Indocement (target price Rp20,750)

Dominating the Java Market

More upside from current levels. Recently, all eyes have turned to the cement sector, thanks to the passing Land Acquisition Bill (LAB) and continuing solid demand growth. Indocement’s share price has performed well, up by more than 5% in the past two weeks while the market only rose ~2%. We see more upside. We raise our TP to Rp20,750 and uphold our Buy rating. Coverage of the cement sector is transferred to Anthony Yunus from Lucky Ariesandi.

Dominating the Java market. Among cement producers, Indocement should be a key beneficiary of rising consumption in Greater Jakarta as well as West and Central Java. In 11M11, Indocement grabbed 42% of the Greater Jakarta market, 58% of West Java, and 44% of Central
Java. Java accounts for 71% of Indocement’s domestic sales volume. Given its 42-58% market share, Indocement is the dominant player in these regions. In addition, with capacity utilisation currently at 86%, Indocement is still able to capture a larger portion of demand in Java, the fastest growing cement market in Indonesia, from peers operating at full capacity.

Robust earnings quality. By utilising some of its excess capacity and expanding its grinding mill in Citereup, which will add 2m tonnes (+11% YoY) of capacity by 2012, Indocement will register ROA of over 20% in FY12F and a FY12-14F earnings CAGR of 16%. More efficient and environmentally-friendly operations through the use of alternative materials and fuels will help Indocement further strengthen its earnings quality.

Reiterate BUY. We raise our assumption of FY11F domestic cement consumption growth to 16% YoY from 11% previously. Overall, we lift our earnings forecasts by ~4% over FY11F-13F, and raise our TP to Rp20,750. At our TP, the stock would be trading at FY12F PER of 17.0x and EV/EBITDA of 11.7x.

A positive outlook on the passing of the LAB
Positive outlook on the passing of the LAB. On 16 December 2011, the Indonesian parliament passed the landmark Land Acquisition Bill (LAB). In our view, the passage of the Land Acquisition Bill is an important trigger for the cement market. It will not only remove the biggest roadblock to potential infrastructure spending, but also demonstrate the Indonesian government’s capability in instituting significant reforms to initiate an investment cycle.

The initial scheme… Initially, the government will choose the project location. Once the locations of the projects are decided, the government will handle the land acquisitions required and assign a team of independent appraisers to value the land. Once 75% of landowners agree to have their land acquired, the price will be set, and they will have to give up their land titles.

… and the following scheme. If there is any disagreement over pricing, the landowners can appeal to the provincial government, State Court and to the Supreme Court within a maximum time frame of 74 days, even during the land acquisition process. This will obviously give more certainty in terms of timing, which had been lacking previously.

The multiplier effect. In our view, the greatest benefit to Indocement is the multiplier effect from the implementation of this law, which will lead to better infrastructure and consumer spending growth, especially for housing. The direct impact will not be as much as the above-mentioned
multiplier effect, as most of the company’s revenue comes from bag/retail sales (~80%) rather than bulk sales to big projects such as toll road and property construction (~20%).

Dominating the Java market
Rising consumption in Java. Indonesia’s domestic cement consumption rose 18% YoY in 11M11, underpinned by surging demand from Java (+19% YoY). Java is Indonesia’s largest cement consuming province, accounting for 55% of total demand in 11M11. Over the same
period, cement consumption in Greater Jakarta, West Java, and Central Java grew at the fastest YoY rate in the country, at 28%, 21% and 21% respectively. Together, these regional markets account for 43% of the domestic cement market, and 78% of Java demand.

Robust market share. Among cement producers, Indocement would be a key beneficiary of rising cement consumption in Greater Jakarta, as well as West and Central Java. In 11M11, Indocement grabbed 42% of the Greater Jakarta market, 58% of West Java, and 44% of Central
Java. Java accounts for 71% of Indocement’s domestic sales volume. Given a 42-58% market share, Indocement is the dominant player in these regions.

Capturing demand. With 86% of its 18.6m-tonne capacity located in Java, Indocement is the biggest beneficiary of the region’s strong growth. Current utilisation of 80% ensures that Indocement has the needed capacity to capture a larger portion of growing demand and
push margin growth going forward. Its market dominance reinforces its strong brand, allowing Indocement to be at the forefront of customers’ minds for project developments in and around Java.

Robust earnings quality
Optimising capacity. By having some excess capacity and expanding its grinding mill in Citereup which will add 2m tonnes (+11% YoY) of capacity by the end of 2012, we expect Indocement to register FY12F ROA of over 20% and FY12-14F earnings CAGR of 16%. In addition, the company is exploring the possibility of building a full cement plant in two locations, each having capacity of 2.5m tons, with construction potentially starting in 2013-14.

Rising PCC sales may help guard profitability. Efficient operations resulted in increasing production of low-clinker cement outputs (Portland Composite Cement/PCC), saving energy and hence cost. Further use of alternative materials and fuels will help Indocement expand its profit margins. In turn, this should strengthen the company’s earnings quality, in our view.

Reiterate BUY. We raise our assumption of FY11F domestic cement consumption growth to 16% YoY from 11% previously. Overall, we lifted our earnings forecasts by ~4% in FY11F-13F and raise our TP to Rp20,750. At our TP, the company would be trading at FY12F PER of 17.0x and EV/EBITDA of 11.7x.

source: KIM ENG dated 11 January 2012