Voksel Electric Cabling the Country

We initiate coverage on Voksel Electric (VOKS) with a BUY and IDR2,400 TP – a 65% upside to the current price. VOKS is the undisputed leader in the manufacturing of high-medium voltage aluminum and fiber optic cables. As a major supplier to PLN and TLKM, it is the main beneficiary of Government megaprojects in power and telco, offering 22% net profit CAGR for FY11-FY15F and 25% ROAE in 1Q13. It currently trades at 7.2x/6.1x FY13/FY14F P/E – a 55%-65% discount to other infrastructure proxies.

Direct beneficiary to aggressive power & telco spending, a USD4.5bn opportunity
We prefer VOKS compared to other listed cable companies due to its dominance over PLN’s and TLKM’s cable demand, thus making it a direct beneficiary to the Government’s aggressive infrastructure spending. 50% of its total FY12 revenue came from Government projects – 40% from state power company PT Perusahaan Listrik Negara (PLN) and 10% was from state telecommunications company PT Telekomunikasi Indonesia Persero (TLKM, Neutral, TP: IDR10,600). PLN plans to disburse an aggressive USD29bn between now and 2021 for electricity transmission and distribution development, of which ~15% (i.e. USD 4.5bn) is allocated for cable procurement, an industry in which VOKS is a market leader.

22% net profit CAGR with the highest net margins in the industry
The project-based nature and visibility of PLN’s and TLKM’s orders ensure a higher conviction of the cable company’s 22% net profits CAGR for FY11-FY15F – a huge competitive advantage compared to other manufacturers, which are at the mercy of a crowded business-to-consumer (B2C) ‘free-market’, squeezed margins on low-voltage copper cable sales and uncertain demand. Due to its customer profile and dominance over high-margin high-medium voltage & fiber optic cables manufacturing, VOKS maintains the highest net margins in the industry, at ~ 5.7%.

55%-65% discount to other infrastructure proxies
We recommend a BUY on VOKS, with a TP of IDR2,400 – implying a 12.0x FY13 P/E. The counter is currently trading at 7.2x FY13F P/E and 6.1x FY14F P/E – a 55%-65% discount to the Construction and Cement sector average.

Valuation and Target Price (TP)
We are initiating coverage on VOKS with a BUY and IDR2,400 TP – a 60% upside to the current share price. We are basing this TP on 12.0x target P/E over the company’s FY13F earnings – which is at 25% and 40% discount to the daily rolling forward P/E of the Cement and Construction sector respectively – and consistent with the company’s relative valuation to the sector prior to the sector’s re-rating. We continue to believe that a discount is justifiable due to the company’s currently thin liquidity and small market capitalization.

However, we believe VOKS also deserves the re-rating enjoyed by Construction companies and that the widening premium with Cement sector should be narrowed – considering that they are all direct proxies and beneficiaries to the booming infrastructure and property developments. We reckon VOKS should deliver a minimum of 20% net profit CAGR for FY11-FY15F.

We further think that the company deserves a re-rating as it possesses: i) solid balance sheet with a consistent net cash position to fuel its expansion plans, and ii) robust and foreseeable pipeline due to stable winning rates for projects from state power company PLN and state telecommunication company TLKM. The stock has been largely overlooked as it has been dormant since Indonesia’s last infrastructure boom pre the 1997 Asian Financial Crisis. VOKS is currently trading at 7.2x and 6.1x FY13F and FY14F P/E respectively – a 55%-65% discount to other infrastructure proxies in Constructions and Cement. BUY.

Investment thesis summary
We believe VOKS deserves a re-rating enjoyed by other infrastructure proxies for the following reasons:
Direct beneficiary of power and telco infrastructure boom. VOKS is undisputedly the supply leader for both PLN and TLKM, generating 60%-70% of its revenue from the duo. It commands ~70% winning rate to all PLN cable tenders. Due to its dominance on high margin products such as high-medium voltage and fiber optic cables, VOKS commands the highest profits in the industry – 25.4% ROAE, 5.7% net margins.

Conviction for 22% net profits CAGR between FY11-FY15F. VOKS’ projects-based business model, particularly its tender deals with PLN and TKLM, gives it certainty – estimated at 22% net profits CAGR between F11 and FY15F. In contrast, the earnings of other players such as SSCO are less visible given that they generally do not operate on a project-based model, ie independent cable distributors order their products on a monthly basis based on demand from their respective clients.

Cheap valuation at 55%-65% discount to other infrastructure proxies. We recommend a BUY on VOKS with a IDR2,400 TP – implying a 12.0x FY13 P/E. VOKS is currently trading at 7.2x and 6.1x FY13F and FY14F respectively – a 55%-65% discount to Construction and Cement sectors.

Industry at a glance
Power transmission & distribution a USD4.5bn opportunity. Indonesian cable companies generally focus on manufacturing one or more of the following categories of electricity conductors: i) electrical transformer cable & wiring, ii) power transmission & distribution, and iii) building & industrial cable & wiring (market cable). As a rule of thumb, medium to high voltage power transmission & distribution cables are manufactured with aluminum due to the commodity’s heat & corrosion resistant characteristics. These types of cables command 15%-19% gross margin and there are few players in this sphere due to high engineering knowhow required.

Companies sell these types of cables to PLN through an open tender, with the winner having an advantage in subsequent biddings due to PLN’s internal scoring system that award additional points to trusted manufacturers – ensuring a captive demand to previous winners. Due to its established relationship with PLN, VOKS commands approximately 70% winning rates for all PLN’s transmission and distribution annual budgetary project disbursement for power cables. The Government plans to disburse USD29bn between now and 2021 for electricity transmission and distribution development, ~15% of which is allocated for cable procurement, a segment in which VOKS is the undisputed leader.

Proxy to property boom
Building and industrial/market cables are largely made from copper. Production demand for market cables generally comes from independent distributors – who have business relationships with end-users ie construction and engineering, procurement and construction (EPC) contractors – and thus the balance of power is in favor of the distributors. At present, every large manufacturer in the industry has a finger in market cable production pie due to the heightened demand from Indonesia’s property boom and the segment’s low technical requirements. A crowded market and a weak manufacturers’ bargaining power resulted in a mere 8%-10% gross margin.

Notwithstanding that, copper cables generally sell for quadruple the aluminum cable prices as a reflection of its raw material prices. Through its subsidiary and wholly owned distributor-cum-marketer PT Prima Mitra Elektrindo (PME), VOKS has bypassed the industry dependency on distributors and directly targets the end-users of building cables – winning some of the most prestigious projects such as Jakarta’s Senayan City Complex and Singapore Sports Hub.

Fiber optics cable the next big thing. The Indonesian Government, through TLKM, is currently undergoing the Second Palapa Project in Eastern Indonesia – a mega-plan to increase Indonesia’s broadband penetration to 100% by 2015 with an annual budget of at least USD105m. We foresee heightened fiber optics demand in the market as elevated data communication requires an ever bigger fiber optics network in the foreseeable future. Note that fiber optics cable command ~ 20% margins – the highest in the cable market. To capture this expansive demand, VOKS plans to increase its fiber optics manufacturing capacity by 20% to 1.2m km annually – double that of the second largest player to the segment, PT Jembo Cable Co Tbk (JECC, Not Rated).

Company at a Glance
Company history. PT Voksel Electrics Tbk (VOKS) was first established in 1971 as a small factory producing low voltage electrical copper cables and wires, before expanding into a wider range of products, including various aluminum cables and conductors. In 1989, the company started joint-venture operations with Japan’s Showa Electric Wire & Cable Co Ltd, which helped to facilitate the transfer of technology and extended the VOKS products to the export markets.

To support its expansion program, VOKS conducted its initial public offering (IPO) both in the Jakarta and Surabaya Stock Exchanges. Between 1993 and 1997, VOKS started producing medium voltage and optical fiber cables. It is still the undisputed market leader in Indonesia for both products. By 2012, VOKS was the largest cable supplier to Indonesia’s state power company PLN and state telecommunication company TLKM.

Agile management strategy a competitive advantage in a cyclical biz. Following the Asian Financial Crisis in 1997, which saw its domestic-focused sales wiped out and retained earnings balances falling into the negative territory, VOKS re-oriented its business coverage to the export markets – to Southeast Asia, Africa, and the Middle East. At end-2008, more than 34% of the company’s sales were generated from exports. As the domestic market picked up on the back of Indonesia’s infrastructure cycle that started in 2010, VOKS customer mix nimbly changed to capture this pent up demand due to its long-standing relationships with PLN and TLKM.

As at 1Q13, 69% of VOKS’s orders in hand were from the two state companies. Through wholly-owned subsidiary PT Prima Mitra Elektrindo (PME), the company has aggressively expanded into the property and industrial fields, catering specifically to prestigious B2B projects such as the Senayan City Complex, Kuningan City, and the Medan Kuala Namu International Airport in Medan. We think that VOKS’ nimble moves to capture growing opportunities in various geographies would prove a competitive advantage in a business widely vexed with cyclicality.

Leaving no stones unturned. VOKS is the only player in the industry with three vertically integrated wholly owned subsidiaries to support its core cable manufacturing and sales business. These “downstream” subsidiaries consist of PT Bangun Prima Semesta (BPS), PT Prima Mitra Elektrindo (PME), and PT Cendikia Global Solusi (CGS). BPS was established as an engineering company with a focus on the construction of electrical infrastructure network, ie installation and stringing of underground or overhead cables, which is a value added proposal to PLN.

To mitigate the strong distributor power in the low voltage copper cables market (for buildings & industrials), PME was set up as VOKS’ distributor to increase the availability of its cables to B2B and B2C markets – directly selling to project owners and retail outlets. CGS, on the other hand, was set up to design, install and implement fiber optic networks for customer (ie TLKM) and rent out VOKS’ own network to capture the increased demand in telecommunication infrastructure.

Solid Fundamentals & Growth Prospects Warrants a Re-Rating
PLN & TLKM project dominance fuels earnings growth. As at mid-May, VOKS has booked IDR1.6trn worth of orders in hand to be executed by year-end, of which 69% are orders from PLN and TLKM. This number translates to 55.8% of VOKS’ FY13 target revenue of IDR2.8trn, ensuring that the rest of the year would be robust. 1Q13 top- and bottom-line earnings made up 20.9% and 15.7% of the company’s FY13 estimates, in line with its seasonal pattern. VOKS generally books ~70% of its net profits in 2H pending product delivery because the Indonesian State Budget is disbursed back-ended towards the end of the year.

We expect the company to chalk up IDR 166.4bn and IDR196.2bn worth of net profits in FY13 and FY14, on par with Management’s guidance. Our numbers translate to 22% CAGR to its bottom-line between FY11 (the start of Indonesia’s investment upcycle) to FY15F. Note that such visibility is harder to gain from companies that rely solely on independent distributors for sales, such as PT Supreme Cable Manufacturing Corp Tbk (SCCO; Not rated), as production plans would have to be made on a month-by-month basis depending on orders from these distributors, which in turn are based on demand from their “retail” clients.

Dominance over high margin market segments + improving ASP + solid cost management = margin expansion. Around ~80% of VOKS’ cost of revenue is derived from raw material prices ie of aluminum and copper. As VOKS books its cost of revenues based on weighted average costing method, its gross margin may somewhat be affected by commodity prices and IDR exchange rate movements. VOKS’ gross margin strengthens with a three- to six-month delay when raw material prices improve – because costs were booked at lower inventory prices while new contracts were booked on a higher tender price.

However, unlike free-market competitors, which have limited capability to hedge their positions due to uncertain monthly demand, VOKS’ bulk sales contracts to project owners such as PLN and TLKM has enabled it to secure the highest gross margins in the industry (at ~15%) for the past three years. This was despite the very volatile commodity prices. Additionally, three-quarters of VOKS’ sales mix is derived from transmission & distribution cables (which command 15%-19% gross margin), and fiber optics (~20% gross margin). A combination of high-margin product mix and a contract-based business model enabled VOKS to consistently deliver the highest ROAE (at 25.36% in 1Q13) and net margin (5.73%) in the industry.

We foresee continued margin expansion on the back of: i) elevated demand and limited number of suppliers for medium-high voltage power cables & fiber optics, ii) higher ASP due to bottom-reversal of aluminum and copper prices, and iii) solid cost management due to a contract-based manufacturing business model. Consequently, we expect VOKS to register a net margin of 5.8%-6.2% in FY13-FY14, a ~400bps improvement to its historical numbers.

Prudent management in expansionary mode, rock solid balance sheet keeps future prospects in check. VOKS’ shareholders’ equity has grown twofold since the 2010 ownership and Management restructuring, even without any quasi-reorganization (to wipe out the 1997 Asian Financial Crisis effect ) as was adopted by competitors PT Kabelindo Murni Tbk (KBLM, Not rated) and PT KMI Wire and Cable Tbk (KBLI, Not rated) in 2007 and 2010 respectively. Its debt is at the lowest level for the past decade at end-FY12, at 0.2x Debt-to-Equity Ratio, and comprises solely of short term working capital loans. The company has been in a net cash position since last year, during the same period its retained earnings turned positive for the first time since FY97.

In mid-FY12, VOKS paid out 36% of it FY11 earnings as cash dividend, a yield of ~4.0% at that point of time. A consistent dividend schedule soon followed, with a 28% payout (from FY12 net income) early this month, a slight 2% increase on a per share basis due to higher capital expenditure requirements for its business expansion. As at end-FY12, VOKS has an annual production capacity of 11,630 tonnes of copper cable, 15,800 tonnes of aluminum cable, and 1.0m km of fiber core.

Factory utilization has been running at as high as 95% during 2H and 85% through the year – demonstrating an urgent need for additional capacity. By the end of FY13, VOKS is slated to produce 11,630 tonnes of copper cable, 21,636 tonnes of aluminum cable, and 1.2m km of fiber core – the largest total capacity in the industry. The capacity increase with its planned factory expansion will cost around IDR72.8bn, which VOKS could easily finance and still end the year solidly with IDR39.8bn net cash.

Recommendation
We initiate coverage on VOKS with a BUY and TP of IDR2,400, which offers a 60% upside to the current share price. Our TP implies 12.0x target FY13 P/E but at a 40%/25% discount to Construction Sector/Cement Sector as historically recorded. We deem the discount justified for now in light of VOKS’ small market capitalization and thin liquidity. Having said that, we also believe it deserves a re-rating from the current valuation (at 7.2x FY13 P/E) in view of the current climate. We prefer VOKS compared to other listed cable companies due to its dominance over PLN’s and TLKM’s cable demand, thus making it a direct beneficiary to the Government’s aggressive infrastructure spending.

Additionally, the project-based nature and visibility of PLN’s and TLKM’s orders ensure a higher conviction of the cable company’s 22% net profits CAGR for FY11-FY15F – a huge competitive advantage compared to other manufacturers. Dominance over high-margin market segments and better cost hedging capability due to bulk manufacturing contracts with PLN & TLKM provides VOKS with the highest net margins and ROAEs in the industry. We foresee a margin expansion to take place in FY13-FY14 as cost bookings are set to improve on the back of bottom reversal of raw material prices, while the constrain in the supply of high-medium voltage cable & fiber optics would push for an elevated ASP. Lastly, we like VOKS’ rock solid balance sheet with its net cash position, which provides a strong support to its robust expansion plans.
Where we may be wrong.

The following risks may hamper VOKS’ outlook:
Disruptions over PLN’s and TLKM’s project budget disbursements
The Government’s budget disbursement for PLN and TLKM projects may be delayed in the 2014 election year. However, we believe that the new Government would stay committed the infrastructure development to ensure Indonesia’s economic growth, and that any delay would only translate to an accumulated future demand.

Volatile raw material prices & forex may adversely affect margins
Although VOKS’ operational margins are largely shielded from the effects of raw material price & forex fluctuations due to the contracted nature of its manufacturing process, extreme swings may affect the company’s margins.

Low trading liquidity
Management seeks to enlarge VOKS’ shareholding base as the company goes through an expansionary cycle, as low trading liquidity may limit the stock’s price appreciation and investor interest.