Wijaya Karya Indonesia’s EPC Mogul

We re-instate coverage on Wijaya Karya (WIKA) with a strong BUY and IDR1,600 TP, reflecting a potential 16% upside from its current price. As we roll over our valuation to FY13, we base this TP on a 14.6x target PER over its FY14 EPS. The company’s long-standing relationship with state oil & gas company Pertamina and the nation’s power company PLN spells solid growth in its EPC business, which is expected to see margin expansion. With its diversified operations, strong balance sheet and clear strategic direction, enhanced by its status as the most liquid construction company, WIKA deserves a premium over its competitors.

24% earnings CAGR for FY13-14
WIKA’s orderbook has been increasing by 22.3% CAGR over the past six years. Based on the IDR15.6trn worth of contracts carried over from last year as well as new contracts targeted for FY12, WIKA’s orderbook should double, thus boosting its revenue to IDR9.51trn this year. We forecast revenue to continue to climb to IDR11.07trn and IDR14.71trn for FY13f and FY14f, in tandem with the growth trend from FY11-12 (25.6% CAGR), spurred by the government’s push for infrastructure developments.

Margins to widen as EPC projects increase
WIKA currently commands a 74% share in Indonesia’s engineering, procurement and construction (EPC) market, which is dominated by three state-owned EPC players. Gross margin from the EPC business is ~12%, 200-300bps higher than civil & building construction. Between FY10 and FY12, WIKA’s EPC revenue grew from a mere 1% at end-FY10 to 31% of total consolidated revenue in FY12. With that, coupled with the group’s familiarity with Pertamina & PLN as the main EPC project owners in Indonesia, we expect WIKA’s bottomline margins to expand by a 24.3% CAGR between FY12 and FY14.

Strong balance sheet & cash flow from government projects
More than 70% of WIKA’s projects are owned by the Indonesian government or other state-owned enterprises (SOEs). As the company has consistently posted net cash, we expect it to maintain a net cash position. Government projects, unlike private projects, guarantee a stable cash flow as they are paid for on a monthly basis, which helps to smoothen any fluctuation in cash flow and reduce the incidence of bad debts.

Valuation and Target Price
We are re-initiating coverage on WIKA with a strong BUY and IDR1,600 TP, providing a 16% upside to the current share price. As we roll over our valuations to FY13, we are basing our TP on a target PE of 14.6x over its FY14 earnings, which is +1 standard deviation above its historical average forward PER. We continue to believe that the company would trade at the upper range of its precedent valuation as its strong order book and the government’s push for infrastructure projects would continue to propel its earnings upside.

We prefer WIKA compared to other Indonesian construction companies for its diversified operation, higher EPS growth, strong balance sheet, and clear management strategic direction. Its long-standing relationship with Pertamina (state oil & gas company) and PLN (state power company) will spur steady growth in its EPC business, which should see widening margins going forward. As it is the most liquid construction stock with the largest market capitalization in Indonesia, we find WIKA’s valuation premium over its competitors is justified.

Strong order book to fuel earnings growth
WIKA’s orderbook has been increasing by a 22.3% CAGR over the past six years. We expect the company to chalk up revenue of IDR11.07trn and IDR14.71trn for 2013f and 2014f (24% CAGR). WIKA has achieved IDR6.37trn worth of revenue in 9M12, up 17.0% y-o-y, representing 66.9% of our target FY12 revenue. We expect the momentum to pick up in 4Q12 as the government’s spending budget generally remains back-ended in the last quarter of a year. We foresee the quarter contributing ~33% of its FY12 net revenue. Historically, 4Q accounts for 30%-35% of the company’s FY revenue and 30%-45% of FY net profits.

Share price driver
WIKA’s share price has historically reacted to earnings delivery. Over the past four years, the share price has had a 81.5% correlation to its earnings growth. We expect that a decidedly strong earnings growth on the back of a solid order book would serve as a catalyst for an organic share price appreciation. We forecast that WIKA would generate strong 23.2% and 17.0% net profits growth y-o-y in FY12 and FY13. This growth momentum will continue in FY14 as its new projects may then leverage on the new Land Clearing Bill.

Margin expansion by larger EPC services
The company’s good relationship with Pertamina and PLN makes WIKA a front-runner in securing EPC projects (e.g. oil refineries, power plants, etc). The government plans to pour in at least USD6.5bn (IDR61.8trn) worth of power works up to FY15, and we expect WIKA to win the majority of the bids for these projects. At present, it controls 74% of the EPC market (excluding international players)– way ahead of the second biggest player, PTPP, at 17%.

The EPC business fetches ~12% gross margin, 200-300bps above that from general construction works. We expect revenue contribution from EPC projects to hit >30% for the upcoming years (the company has guided for a 31.4% contribution in FY12), thus ensuring strong net margin expansion.

Strong cash flows from government projects
WIKA has been operating on a Net Cash Flow position for the past couple of years. We foresee this favourable condition to continue in the future despite a strong 24% CAGR revenue growth for the next two years. Projects from the government and SOEs account for ~70% of WIKA’s orderbook. The industry norm dictates that construction companies receive cash payments based on the percentage of project completed as set by their contracts. On the contrary, owners of government and SOE projects disburse cash payments monthly based on project completion within that particular month, thus softening the effects of cash flow seasonality and cost overruns.

Where we may be wrong
The following risks may affect WIKA’s share price and outlook: i) the actual implementation of the Land Clearing Bill fails to address the current difficulty in land acquisition for infrastructure development, and ii) delays in project tenders due to the upcoming campaign season and presidential election.

Brief history
WIKA was established in 1960 to take on electrical and water pipe installation works. In the early ‘60s, the company was a sub-contractor to the development of Gelanggang Olah Raga Bung Karno (still the largest sporting complex in Indonesia today) and expanded to cater for general construction works across the country. By the 80s, it had undergone significant expansion that led to the establishment of several business units, namely Civil Construction, Building, Housing Facilities, Concrete & Metal Products, Industrial Construction, Energy, and Commerce.

In two decades, WIKA had transformed into an integrated and diversified construction company. In 1997, WIKA officially spun off its Concrete business unit to create a subsidiary, WIKA Beton, followed by WIKA Realty and WIKA Intrade in 2000.

As the company grew rapidly, it undertook an IPO and was listed on the IDX on 27 Oct 2007, releasing 28.5% of its share capital to the public (including those classified as Employee/Management Stock Option Program and Employee Stock Allocation). The government of Indonesia remained its majority shareholder. In 2008, it established WIKA Gedung to specialize in the development of high-rise buildings. Shortly thereafter, the group acquired 70.1% share of PT Catur Insan Pertiwi (renamed WIKA Insan Pertiwi) to specialize in the mechanical-electrical contracting business.

In 2010, WIKA’s management rolled out Vision 2020, a strategic corporate move to become an integrated construction, EPC, and investment company. As of 9M12, the company generated 38% of its revenue from construction services, 36% from mechanical and engineering services (including EPC), and 21% from industrial concrete production.