Indocement (INTP.IJ) TP20,500

CIO Notes
Summary of full-length report


Indonesian cement
Sector outlook - Overweight
Building up a storm
The cement sector is one of the best proxies to Indonesia’s consumption boom. Record levels of investment and FDI have propelled domestic cement sales to all-time highs. Rapid urbanisation and a rising middle class are driving housing demand. Passage of the Land Acquisition Bill and the public provision of infrastructure are icing on the cake. Market concerns on foreign firms disrupting the cosy market structure are premature. We are Overweight Indonesian cement producers and like Indocement, Holcim and Semen Gresik.

Proxy to domestic consumption boom
􀂉 The cement sector is one of the best proxies to ride the domestic consumption boom.
􀂉 Property development is fuelling a multiyear growth wave in cement consumption.
􀂉 Record levels of investment and FDI has also driven domestic cement sales.
􀂉 Given a tepid competitive environment, Indonesia’s top-three producers -
Indocement, Holcim and Semen Gresik - are best poised to capture demand growth.

Infrastructure - Icing on the cake
􀂉 Aggressive public investment will further boost cement consumption.
􀂉 Infrastructure reform can contribute 44 million tonnes of incremental demand over the next decade, tripling the size of the domestic market to 116 million tonnes by 2020.
􀂉 But a stronger regulatory framework is needed and passage of the Land Bill is key.
􀂉 Legislators are guiding for an October 2011 resolution.

Material barriers to entry
􀂉 Market concerns on the potential for foreign competitors to disrupt the cosy
Indonesian cement-market structure are premature.
􀂉 They face major barriers to entry such as acquiring land, accessing raw materials and
building distributions networks, while brand equity is also important in this market
􀂉 Risk of overcapacity is low and disproportionately reliant on Anhui Conch’s ability to
execute its intention to build 17 million tonnes (70% of pledged new foreign capacity).

Buying opportunity
􀂉 A laggard over the past 12 months, the sector is poised for a come back.
􀂉 Catalysts for the sector are record domestic sales continuing in seasonally stronger
2H11, margin expansion from falling commodity prices and growth in Java.
􀂉 Valuations are more attractive after the market correction. The sector is trading on
12x 12CL PE against a five-year average of 14x.
􀂉 Our top pick is Indocement as it has the most capacity, leverage to high-growth
Java markets and price leadership. We also like Holcim and Semen Gresik.

Proxy to domestic consumption boom
Indonesia is Asean’s largest cement market. Having grown in line with GDP over the past five years, the country’s appetite for cement has swelled to 15%, or more than two times GDP growth, in 2011. Following three consecutive months of record sales volume, Indonesian cement consumption exceeded expectations, reaching 27 million tonnes in 7M11. Annualised, this implies 46 million tonnes of domestic cement sales in 2011 (+13% YoY, against 6-8% producer guidance in 1H11).

Seasonality and public-infrastructure spending represent further volume upside in 2H11. Despite an annual dip during Ramadan (which would impact August sales this year), 2H historically accounts for 53% of fullyear consumption.

Demand is driven by private-sector spending, mostly for residential needs, due to rapid urbanisation and a rising middle class. Every year, four million people migrate to urban areas, driving demand for housing. Residential and commercial-property developments are fuelling a multiyear growth wave in cement consumption.
In the aftermath of the S&P downgrade of US treasuries, fears of a global growth slowdown have weighed on investors. Notably however Indonesia is very insulated and resilient in such a potential situation with two-thirds of GDP generated from domestic consumption.

Even looking back to 2008-09 during the last global financial crisis we can observe from domestic cement sales that there was very limited impact on the industry, highlighting its resilience.

Infrastructure - Icing on the cake
Indonesia is due for an infrastructure boom. As our economist Anthony Nafte points out, the country is on the brink of capacity limits (be it ports, airports,power or roads). This is forcing the government to step up the pace of infrastructure implementation, by improving upon its track record of fiscal inefficiency, and adopting a legislative definition of eminent domain. We believe cement producers offer the best optionality on infrastructure growth.

Capital expenditure by the government quadrupled between 2004 and 2010, to Rp82tn, and is budgeted to grow 65% in 2011 to Rp135.9tn (US$16bn). Assuming all budgeted funds are disbursed (optimistic given its perennial under-spending record), these figures still represent less than 2% of GDP. A key hurdle to infrastructure development remains the lack of a legislative mechanism for land clearing. Indonesia does not have a legal definition of eminent domain to secure land for public-interest projects. This could change, with parliament now deliberating a bill on land acquisition. Passage would provide a stronger regulatory framework which defines publicinterest projects (versus private interest), mandates the surrendering of land for the former, appoints a government body to implement the land-acquisition
process (BPN - National Land Agency) and outlines a process for compensating owners. A draft bill was submitted to parliament in February 2011. Legislators are guiding a decision by October 2011.

Passage of the Land Acquisition Bill will be a significant catalyst for cement stock prices. Given legislative setbacks, we believe this event has yet to be factored into share prices. Adoption of the Land Bill should drive greater upside.

Material barriers to entry
Domestic producers will be the key beneficiaries of rising demand. Operating in a concentrated industry, the nation’s top-three - Semen Gresik, Indocement and Holcim - supply 90% of the market. We believe concerns over the potential for foreign competitors to disrupt the cosy domestic cement-market structure are premature. While foreign players including Siam Cement, China Triumph and Anhui Conch have pledged in excess of US$4bn to construct 25 million tonnes of new capacity, there are major barriers to entry such as acquiring land, accessing raw materials and building distributions networks. Brand recognition is another major factor. The risk of overcapacity is low in our view and disproportionately reliant on Anhui Conch’s ability to execute its intention to build 17 million tonnes (roughly 70% of pledged new foreign capacity).

Buying opportunity
After lagging over the past 12 months, the sector is poised for a rebound with several catalysts on the horizon. Record demand, rising ASP and easing commodity prices bode well for earnings upside in 2H11. Passage of the Land Bill and resilient barriers to entry should drive a sector rerating.

Our top pick is Indocement as it has the most capacity, leverage to highgrowth
Java markets and price leadership. We also like Holcim and
Semen Gresik.

Indocement is our top pick in the sector
Indocement is our top pick in the sector. The company is best poised for earnings upgrades in 2H11 on the back of volume and margin upside. The company has the greatest exposure to West and Central Java, which have above-trend growth. It is the dominant supplier in these regions, where it enjoys up to 58% market share. It also has the most excess capacity to capture this growth. Furthermore, as the historical market price leader, Indocement may record the highest ASP rise among its peers.

Also BUY Holcim
Given a strong West Java and Jakarta franchise, we continue to like Holcim as a proxy to urbanisation and infrastructure development. Domestic sales rose 34% in 7M11and is on pace to grow by 25% through 2011. The company offers the highest 2010-12 earnings Cagr among its peers, at 24%.

Semen Gresik to Outperform
Following a period of capacity constraint, Semen Gresik is ushering in a brighter 2012, with five million tonnes of new capacity coming onstream in 1Q. This will raise total installed capacity to 25.2 million tonnes and ensure production growth through at least 2014. ASP hikes in July 2011 could also drive earnings upside in 2H11. However, we underweight Semen Gresik relative to peers. The share price has performed better than Indocement and Holcim over three and 12-month holding periods, suggesting less upside on a sector rerating.

source: CLSA dated 6 September 2011