
in the middle of 1Q03. Thus nickel matte production of 32.0mn lbs
was up 17.6% QoQ but down 7.8% YoY. The rebuilt furnace has been
restarted, reheated for 1 ½ months, and was fully operational at the
end of 1Q03. The next scheduled furnace overhaul is in 2005, but
could be pushed out a year due to “life enhancement” practices of the
company. Inco should be able to average 36mn lbs per quarter for the
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 BAHANA
Securities
remainder of the year in order to meet the company’s FY03 production
target of 140mn lbs per year (+6.7% YoY). The company has already
exhibited that it can operate its processing facilities at feed rates equiva-
lent to designed capacity of roughly 150mn / year (37.5mn per quarter).

Production Data 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 QoQ YoY
Nickel production (mn lbs) 34.2 34.7 34.6 34.7 27.2 32.0 17.6% -7.8%
Nickel deliveries (mn lbs) 30.9 35.2 39.6 32.5 29.3 30.5 4.1% -13.4%
Avg. realised price (per lb) $1.78 $2.00 $2.38 $2.48 $2.45 $2.82 15.1% 41.0%
Avg. realised COGS (per lb) $2.16 $1.87 $1.94 $1.88 $2.11 $2.06 -2.8% 10.3%

Source: Company

First quarter ore grade tempo-
rarily high
This year’s production will be helped by an improvement in ore grades,
which were disappointing last year due to increased mine complexity
and variability of ore deposits. Inco has rectified the situation by in-
creased drilling and delineation of the ore body, and blending of different
ore grades. In addition, better overall coordination between the mining
and processing units has resulted in ore grades that are better suited to
specifications of the smelting facilities. In 1Q03 the nickel ore content
spiked to 1.92%, compared to 1.69% in 1Q02 and well above the FY03
target of 1.77%. However, the company stated that this was simply due
to a fortuitous patch of extremely rich ore, as opposed to operational
improvements, and is not an indication of what to expect in the future.

NICKEL PRODUCTION (MN LBS)







 


















     ( (

Source: Company & Bahana Estimates

Margins expand on nickel price
increase
The increase in nickel prices and deliveries in the quarter resulted in a
dramatic increase in the gross margin to 27.5% compared to 13.1% in
4Q01 and 17.1% for FY02. As a result, Inco’s operating profit improved
by 151% QoQ and 354% YoY to US$23.9mn. This rise occurred despite
high oil prices at the end of 2002, although high oil prices in 1Q03 will
dampen 2Q03 margins. Net income of US$15.0mn was up 160% QoQ
and 838% YoY and represented 27% of our FY03 estimate for net in-
come.
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 BAHANA
Securities
INCO OPERATING MARGIN











4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4






Source: Company

Help from oil prices? Oil accounts for roughly 45% of cash costs and every US$1.00/barrel
increase results in an US$0.02 per pound increase in the cash cost of
nickel production. Approximately 60% of 2002 oil needs were hedged
at US$18.20/barrel while 20% of 2003 consumption is hedged at
US$18.00/barrel versus current prices of US$26 per barrel and roughly
US$33 average in 1Q03. Thus Inco stands to benefit from a continued
drop in oil prices and our FY03 estimates assume an average market
price of roughly US$26/bbl, and incorporates a steady decrease in oil
prices to US$22/bbl in the fourth quarter.

NICKEL & OIL PRICE SCENARIOS (US$ MN)

Oil Price
$ 18 $ 20 $ 22 $ 24 $ 26 $ 28 $ 30
$ 3.70 96.5 92.9 89.2 85.6 81.9 78.3 74.7
$ 3.60 86.7 83.1 79.4 75.8 72.1 68.5 64.9
$ 3.50 76.9 73.3 69.6 66.0 62.3 58.7 55.1
$ 3.40 67.1 63.5 59.8 56.2 52.5 48.9 45.3
$ 3.30 57.3 53.7 50.0 46.4 42.7 39.1 35.5
$ 3.20 47.5 43.9 40.2 36.6 32.9 29.3 25.7
$ 3.10 37.7 34.1 30.4 26.8 23.1 19.5 15.9
Source: Bahana Estimates

Cash Flow / Balance Sheet

Operation cash flow of US$62mn in 1Q03 was helped by a US$25mn

drop in receivables and allowed Inco to make a scheduled principal
repayment of US$38mn and still register an increase in cash. Gross
debt was reduced to US$230mn, and net debt declined to US$200mn
(net debt to equity 25.5%). Inco’s next principal repayment is in the
third quarter and remaining debt will be fully retired in 1Q06. We esti-
mate FY03 Ebitda will reach US$165mn compared to principal and
interest payments of US$87mn and capex of US$35mn. Most of Inco’s
debt is owed to the major shareholders at very attractive terms of
LIBOR +1%. The collapse in interest rates and lower debt level has
reduced interest expense dramatically and in 1Q03 was only US$2.1mn
versus US$3.2mn and US$8.6mn in 1Q02 and 1Q01 respectively.
6
 BAHANA
Securities
CONSOLIDATED PROFIT AND LOSS ACCOUNT CONSOLIDATED CASH FLOW STATEMENT

(US$ mn) 2000A 2001A 2002A 2003F 2004F (US$ mn) 2000A 2001A 2002A 2003F 2004F
Revenue 401.6 296.4 321.0 371.3 386.1 Cash from operations 189.0 140.2 100.4 179.5 179.1
Cost of goods sold 248.3 259.8 265.5 279.3 277.4 Cash from customers 390.8 331.9 279.4 393.3 384.7
Gross Profit 153.3 36.6 55.6 92.0 108.7 Payment of expenses (189.0) (186.0) (199.4) (210.2) (203.0)
Taxes (4.9) (3.2) 13.9 - -
Operating expenses 1.9 2.5 2.4 2.5 2.7
Others (7.9) (2.5) 6.4 (3.6) (2.5)
Operating profit 151.4 34.1 53.2 89.5 106.0
Depr. and amort. 76.8 80.7 71.4 74.0 76.4 Cash from investing act. (32.7) (28.6) (30.8) (35.0) (30.0)
EBITDA 228.2 114.8 124.5 163.5 182.4 PP&E (32.7) (28.6) (30.8) (35.0) (30.0)
Long-term payables - - - - -
Interest income (36.1) (23.4) (11.2) (9.2) (6.9)
Short-term investment - - - - -
Interest expense
Other - - - - -
FX gain (loss)
Other income (exp.) 1.4 2.7 1.7 - - Cash from financing act. (121.5) (104.9) (90.6) (93.2) (100.8)
Pre-tax profit 116.7 13.4 43.7 80.3 99.1 Inc/dec st loans & pay. - - - - -
Inc/dec lt debt (86.3) (76.9) (76.9) (76.9) (76.9)
Income tax 36.3 4.1 13.4 24.1 29.7
Dividends - - - - -
Minority interests - - - - -
Other (35.2) (28.0) (13.7) (13.8) (11.4)
Net profit 80.5 9.3 30.3 56.2 69.4
Net Inc/(dec) in cash 34.8 6.8 (21.0) 51.3 48.3
CONSOLIDATED BALANCE SHEET
RATIOS
(US$ mn) 2000A 2001A 2002A 2003F 2004F
Cash and equivalents 36.7 43.5 22.5 73.8 122.1 2000A 2001A 2002A 2003F 2004F
Accounts receivable 37.8 3.5 43.6 21.6 23.0 ROA (%) 6.2 0.7 2.5 4.6 5.7
Inventories 52.6 59.5 56.1 57.0 57.0 ROE (%) 11.7 1.3 4.0 7.0 8.1
Other current assets 22.6 24.3 21.5 21.0 21.0 Gross margin (%) 38.2 12.4 17.3 24.8 28.2
Total current assets 149.7 130.9 143.7 173.4 223.1 Operating margin (%) 37.7 11.5 16.6 24.1 27.5
Fixed assets - net 1,121.0 1,053.5 1,008.3 969.3 922.9 Pre-tax margin (%) 28.7 3.6 13.1 21.6 25.7
Other 30.0 46.0 64.9 64.9 64.9 Net margin (%) 20.0 3.1 9.4 15.1 18.0
Total Assets 1,300.8 1,230.3 1,216.8 1,207.5 1,210.9
Net interest cover (x) 6.3 4.1 10.1 17.7 26.3
S/T debts - - - - - Gross debt/equity (%) 56.4 47.1 34.9 23.3 13.1
Accounts payable 27.9 10.0 16.4 16.4 16.9 Net debt/equity (%) 51.4 41.2 32.0 14.4 -0.8
Current maturities 64.8 76.9 76.9 76.9 76.9 Total debt/EBITDA (x) 1.8 3.0 2.2 1.6 1.5
Other current liabilities 20.6 19.4 21.5 16.7 11.9
Total current liabilities 113.3 108.7 116.5 110.0 105.7 SHARE VALUATION

Bank loans 346.1 269.2 192.3 115.4 38.4 (US$ mn) 2000A 2001A 2002A 2003F 2004F
Notes payable & bonds - - - - - Current share price Rp6,250
Other liabilities 113.0 117.0 137.0 157.4 185.0 Market Cap. (Rpbn) 1,553
Total liabilities 572.3 494.9 445.7 382.7 329.2 Enterprise value (Rpbn) 3,497
No. of shares (mn) 248.4 248.4 248.4 248.4 248.4
Shareholders’ equity 728.5 735.4 771.1 824.8 881.7
EPS (US$) 0.32 0.04 0.12 0.23 0.28
Total Liabilities & Equity 1,300.8 1,230.3 1,216.8 1,207.5 1,210.9 EPS growth (%) 278.8 -88.5 226.8 85.5 23.5
EBITDA growth (%) 134.2 -49.7 8.4 31.3 11.5
PER (x) 2.2 19.2 5.9 3.2 2.6
DPS (Rp) 0.0 0.0 0.0 0.0 0.0
EV/EBITDA (x) 1.7 3.4 3.2 2.4 2.2
Dividend yield (%) 0.0 0.0 1.4 7.0 14.0

7
 BAHANA
Securities

PT Bahana Securities
Graha Niaga 18-20th Floor
Jl.Jend. Sudirman Kav 58
Jakarta 12190
Indonesia
Tel. (62-21) 250-5080

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