TOTL the Construction Sector’s Dark Horse Performer

We are re-instating coverage on TOTL with a BUY and IDR1,060TP
The company is currently trading at 17.7x and 13.4x 2012E & 2013E PER compared to the industry at 18.8x and 14.3x. We like TOTL’s operations for the following reasons: 1) robust order book growth on the back of loyal customer base, 2) direct contracting business model which delivers for the highest margin in the industry & excellent quality of receivables, 3) dual exposure to its price appreciation and high dividend yield, and 4) ownership of the strongest balance sheet in the industry with abundant cash on disposal on a zero financial leverage. TOTL is often overlooked due to its conservative operations, yet we think the dark horse deserves a re-rating for its consistently brawny performance.

Distinct business model due to strong reputation & bargaining power
The company manages to avoid exposure to raw material cost fluctuations and guarantees strong margins through a “direct contracting” business model. 75% of TOTL’s revenue is generated by satisfied customers which include well-known names such as Agung Podomoro, Panin Group, CT Corp, Ramayana Group and Lippo Group, among others. We expect project flows to continue its robust expansion at a steady 13%-14% CAGR for FY13-FY14.

Solid dividend play on the back of sturdy balance sheet
TOTL stunned the market late last year when the company announced a 120.2% payout rate for investors, a 16% dividend yield to the average FY11 market price. At our calculation, TOTL is expected to generate 3.7% – 4.1% dividend yield to the current share price between FY12-FY14, double the industry average at ~ 2.0%. TOTL’s strong dividend play is supported by a combination of zero leverage and abundant cash, which stands at ~40% of total assets.

Expansion into high-margin businesses
Refusing to sit on a pile of cash for mediocre growth, TOTL established Total Persada Development (TDP), which is currently building and developing a condotel project in Tanjung Benoa, Bali in conjunction with the Ramada hotel management chain. The company is also ventureng into high-margin, high growth EPC business through its newly-formed subsidiary PT Total Persada Industri (TPI).

Where we may be wrong
Our main concern is the company’s ability to execute non-construction projects and stiffer competition within the property (i.e. high rise buildings, commercial centers) constructions, wherelarge foreign contractors have recently entered the market.

Valuation and Target Price
We are re-instating coverage on TOTL with a BUY and IDR1,060 TP, an 18% to the current share price. As we roll over to FY13, we are basing this TP on target 15.0x PER over TOTL’s FY14 earnings, +1 standard deviation above its historical average forward PER. We continue to believe that the company would trade on the upper range on its precedent valuation for at least four reasons: 1) strong order book due to its solid reputation on timely delivery & quality work and loyal customer base, 2) direct contracting business model which contributes for higher margins and lower risk of bad debts, 3) market recognition upon its high dividend yield as a result of the company’s strong cash position, and 4) sector re-rating on the back of government’s push for investment upcycle.

Despite our industry view that infrastructure would be the main industry growth driver and TOTL’s bare minimum government-related projects, we really like TOTL for as it provides a reliable double exposure to capital gains and dividend yield – a rare gem among Indonesian construction play. TOTL is currently trading at 17.1x& 13.4x 2012E & 2013E PERs, at par with industry average at 18.8x & 14.3x.

Loyal customers deliver strong order book
Although TOTL has yet to participate within the government-driven infrastructure projects, the company is evidently the main destination for any Indonesian private sector projects. 75% of TOTL’s revenue is generated by satisfied customers which include well-known names such as Agung Podomoro (property developer), Panin Group (banking/commercial centers), CT Corp (banking/media), Ramayana Group (retail), and Lippo Group (property/healthcare/education).

As Indonesia’s economy is expected to grow by 6.3%-6.8% annually between FY12-FY14, we expect project flows to continue its robust expansion. Over the years, TOTL’s order book has grown by a steady 13%-14% CAGR. We see this trend to continue going into FY13-FY14 as the company has established a rock-solid customer base in the names of Indonesia’s largest conglomerations – a largely conservative estimate based on company’s guidance, especially considering a 24.8% expected increase in revenue booking this year.

Direct contract scheme guarantees strong margins and reduces risk of bad debts
In order to minimize tax avoidance and reduce incidences of revenue overstatements, the Indonesian government imposed a novel tax regulation in 2008 (PP no. 51/2008). The regulation requires construction companies to pay a fixed tax rate at 3% of their revenue bookings in a particular year. This also implies a higher effective income tax rate at ~40% of EBIT compared to ~30% pre-2008. The regulation did not only force Indonesian construction companies to incur lower net margins, it also forced companies to pay off taxes regardless whether they produced negative EBIT margins.

This regulation also meant that construction companies are especially fragile to the heightened risk of material cost increases, which makes up ~40% of total costs. To combat these risks and due to their stronger bargaining position with loyal customer base, TOTL introduced what they call a “direct contracting” scheme. Instead of covering for raw material purchases during the length of the projects, TOTL offered to open up relationships between their raw material suppliers and project owners for direct purchases.

Instead of building their margins on raw materials, TOTL charges project owners a form of “coordination fees” for these direct contracting projects. This situation helps to explain the company’s revenue declines between 2008-2009, as well as higher net margins compared to the industry. We are excited to learn about the management’s proven adaptability and clever move in facing difficult challenges, especially because this business model has also strengthened the company’s balance sheet by reducing aging receivables and collection period.

Exposure to capital gain and dividend plays
TOTL stunned the market late last year when the company announced a 120.2% payout rate for investors, a 16% dividend yield to the average full-year market price. The company recently announced a dividend policy of 50% payout rate for a minimum IDR200bn net income and 40% for anything below. At our calculation, TOTL is expected to generate 3.7% – 4.1% dividend yield to the current share price between FY12-FY14, double the industry average at ~ 2.0%.

The Strongest Balance Sheet in the Industry
TOTL’s strong dividend play is supported by a combination of zero leverage and abundant cash. The company shows a similar quality of aging receivables compared to State-Owned Enterprises, demonstrating its ability to deal solely with reputable clients, as well as optimizing asset utilization. The company also posts the highest ROAE and ROAA among all other firms in the industry. We see that TOTL’s cash pile definitely would give it an advantage to take up larger projects compared to financially weaker competitors, as well as ability for robust future expansion potential.

Expanding into infrastructure development
One of investors’ biggest worry regarding TOTL’s operations is its ability to grow beyond constructions. At present, the company is a pure play contractor specializing in commercial, high rise buildings, and industrial constructions. At present, around 92% of the company’s revenue is contributed by constructions, while the rest comes from rental of its office building space to third parties. In fact, the company’s choice to distribute high dividend payouts might have been undermined by its ability to grow (TOTL expects 13%-14% CAGR compared to the industry at ~20%).

Although on a limited scale, we are encouraged by the company’s move to establish subsidiary Total Persada Development (TDP), which is currently building and developing a condotel project in Tanjung Benoa, Bali in conjunction with the Ramada hotel management chain. We are also delighted to learn that the company has taken the necessary step to expend into high-margin, high growth EPC business through its newly-formed subsidiary PT Total Persada Industri (TPI). TPI is expected to start operating in FY13, although we have yet to estimate its revenue contribution into our model on the basis of uncertainties in future tender processes.

Where we may be wrong
Our main concern is the company’s ability to execute non-construction projects. We also realize stiffer competition within the property (i.e. high rise buildings, commercial centers) constructions, where medium-to-large foreign contractors have recently entered the market through joint ventures with Indonesian companies, such as PT. Tatamulia Nusantara Indah – a JV between India’s Tata and the Mulia Group.