Indonesia Constructions

Sector Outlook
We maintain an OVERWEIGHT call for the Constructions sector upon the following reasons: i) valuations are reasonable compared to regional players, ii) the government’s infrastructure projects are expected to accelerate earnings growth, iii) there are lower risks in executing projects, as laws will be enforced, iv) the property market’s outlook is solid for the next two years, and v) there is a conducive political and microeconomic environment. We expect contractors to register net profit growth of 20%-30% over the next two years.

Not too late to invest: re-rating on the back of reasonable valuation
Despite construction stocks moving upwards by more than 150% in 2012, it is not too late to invest as Indonesian companies’ valuations are modest compared to their growth potential. The sector is currently trading at 15.8x 2013f PER over a 33.3% total market EPS CAGR, which translates to 0.5x PE/G – the lowest among regional peers.

Sector re-rating are bound to happen as the sector should move to at least the 0.7x (at par with Thailand with similar growth). Our top picks are Wijaya Karya (WIKA) and Total Bangun Persada (TOTL). We are most excited about WIKA for its sturdy balance sheet, market liquidity, and largest domestic presence within the high-margin EPC sphere.

We forecast WIKA’s bottomline margin to increase by 24.3% CAGR in FY13f&FY14f, backed by strong EPC pick up (a USD70.4bn government endeavor) which would contribute to ~35% of its revenue. We also like TOTL, the largest private property play in the market. TOTL’s loyal customer base in the name of Indonesia’s largest conglomerates guarantees for solid order book & revenue growth, while its zero leverage & cash pile offer for excellent dividend payout quality. Meanwhile, port specialist PTPP commands a 40% winning rate for port projects, worth USD12.3bn over the next 15 years.

Strong revenue growth driven by heavy order book
We expect Indonesian contractors to see 20%-30% topline growth in Fy13-FY14 when the government increases its infrastructure spending, as the country is grossly underdeveloped. Allocations from the state budget are set to grow from 2.1% of GDP in 2012 to 3.1% and 2.9% of GDP in FY13&FY14 respectively.

There will also be public-private projects from the MP3EI, estimated at IDR486trn (USD52bn) for the next two years, 80% above the current projects’ value of IDR285trn (USD29bn). The average take-up rates for all types of properties have been recorded above 80% for the past few years, and thus guarantee strong growth in property construction for the next two years as well.

Ongoing momentum: getting executional risks under control in FY14
So far the market has been building in expectation on the basis of the 2012 Land Clearing Bill, which would reduce & fix the arduous infrastructure land acquisition process to a maximum of 1.5 years. Yet the actual impact of this revolutionary legislation has not yet been reflected on the companies’ earnings.

The Land Clearing Bill would be fully implemented in FY14 and has found a home base at the National Land Administration Bureau (BPN), a body that monitors the completion of this most critical process of infrastructure development. We foresee that the earnings boost for Constructions industry would really take off going into FY13-FY14.

Potential risks
For a sector mainly driven by government projects, risks may include: i) changes in government regulations especially as the 2014 presidential election nears, ii) financing ability and project IRR expectations as the government relies on public-private partnerships, and ii) thin trading liquidity.