Company Focus Gudang Garam

Bloomberg: GGRM IJ | Reuters: GGRM.JK Refer to important disclosures at the end of this report

DBS Group Research . Equity 17 Jan 2019 Finance L.P.

BUY Lighting up (Initiating Coverage)  The biggest beneficiary of the improvement in consumption Last Traded Price ( 16 Jan 2019): Rp84,300 (JCI : 6,413.4) power and absence of excise tax hike in FY19F Price Target 12-mth: Rp94,700 (12% upside)  Expect revenue and earnings to grow by 12%/33% in FY19F  Volume growth would be driven by SKM FF segment Potential Catalyst: No cigarettes excise tax hike in FY19F, improvement  Initiate with a BUY call; our preferred pick in the sector in consumption, and improvement in market share. Initiate coverage with a BUY call and TP of Rp94,700. We like Analyst GGRM as (i) a beneficiary of potential higher consumption power, David Arie Hartono +62 2130034936 [email protected] (ii) the absence of excise tax hike should improve its earnings in Price Relative FY19F, and (iii) its valuation looks attractive at 15.7x FY19F PE - Rp Relative Index with the strong improvement in profitability, working capital, and 91,005.0 market share; we believe that GGRM should continue to narrow its 209 81,005.0 189 valuation gap to HMSP (currently, the discount is at 45%). 71,005.0 169 Potentially higher demand for machine made full flavour cigarettes 61,005.0 149 129 (SKM FF) segment. In our view, the gradual improvement in 51,005.0 109 41,005.0 consumption purchasing power, especially in low to mid-level 89 31,005.0 69 income groups, would improve demand for higher tar cigarettes in Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 the SKM FF segment (which is more favored by the low to mid- Gudang Garam (LHS) Relative JCI (RHS) income groups) rather than SPM or SKM LTN (low tar nicotine)

Forecasts and Valuation which normally targets the mid to upper income groups. FY Dec (Rpbn) 2017A 2018F 2019F 2020F GGRM is the biggest beneficiary, in our view. We estimate Revenue 83,306 90,706 101,307 110,599 EBITDA 13,481 12,787 16,583 17,490 GGRM’s market share to improve to 26.9% in FY19F from 24.5% Pre-tax Profit 10,437 10,423 13,903 14,719 in FY17 – as we assume market share gains in the SKM FF Net Profit 7,754 7,744 10,329 10,936 segment. We prefer companies with more exposure and products Net Pft (Pre Ex.) 7,754 7,744 10,329 10,936 EPS (Rp) 4,030 4,025 5,368 5,684 in the mid- to low-income segment in 2019 and we believe GGRM EPS Pre Ex. (Rp) 4,030 4,025 5,368 5,684 will be in a good position to benefit due to its strong market share EPS Gth (%) 16 0 33 6 in the SKM FF segment. We expect GGRM's revenue and earnings EPS Gth Pre Ex (%) 16 0 33 6 to grow by 11.7%/33.4% in FY19F driven by SKM FF volume. Diluted EPS (Rp) 4,030 4,025 5,368 5,684 Net DPS (Rp) 2,600 2,418 2,415 3,221 Valuation: BV Per Share (Rp) 21,917 23,524 26,478 28,940 PE (X) 20.9 20.9 15.7 14.8 Our DCF-based TP of Rp94,700 for GGRM assumes a WACC of PE Pre Ex. (X) 20.9 20.9 15.7 14.8 10.3% and terminal growth of 4%. P/Cash Flow (X) 19.8 21.6 15.4 15.0 EV/EBITDA (X) 13.4 14.1 10.7 10.0 Key Risks to Our View: Net Div Yield (%) 3.1 2.9 2.9 3.8 Key downside risks are: (i) weaker-than-expected cigarette P/Book Value (X) 3.8 3.6 3.2 2.9 volume growth in FY19F, (ii) changes in excise tax, (iii) slower- Net Debt/Equity (X) 0.4 0.4 0.3 0.2 than-expected selling price increase, (iv) higher-than-expected ROAE (%) 19.0 17.7 21.5 20.5 capex for airport development, and (v) loss in market share. Consensus EPS (Rp): 4,313 4,911 5,446

Other Broker Recs: B: 25 S: 2 H: 1 At A Glance

Issued Capital (m shrs) 1,924 ICB Industry : Consumer Goods ICB Sector: Tobacco Mkt. Cap (Rpbn/US$m) 162,201 / 11,455 Principal Business: PT Gudang Garam Tbk is an Indonesian company Major Shareholders (%) engaged in the manufacturing of cigarettes. The company is a Suryaduta Investama (%) 69.3 leading manufacturer of kretek cigarettes (these clove-type of Suryamitra Kusuma (%) 6.3 cigarettes are a trademark of Indonesia). It produces a wide range Free Float (%) 24.4 of kretek ciga 3m Avg. Daily Val (US$m) 5.9 Source of all data on this page: Company, DBSVI, Bloomberg

ed: TH/ sa: MA, CW, CS

Company Focus Gudang Garam

Table of Contents

SWOT Analysis ...... 2

Investment Thesis ...... 3

Key Assumption ...... 5

Gudang Garam Products...... 6

Company Background ...... 7

Key Management Team ...... 8

Competitive Strengths ...... 9

Growth Strategies ...... 9

Key Risks ...... 9

Critical Data Points to Watch ...... 10

Income Statement ...... 13

Quarterly Income Statement ...... 14

Balance Sheet ...... 15

Cash Flow Statement ...... 16

Valuation ...... 17

Page 2

Company Focus Gudang Garam

SWOT Analysis

Strengths Weakness  Gudang Garam (GGRM) strongly dominates the SKM FF  Transactions related to its non-core business, such as segment, which keeps on winning back its market share in buying land for building an airport in from related Indonesia. parties could raise a corporate governance issue.  GGRM is the second largest player with significant pricing  Potential lower dividend payout ratio in FY19F. power.

Opportunities Threats  Upcoming Presidential Election, government aid, low  Unfavourable government policies on the cigarette excise inflation, reversal of oil prices, and no change in electricity tariff tax, promotion and advertising of the product, and public in FY19F should boost the private consumption and should space for smoking. benefit cigarette volume.  Unfavourable government policies that may decrease  No change in cigarette excise tax would be a great news as purchasing power. it means that the cigarette companies do not have to raise their retail prices.

Source: DBSVI

Page 3

Company Focus Gudang Garam

Investment Thesis

 Key catalyst: Potential high demand for SKM FF and  Estimate revenue to grow at 11.7%/9.2% in FY19F/20F. estimate a strong earnings improvement from stable excise As of 9M18, GGRM had posted an improvement in revenue tax. We think things should turn brighter this year for growth which was mostly driven by higher volume growth (as consumption, albeit at a gradual pace. There are a few we view that GGRM has taken some market share from peers favourable factors: (i) the upcoming presidential election, by not increasing ASP as high as peers). Going forward, we government aid, (ii) low inflation, (iii) reversal of oil prices, forecast GGRM to post 11.7% revenue growth in FY19F on and (iv) no change in electricity tariff. We believe that these the back of (i) better industry volume growth from higher factors will be positive for consumption trend across the affordability (as there is no excise tax hike), (ii) as we foresee consumer products. a better consumption power in low- to mid-income level, we see GGRM as the biggest beneficiary next year and thus In our view, the gradual improvement in consumption boost the volume growth in FY19F. We assume a 5.3%/4% purchasing power, especially in low- to mid-level income volume growth in FY19F/20F, driven mostly from SKM FF groups, would improve demand for higher tar cigarettes in segment. Meanwhile, we also assume ASP to increase by the SKM FF segment (which is more favoured by the low- to 6%/5% in FY19F/20F in the SKM segment and assume mid-income groups) rather than SPM or SKM LTN (low tar 5%/4% ASP hike in FY19F/20F in the SKT segment. nicotine) which normally targets the mid- to upper-income groups.  No excise tax = strong earnings improvement in FY19F. We estimate GGRM to post a strong earnings growth of The government's decision to not increase the excise tax in 33.4% y-o-y in FY19F – as there is no excise tax hike. Based FY19F will benefit the cigarette industry from (i) improvement on our calculation, every 10% hike in excise tax on SKM will in affordability which translate into potentially higher volume impact net earnings negatively by 35%. We estimate that growth, and (ii) improvement in the earnings for the cigarette every 10% hike in excise tax on SKT will impact net earnings company due to lower cost (as excise contributed 70% to the negatively by 6%. total cost of sales).  Strong fundamentals should offset the overhang on  Machine-made full-flavoured clove cigarettes (SKM FF) as airport. GGRM’s recent plan of land acquisition worth the winner, and GGRM will be the biggest beneficiary. As Rp850bn with a total area of 2.68m2 to construct an airport in GGRM’s product mix is still dominated by machine-made Kediri could pose a risk to (i) the dividend payout ratio, and (SKM) full-flavoured cigarettes, we believe the company is (ii) corporate governance issue. In our model, we assume well positioned to embrace the growing machine-made full- Rp8tr of airport capex through FY21F and also lower our flavoured segment; its well-received brand image among dividend payout ratio to 60% for FY19F. smokers should support its growth agenda. According to Nielsen, the industry’s machine-made (SKM) FF market share  Potential impact from index weighting adjustment. The had grown from 28% in 2012 to 34.9% in 2017. Indeed, adjustment in the free float to LQ45 and IDX30 indexes will GGRM saw an increase in its SKM FF volume contribution. potentially have an impact on GGRM weights, but it would be less severe than HMSP. Currently, GGRM is trading at GGRM revenue contribution (%) 15.7x FY19F PE which is comparable with the global tobacco 100% players and overall JCI.

95%

90%

85%

80%

75% 2009 2010 2011 2012 2013 2014 2015 2016 2017

Others Paperboard Klobot clove cigarettes Hand-rolled clove cigarettes ( SKT )

Machine-made clove cigarettes ( SKM ) Source: Company Nb. SKM revenue contribution consists of SKM FF revenue and SKM LTN revenue

Page 4

Company Focus Gudang Garam

Key assumption

GGRM volume (in bn stick) 2017 2018F 2019F 2020F SKT 8.6 8.7 8.8 8.9 SKM FF 61.7 65.4 70.0 73.5 SKM LTN 8.4 7.6 7.3 7.1

GGRM ASP (Rp/stick) 2017 2018F 2019F 2020F SKM ASP 1,067.0 1,120.4 1,187.6 1,247.0 SKT ASP 844.1 886.3 936.9 974.3 Excise tax (Rp/stick) - SKM 530.0 590.0 590.0 645.0 Excise tax (Rp/stick) - SKT 345.0 370.0 370.0 395.0

Source: Company, DBSVI estimate

LQ45 index weighting now and after changes (DBS forecast) Ticker Name Weight Shares Price Free Float % post LO45 BBCA IJ Equity Bank Central Asia Tbk PT 13.66 24,408.46 24,100.00 43.06 16.6% 2.99% HMSP IJ Equity Hanjaya Mandala Tbk PT 10.29 116,318.08 3,810.00 7.50 2.2% -8.11% BBRI IJ Equity Bank Rakyat Indonesia Persero Tbk PT 9.56 122,112.35 3,370.00 43.25 11.7% 2.14% TLKM IJ Equity Telekomunikasi Indonesia Persero Tbk PT 9.09 99,062.22 3,950.00 47.90 12.3% 3.23% BMRI IJ Equity Bank Mandiri Persero Tbk PT 7.89 46,200.00 7,350.00 39.99 8.9% 1.04% ASII IJ Equity Tbk PT 7.74 40,483.55 8,225.00 49.84 10.9% 3.17% UNVR IJ Equity Unilever Indonesia Tbk PT 7.48 7,630.00 42,200.00 15.01 3.2% -4.30% GGRM IJ Equity Gudang Garam Tbk PT 3.56 1,924.09 79,550.00 23.78 2.4% -1.16% BBNI IJ Equity Bank Negara Indonesia Persero Tbk PT 3.35 18,462.17 7,800.00 41.16 3.9% 0.55% UNTR IJ Equity United Tractors Tbk PT 2.94 3,730.14 33,975.00 40.46 3.4% 0.43% ELSA IJ Equity Elnusa Tbk PT 0.06 7,298.50 364.00 44.00 0.1% 0.02% Source: Bloomberg Finance LP., DBSVI estimate

IDX30 index weighting now and after changes (DBS forecast) Ticker Name Shares Price Free Float % Post IDX30 BBCA IJ Equity Bank Central Asia Tbk PT 24,408.46 24,100.00 43.06 17.5% 2.85% HMSP IJ Equity Hanjaya Mandala Sampoerna Tbk PT 116,318.08 3,810.00 7.50 2.3% -8.75% BBRI IJ Equity Bank Rakyat Indonesia Persero Tbk PT 122,112.35 3,370.00 43.25 12.3% 2.04% TLKM IJ Equity Telekomunikasi Indonesia Persero Tbk PT 99,062.22 3,950.00 47.90 13.0% 3.20% BMRI IJ Equity Bank Mandiri Persero Tbk PT 46,200.00 7,350.00 39.99 9.4% 0.92% ASII IJ Equity Astra International Tbk PT 40,483.55 8,225.00 49.84 11.5% 3.17% UNVR IJ Equity Unilever Indonesia Tbk PT 7,630.00 42,200.00 15.01 3.3% -4.69% GGRM IJ Equity Gudang Garam Tbk PT 1,924.09 79,550.00 23.78 2.5% -1.30% BBNI IJ Equity Bank Negara Indonesia Persero Tbk PT 18,462.17 7,800.00 41.16 4.1% 0.51% UNTR IJ Equity United Tractors Tbk PT 3,730.14 33,975.00 40.46 3.5% 0.39% Source: Bloomberg Finance LP., DBSVI estimate

Page 5

Company Focus Gudang Garam

Gudang Garam products

SKT Sigaret Kretek Tangan Gudang Garam Merah Gudang Garam Djaja Gudang Garam Gold Syahrini Taman Sriwedari Gudang Garam Special Deluxe Gudang Garam Tanda Mata Gudang Garam Halim Gudang Garam Halim Brown Gudang Garam Mini Filter Gudang Garam King Size Nusa

No 1 in SKM FF SKM FF Sigaret Kretek Mesin Full Flavor Gudang Garam International Surya Professional Surya Exclusive Surya 12 Premium Surya 12 Surya 16 Surya 20 Surya 50 Gudang Garam Signature Gudang Garam Signature Menthol Gudang Garam Menthol Gudang Garam Nusantara Gudang Garam Nusantara Menthol

Sampoerna A Mild is the leader SKM LT GG Mild GG Mild Shiver Surya Mild Surya Mild Menthol Surya Professional Mild Gudang Garam Deluxe Mild Gudang Garam Deluxe Menthol Gudang Garam Mild Deluxe Menthol Gudang Garam Signature Mild Gudang Garam Signature Mild Menthol Surya Slim Surya Slim Menthol Surya Slim White Source: Company

Page 6

Company Focus Gudang Garam

Company Background

 Corporate History. GGRM was initially founded by Surya cigarette market at the end of 2017. GGRM operates Wonowidjojo in Kediri, East in 1958. The company is a production facilities at two main sites, each with its own leading producer of Kretek cigarettes, the clove cigarettes primary and secondary kretek manufacturing operations. synonymous with Indonesia and the dominant cigarette GGRM produces a wide range of kretek cigarettes including category, drawing on its unique reputation as a major centre low tar nicotine variants, widely known as light and mild, as of the spice trade. Based on Nielsen market research, the well as traditional hand-rolled kretek. The well-known company had a market share of 21.4% of the domestic products include GG International, and GG Surya.

Sales Trend Profitability Trend Rp bn Rp bn 15,677 20.0% 100,000 18.0% 14,677 16.0% 13,677 80,000 14.0% 12,677 12.0% 60,000 11,677 10.0% 8.0% 10,677 40,000 6.0% 9,677 20,000 4.0% 8,677 2.0% 7,677 0 0.0% 2016A 2017A 2018F 2019F 2020F 6,677 2016A 2017A 2018F 2019F 2020F

Total Revenue Revenue Growth (%) (YoY) Operating EBIT Pre tax Profit Net Profit

Source: Company, DBSVI

Page 7

Company Focus Gudang Garam

Key Management Team

Name Pos ition Susilo Wonowidjojo President Director Mr Susilo Wonowidjojo was appointed as President Director in June 2009. Formerly served as Vice President Director since 1990 and before that as Director since 1976 with responsibilities for procurement of raw materials, flavours, inventory, and production management. He is related to Juni Setiawati Wonowidjojo, President Commisioner and is affiliated to the company's shareholders.

Heru Budiman Director Mr Heru Budiman was appointed as Director in 2000. He joined the company in 1990 with responsibility for Treasury and Investor Relations. His background includes senior management positions with International and Leading National Banks. He holds a Bachelor Degree in English from Satya Wacana University.

Herry Susianto Director Mr Herry Susianto was appointed as Director with responsibility for Finance in 2007. His previous position was internal audit head, a role he filled between 2002-2007. He holds a degree in Law from Airlangga University and Masters in Management from Gajayana University.

Buana Susilo Director Mr Buana Susilo was appointed Director in 2008 with responsibilyty in manufacturing technology. He draws upon extensive experience with the company in equipment design, process planning, and configuration. Previously, he served as Deputy Director since 1991 and in early 2000 was in charge of the greenfield construction and development on the second manufacturing facility at Gempol.

Istata Taswin Siddharta Director Mr Istata Taswin Siddharta was appointed as Director in 2012 with major responsibility for Information Technology. He joined the company in 2008 and served as Deputy Marketing Director from 2008-2010. He formerly served as Partner of KPMG Indonesia and has extensive experience as a public accountant for 20 years. He holds a Bachelor's Degree in Accounting from University of Indonesia.

Sony Sasono Rahmadi Independent Director Mr Sony Sasono Rahmadi was appointed as Independent Director In 2012. From 2008-2012, he served as Director at PT Cipta Kretek Nusantara and PT Karyadibya Mahardika. He holds a Bachelor's Degree in Chemical Engineering from The Institute of Technology, Sepuluh Nopember.

Lengga Nurullah Director Ms Lengga Nurullah was appointed as Director in 2015 with responsibility for SKM production at Kediri. Formerly served as Deputy Director for production at Gempol 2015-2015. She joined the company in 2012 and previously worked in automotive manufacturing with Bosch in Germany. She graduated from Technical University of Berlin.

Source: Company

Page 8

Company Focus Gudang Garam

Competitive Strengths

 Potentially higher demand in SKM FF segment. While we category, which has and will continue to attract new assume a recovery in domestic volume growth in FY19F on competitors seeking a share of Indonesia’s substantial market the back of, (i) higher consumer purchasing power during the potential. upcoming Presidential Election which may improve consumption in rural areas, and (ii) potential low price  Another factor that supports cigarette consumption in adjustments in FY19F in the absence of an excise tax hike, Indonesia is that citizens have easy access to cigarettes, not which could improve affordability. In our view, the gradual just because of the wide distribution network that makes improvement in consumption purchasing power, especially in cigarettes available in all corners of the archipelago but also low- to mid-level income groups, would improve demand for because of the relatively low price that is charged for a higher-tar cigarettes in the SKM FF segment (which is more package of cigarettes. Nowhere on earth is a pack of favoured by the low- to mid-income groups) rather than SPM cigarettes as cheap as in Indonesia. On average, a pack costs or SKM LTN (low tar nicotine) which normally targets the US$1.3 a piece in Indonesia. mid- to upper-income groups. Key Risks  …theoretically, the Presidential Election will drive cigarette volume, especially for SKM FF, in FY19F. We see the  Thoughts that the Indonesia government will increase possibility of higher consumption spending in rural areas the excise tax again in FY20F. This year, Indonesia's before the Presidential Election, especially on SKM FF government confirmed that they will not increase the excise products. Looking back at the last Presidential Election in tax on cigarettes in 2019. As a result, it should give some 2014, SKM FF volume increased significantly compared to fresh air to the cigarette industry and we estimate that the other product segments. In our view, this was due to: industry volume could improve in FY19F. This potentially - Indonesians’ preference for kretek (clove) cigarettes, disrupts the revenue from excise tax for next year as the especially SKM FF or hand-rolled cigarettes (SKT). government had previously decided to increase APBN 2019 - Pricing of kretek cigarettes is cheaper vs white cigarettes tobacco excise tax for 2019F by 7.15% to Rp158.8tr (2018F: due to lower excise tax. Rp148.2tr). The government has also decided to delay the - Kretek cigarettes have higher tar vs white cigarettes, simplification. With the current simplification, mid to low resulting in longer smoking time. cigarette manufacturers will remain to fight against bigger players. As of October 2018, excise tax reached Rp106tr  Strong market share in full-flavoured (FF) cigarettes. (+9.8% y-o-y) with 95% coming from tobacco excise tax. We GGRM mostly produces machine-made cigarettes (SKM) full see a potentially higher excise tax in FY20F post the flat excise flavoured (FF) cigarettes which contributed to around 78% of in FY19F; as the government still requires to collect tax from the company’s sales volume in 2017. Through its key brands, the cigarette industry and it would have an impact on the (i) Surya 16 and GG international – GGRM is the market leader cigarette industry volume which is likely to decline in FY20F, in the SKM FF segment (c. 18% market share in the industry). and (ii) lower earnings growth from the cigarette players in Overall, GGRM has a 24.5% market share in the industry as FY20F. of 2017.  Sensitivity analysis on excise tax to GGRM earnings. Growth Strategies Based on our calculation, every 10% hike in excise tax on SKM will impact net earnings negatively by 35%. We  Consistent product quality and relentless efforts in estimate that every 10% hike in excise tax on SKT will impact marketing and distribution would play a vital part in net earnings negatively by 6%. contributing to both volume and revenue growth for GGRM. The consistency of product quality would enable the  Airport investment at Kediri airport remains at risk. company’s products to sustain market presence. GGRM’s recent plan of land acquisition worth Rp850bn with 2 a total area of 2.68m to construct an airport in Kediri could  Aggressive advertising and promotion. GGRM’s pose a risk to the dividend payout ratio, in our view. We see advertising and promotion programmes continued to build dividend payout ratio being downgraded to 60% in FY19F (vs and maintain brand presence in a hotly contested consumer more than 75% in the past).

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Company Focus Gudang Garam

CRITICAL DATA POINTS TO WATCH SKM FF Volume

73.5 74.2 70 Critical Factors 65.4 61.7 63.6 58.7 Cigarette excise tax. The most negative impact is from the Indonesian 53.0 government’s tendency to raise excise tax rates on tobacco products 42.4 at the start of the year. This is to collect tax revenue as well as to 31.8 discourage the consumption of cigarettes (the higher excise should 21.2 lead to higher retail prices). The higher excise tax could lead to a 10.6 higher retail price of cigarettes which would result in a soft cigarette 0.0 2016A 2017A 2018F 2019F 2020F industry volume growth.

SKM LTN Volume Indonesia consumer purchasing power. In the past, regional 9.9 minimum wage (UMR) growth outpaced excise tax growth, leading 10.1 8.4 to better volume growth of the cigarette industry, due to the two 8.1 7.56 7.26 7.11 main reasons: - Most smokers in Indonesia are in the low- to mid-income 6.1

groups, which are more sensitive towards selling price 4.0 movements. - Higher UMR growth enables the low- to mid-income groups 2.0

to have higher disposable income. 0.0 2016A 2017A 2018F 2019F 2020F

However, the situation has changed in the past three years. Excise tax SKT Volume growth has outpaced UMR growth, resulting in a softening of 8.79 8.88 purchasing power in the low- to mid-income groups. This has caused 9.06 8.46 8.62 8.71 cigarette volume to decline to single-digit growth. 7.25

ASP increase to maintain the margin. Normally, in the event of higher 5.43 excise tax; the cigarette companies will increase their ASPs to pass on 3.62 the higher excise. The slower-than-expected of the company to pass on the ASP will have an impact on its gross profit margin. 1.81

0.00 2016A 2017A 2018F 2019F 2020F SKM Excise

821 829.3 758 761 680 663.4 615

497.6

331.7

165.9

0.0 2016A 2017A 2018F 2019F 2020F

SKT Excise

552 557.2 522 524 494

445.8 420

334.3

222.9

111.4

0.0 2016A 2017A 2018F 2019F 2020F

Source: Company, DBSVI

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Company Focus Gudang Garam

Balance Sheet: Leverage & Asset Turnover (x) ROE is on the rise. In 2017, GGRM recorded an ROE of 19% and we 1.5 0.50 estimate the ROE in FY18F to be at 17.7% on the back of lower 1.5 0.40 earnings assumption in FY18F – as the industry volume remained 1.4 quite soft in FY18F which resulted in a softer growth in volume and 0.30 1.4 inability to increase the ASP higher. Meanwhile, we estimate an 0.20 increase of ROE in FY19F to 21.5% on the back of strong 1.3 improvement in earnings as the excise tax will be flat in FY19F. 0.10 1.3 Airport investment could have an impact on lower dividend, in our 0.00 1.2 view. The recent plan from GGRM to build the airport in Kediri and 2016A 2017A 2018F 2019F 2020F with the cost of construction potentially reaching between Rp8-10tr Gross Debt to Equity (LHS) Asset Turnover (RHS) over 3-5 years' time horizons would have an impact on lowering the Capital Expenditure company's dividend payout ratio (DPR). We forecast a DPR of 60% in Rp bn 3,500.0 FY19F from above 75% in the past. 3,000.0

2,500.0

Share Price Drivers: 2,000.0

No excise tax in FY19F. After three years of negative growth in the 1,500.0

Indonesia cigarette volume; we expect a better volume growth this 1,000.0 year as there will be no changes in excise tax in FY19F which should 500.0 translate into an improvement in the volume growth due to better 0.0 affordability. 2016A 2017A 2018F 2019F 2020F Capital Expenditure (-)

Key Risks: ROE (%)

Excise tax hike. A higher-than-expected excise tax hike may affect (i) 20.0% the industry volume, and (ii) the company’s earnings going forward; especially if coupled with a weak economic environment. 15.0% Regulatory issues. The regulatory issues may include (i) packaging requirements, and (ii) advertisement bans. 10.0% Raw material prices. The biggest raw materials are (i) tobacco, and (ii) cloves which are sourced locally. The price movement of both raw 5.0% materials could pose an impact to the company’s GPM. Note that the 0.0% impact would be minimal and has some lag time given that the 2016A 2017A 2018F 2019F 2020F cigarette companies have ample inventories to provide buffer against immediate impact on swings in raw material prices. Forward PE Band (x) (x) Shift in consumer preference. As Indonesia's cigarette industry is 17.0 dominated by kretek-based products, if the consumer preference 15.0 changes, it would be detrimental to the current product portfolio. +2sd: 20x Healthier lifestyle. As people are moving towards a healthier lifestyle, 13.0 +1sd: 17x we think that more people would reduce their smoking habit, thus 11.0 Avg: 9.5x leaving the industry at a sunset stage. 9.0

-1sd: 10.9x 7.0

Company Background -2sd: 7.8x 5.0 PT Gudang Garam Tbk is an Indonesian company engaged in the Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 manufacture of cigarettes. The company is a leading manufacturer of kretek cigarettes (these clove-type cigarettes are a trademark of PB Band (x) (x) Indonesia). It produces a wide range of kretek cigarettes including 3.7 low-tar, low-nicotine variants, and traditional hand-rolled kretek, which are distributed domestically and worldwide. The company 3.2 +2sd: 20x markets its products under the Gudang Garam family, Surya family, 2.7 +1sd: 17x and GG family brand names. The company was formerly known as 2.2 Avg: 1.84x PT Perusahaan Rokok Tjap "Gudang Garam" Kediri. PT Gudang 1.7 Garam Tbk was founded in 1958 and is headquartered in Kediri, -1sd: 10.9x 1.2 Indonesia. PT Gudang Garam Tbk is a subsidiary of PT Suryaduta -2sd: 7.8x 0.7 Investama. Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Source: Company, DBSVI

Page 11

Company Focus Gudang Garam

Segmental Breakdown

FY Dec 2017A 2018F 2019F 2020F

Revenues (Rpbn)

Machine-made clove cigarettes ( SKM ) 74,853 81,745 91,728 100,496 Hand-rolled clove cigarettes ( SKT ) 7,276 7,716 8,237 8,652

Klobot clove cigarettes 36.0 36.0 35.0 35.0 Paperboard 990 1,089 1,198 1,318 Others 151 121 109 98.0

Total 83,306 90,706 101,307 110,599 Revenue (Rpbn)

Machine-made clove cigarettes ( SKM ) 74,853 81,745 91,728 100,496

Hand-rolled clove cigarettes ( SKT ) 7,276 7,716 8,237 8,652 Klobot clove cigarettes 36.0 36.0 35.0 35.0

Paperboard 990 1,089 1,198 1,318 Others 151 121 109 98.0

Total 83,306 90,706 101,307 110,599

Source: Company, DBSVI

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Company Focus Gudang Garam

Income Statement (Rpbn) Margins Trend FY Dec 2015A 2016A 2017A 2018F 2019F 2020F 16.0% 15.0% Revenue 70,366 76,274 83,306 90,706 101,307 110,599 14.0% Cost of Goods Sold (54,880) (59,657) (65,084) (72,388) (78,670) (86,663) 13.0% Gross Profit 15,486 16,617 18,222 18,319 22,636 23,936 12.0% 11.0% Other Opng (Exp)/Inc (5,493) (6,497) (6,970) (7,072) (7,704) (8,187) 10.0% Operating Profit 9,993 10,120 11,252 11,247 14,933 15,749 9.0% Other Non Opg (Exp)/Inc 72.0 2.00 (15.0) 0.0 0.0 0.0 8.0% 2016A 2017A 2018F 2019F 2020F Associates & JV Inc 0.0 0.0 0.0 0.0 0.0 0.0 Operating Margin % Net Income Margin % Net Interest (Exp)/Inc (1,430) (1,191) (801) (824) (1,030) (1,030) Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0 0.0

Pre-tax Profit 8,635 8,931 10,437 10,423 13,903 14,719 Tax (2,182) (2,258) (2,681) (2,678) (3,572) (3,781) Minority Interest (17.0) 4.00 (2.0) (2.0) (2.0) (2.0) Preference Dividend 0.0 0.0 0.0 0.0 0.0 0.0 Net Profit 6,436 6,677 7,754 7,744 10,329 10,936 Net Profit before Except. 6,436 6,677 7,754 7,744 10,329 10,936 EBITDA 11,812 12,208 13,481 12,787 16,583 17,490 Growth Revenue Gth (%) 7.9 8.4 9.2 8.9 11.7 9.2 EBITDA Gth (%) 16.7 3.3 10.4 (5.1) 29.7 5.5 Opg Profit Gth (%) 16.1 1.3 11.2 0.0 32.8 5.5 Net Profit Gth (Pre-ex) 19.1 3.8 16.1 (0.1) 33.4 5.9 (%) Margins & Ratio Gross Margins (%) 22.0 21.8 21.9 20.2 22.3 21.6 Opg Profit Margin (%) 14.2 13.3 13.5 12.4 14.7 14.2 Net Profit Margin (%) 9.1 8.8 9.3 8.5 10.2 9.9 ROAE (%) 18.2 17.3 19.0 17.7 21.5 20.5 ROA (%) 10.6 10.6 12.0 11.3 14.2 14.0 ROCE (%) 8.9 9.1 11.1 10.4 13.2 13.1 Div Payout Ratio (%) 77.7 74.9 64.5 60.1 45.0 56.7 Net Interest Cover (x) 7.0 8.5 14.1 13.6 14.5 15.3

Source: Company, DBSVI

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Quarterly / Interim Income Statement (Rpbn) Revenue Trend 30,000 7% FY Dec 2Q2017 3Q2017 4Q2017 1Q2018 2Q2018 3Q2018 6% 25,000 5% Revenue 20,275 21,278 21,783 21,981 23,324 24,584 20,000 4%

Cost of Goods Sold (16,246) (16,586) (16,680) (17,568) (18,748) (19,863) 15,000 3%

2% Gross Profit 4,029 4,692 5,103 4,413 4,576 4,722 10,000 1% Other Oper. (Exp)/Inc (2,216) (1,411) (1,719) (1,690) (2,289) (1,548) 5,000 0%

Operating Profit 1,813 3,281 3,384 2,723 2,286 3,173 0 -1%

2Q2017 3Q2017 4Q2017 1Q2018 2Q2018 3Q2018 3Q2016 4Q2016 1Q2017 Other Non Opg (Exp)/Inc 0.0 0.0 0.0 0.0 0.0 0.0 2Q2016

Revenue Revenue Growth % (QoQ) Associates & JV Inc 0.0 0.0 0.0 0.0 0.0 0.0 Net Interest (Exp)/Inc (130) (216) (222) (195) (101) (180) Exceptional Gain/(Loss) (4.0) (4.0) 0.0 3.00 33.0 18.0

Pre-tax Profit 1,679 3,061 3,162 2,531 2,219 3,011 Tax (444) (766) (826) (638) (555) (805) Minority Interest 0.0 (1.0) 0.0 0.0 2.00 (3.0) Net Profit 1,235 2,293 2,336 1,893 1,665 2,203 Net profit bef Except. 1,239 2,297 2,336 1,890 1,632 2,185 EBITDA 2,346 3,833 4,019 3,260 2,831 3,723

Growth Revenue Gth (%) 1.5 4.9 2.4 0.9 6.1 5.4 EBITDA Gth (%) (28.9) 63.4 4.8 (18.9) (13.1) 31.5 Opg Profit Gth (%) (34.6) 81.0 3.2 (19.6) (16.0) 38.8 Net Profit Gth (Pre-ex) (34.6) 85.4 1.7 (19.1) (13.6) 33.9 (%) Margins Gross Margins (%) 19.9 22.0 23.4 20.1 19.6 19.2 Opg Profit Margins (%) 8.9 15.4 15.5 12.4 9.8 12.9 Net Profit Margins (%) 6.1 10.8 10.7 8.6 7.1 9.0

Source: Company, DBSVI

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Balance Sheet (Rpbn) Asset Breakdown FY Dec 2015A 2016A 2017A 2018F 2019F 2020F Net Fixed Debtors - Assets - 3.5% 34.1% Net Fixed Assets 20,106 20,499 21,409 22,868 23,718 23,977 Invts in Associates & JVs 0.0 0.0 0.0 0.0 0.0 0.0 Other LT Assets 830 520 1,587 1,587 1,587 1,587 Assocs'/JVs - Cash & ST Invts 2,726 1,595 2,329 2,179 5,565 8,162 0.0% Inventory 37,256 37,545 37,920 39,664 40,952 42,738

Debtors 1,568 2,090 2,229 2,351 2,626 2,867 Bank, Cash Inventory - and Liquid Other Current Assets 1,019 703 1,286 1,286 1,286 1,286 59.1% Assets - 3.2% Total Assets 63,505 62,952 66,760 69,936 75,733 80,617

ST Debt 20,561 19,753 20,600 20,600 20,600 20,600

Creditor 2,559 1,118 1,214 1,297 1,409 1,552

Other Current Liab 925 767 797 797 797 797 LT Debt 0.0 0.0 0.0 0.0 0.0 0.0 Other LT Liabilities 1,452 1,749 1,961 1,961 1,961 1,961 Shareholder’s Equity 37,900 39,487 42,171 45,263 50,946 55,684 Minority Interests 108 77.0 17.0 18.0 20.0 22.0

Total Cap. & Liab. 63,505 62,952 66,760 69,936 75,733 80,617

Non-Cash Wkg. Capital 36,359 38,453 39,424 41,208 42,657 44,541 Net Cash/(Debt) (17,835) (18,158) (18,271) (18,421) (15,035) (12,438) Debtors Turn (avg days) 8.0 8.8 9.5 9.2 9.0 9.1 Creditors Turn (avg days) 12.2 11.7 6.8 6.5 6.4 6.4 Inventory Turn (avg days) 247.3 237.1 219.2 199.9 191.0 179.9

Asset Turnover (x) 1.2 1.2 1.3 1.3 1.4 1.4 Current Ratio (x) 1.8 1.9 1.9 2.0 2.2 2.4 Quick Ratio (x) 0.2 0.2 0.2 0.2 0.4 0.5 Net Debt/Equity (X) 0.5 0.5 0.4 0.4 0.3 0.2 Net Debt/Equity ex MI (X) 0.5 0.5 0.4 0.4 0.3 0.2 Capex to Debt (%) 14.1 11.3 15.7 14.6 12.1 9.7

Source: Company, DBSVI

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Cash Flow Statement (Rpbn) Capital Expenditure FY Dec 2015A 2016A 2017A 2018F 2019F 2020F Rp bn 3,500.0 Pre-Tax Profit 8,635 8,931 10,437 10,423 13,903 14,719 3,000.0 Dep. & Amort. 1,748 2,086 2,244 1,540 1,650 1,740 2,500.0 2,000.0 Tax Paid (2,182) (2,258) (2,681) (2,678) (3,572) (3,781) 1,500.0

Assoc. & JV Inc/(loss) 0.0 0.0 0.0 0.0 0.0 0.0 1,000.0

Chg in Wkg.Cap. (5,440) (1,847) (970) (1,783) (1,450) (1,884) 500.0 Other Operating CF 440 26.0 (824) 0.0 0.0 0.0 0.0 2016A 2017A 2018F 2019F 2020F Net Operating CF 3,201 6,938 8,205 7,502 10,532 10,794 Capital Expenditure (-) Capital Exp.(net) (2,900) (2,226) (3,240) (3,000) (2,500) (2,000) Other Invts.(net) 0.0 0.0 0.0 0.0 0.0 0.0

Invts in Assoc. & JV 0.0 0.0 0.0 0.0 0.0 0.0 Div from Assoc & JV 0.0 0.0 0.0 0.0 0.0 0.0

Other Investing CF 0.0 0.0 0.0 0.0 0.0 0.0

Net Investing CF (2,900) (2,226) (3,240) (3,000) (2,500) (2,000) Div Paid (1,568) (5,024) (5,003) (4,652) (4,646) (6,198) Chg in Gross Debt 2,414 (808) 847 0.0 0.0 0.0

Capital Issues 0.0 0.0 0.0 0.0 0.0 0.0 Other Financing CF 331 1,456 676 0.0 0.0 0.0

Net Financing CF 1,177 (4,377) (3,480) (4,652) (4,646) (6,198) Currency Adjustments 8.00 (5.0) 3.00 0.0 0.0 0.0 Chg in Cash 1,486 330 1,487 (150) 3,386 2,597 Opg CFPS (Rp) 4,491 4,565 4,768 4,826 6,227 6,589 Free CFPS (Rp) 156 2,449 2,580 2,340 4,174 4,571

Source: Company, DBSVI

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Valuation

 Initiating coverage: BUY, TP of Rp94,700. Our DCF- a better outlook for Indonesia's cigarette sector and expect based TP of Rp94,700 for GGRM assumes a WACC of GGRM to be the main beneficiary from (i) big SKM FF 10.3% and terminal growth (TG) of 4%, with cash flow market share which would improve the volume growth, and discounted back to FY25F. To arrive at our WACC of 10.3%, (ii) strong earnings improvement on the back of a flat excise we assume a risk-free rate of 8.03%, market risk premium tax. of 5%, and equity beta of 1.03x. Our TP implies 17.7x FY19F PE which is slightly above its historical 5-year mean. Currently, the stock is trading at 15.7x FY19F PE. As we see

GGRM forward PE band (x)

25.0

+2 stdev 20.0 +1 stdev

Average

15.0 -1 stdev

-2 stdev

10.0 15 16 17 18

Source: Bloomberg Finance LP (Data as of 31 December 2018)

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DBSVI recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends

Completed Date: 17 Jan 2019 07:11:24 (WIB) Dissemination Date: 17 Jan 2019 15:19:29 (WIB)

Sources for all charts and tables are DBSVI unless otherwise specified.

GENERAL DISCLOSURE/DISCLAIMER This report is prepared by PT DBS Vickers Sekuritas Indonesia (''DBSVI''). This report is solely intended for the clients of DBS Bank Ltd, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of PT DBS Vickers Sekuritas Indonesia (''DBSVI'').

The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”) have not conducted due diligence on any of the companies, verified any information or sources or taken into account any other factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we do not make any representation or warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group, may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies.

Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may not contain all material information concerning the company (or companies) referred to in this report and the DBS Group is under no obligation to update the information in this report.

This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer.

The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that:

(a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and (b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein.

Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets.

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Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report.

DBSVUSA, a US-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making.

ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s) primarily responsible for the content of this research report, in part or in whole, certifies that he or his associate1 does not serve as an officer of the issuer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the management of the issuer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or his associate does not have financial interests2 in relation to an issuer or a new listing applicant that the analyst reviews. DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately. There is no direct link of DBS Group's compensation to any specific investment banking function of the DBS Group.

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Compensation for investment banking services: 3. DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively.

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1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst. 2 Financial interest is defined as interests that are commonly known financial interest, such as investment in the securities in respect of an issuer or a new listing applicant, or financial accommodation arrangement between the issuer or the new listing applicant and the firm or analysis. This term does not include commercial lending conducted at arm's length, or investments in any collective investment scheme other than an issuer or new listing applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new listing applicant.

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Thailand This report is being distributed in Thailand by DBS Vickers Securities (Thailand) Co Ltd.

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DBS Regional Research Offices

HONG KONG MALAYSIA SINGAPORE DBS (Hong Kong) Ltd AllianceDBS Research Sdn Bhd DBS Bank Ltd Contact: Carol Wu Contact: Wong Ming Tek (128540 U) Contact: Janice Chua 11th Floor The Center 19th Floor, Menara Multi-Purpose, 12 Marina Boulevard, 99 Queen’s Road Central Capital Square, Marina Bay Financial Centre Tower 3 Central, Hong Kong 8 Jalan Munshi Abdullah 50100 Singapore 018982 Tel: 852 3668 4181 Kuala Lumpur, Malaysia. Tel: 65 6878 8888 Fax: 852 2521 1812 Tel.: 603 2604 3333 Fax: 65 65353 418 e-mail: [email protected] Fax: 603 2604 3921 e-mail: [email protected] e-mail: [email protected] Company Regn. No. 196800306E

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