Wijaya Karya Solid Strategies In Place

We reiterate our strong BUY on WIKA at a TP of IDR2,200
It is trading at a premium to the industry at 21.2x P/E for 2013, but deservedly so. It has the most sustainable growth prospect due to its strategic ownership of WIKA Beton and its solid investments in human capital.

Earnings upgrade on a better portfolio mix
After cost overruns last year, we expect Wijaya Karya (WIKA)’s EPC/CIP gross margins to improve in light of the divestment of WIKA Jabar Power (WJP) as well as a better portfolio mix through its IPP projects, with a mandated 18%-22% internal rate of return (IRR). We have upgraded our FY13 earnings forecast for WIKA by 10%/6% for its revenue/net profit.

Doing it right
WIKA Beton helps to ensure the company’s supply of raw materials, while the group’s aggressive outreach into Indonesian top universities through scholarships and financial aid provides a steady stream of quality employees. Furthermore, its salary base, the most competitive in the industry, ensures the sustainability of its human capital. Its aggressive expansion into investment activities also ensures a high rate of wins of construction jobs. The company offers the strongest balance sheet among all state-owned (SOE) construction firms, which enables it to take on the SOE-dominated infrastructure projects with the least financial strain.

A competitive advantage
WIKA’s 78.4% ownership of WIKA Beton, the largest pre-cast and concrete producer in Indonesia with a 60% market share, provides it with one of the most strategic competitive advantages against the lean supply of raw materials (WIKA Beton is currently operating upwards of 95% utilization). In view of the recurring demand for WIKA Beton’s products and its strong presence in the precast industry, we have decided to split up its operations for a standalone valuation.

A strong BUY, with a new SOP-based TP
We continue to reiterate our strong BUY recommendation on WIKA with its new TP at IDR2,200. We valued WIKA Beton with the DCF method, at IDR1,000/share, representing 45% of the company’s fair value despite its 20% contribution to the group’s topline, on the back of its strategic position. We value the rest of the company (construction, EPC, and realty) at IDR1,200/share, basing our FB off of a 19.0x target P/E over its FY13 earnings.

Strong BUY
We continue to reiterate our strong BUY on WIKA with a new TP of IDR2,200, providing a 12% upside to the current share price. We have decided to assess WIKA Beton separately to capture the value that the subsidiary has brought to its parent company in light of the lean raw materials supply in the industry. We value WIKA Beton at IDR1,000/WIKA share, representing 45% of the company’s fair value despite its 20% contribution to the group’s topline, on the back of its strategic position in WIKA’s operations. WIKA Beton is vital for the company’s competitive edge as it holds a 60% market share in national precast and concrete supply.

In view of the recurring demand for WIKA Beton’s products and its strong presence in the precast industry, we are using the DCF method to determine its worth. The price for WIKA Beton was derived from a 7.5% Risk Free Rate, 11% WACC, and 5% terminal growth rate. We value the rest of the company (construction, EPC, and realty) at IDR1,200/share — basing our fair price off of a 19.0x target P/E over their FY13 earnings, sans WIKA Beton, at IDR400bn or IDR66/share), which is +1 SD above WIKA’s historical average forward P/E since the construction boom started in 2010.

Earnings upgrade on a better portfolio mix
The company recently divested its majority ownership of WIKA Jabar Power (WJP), a struggling 40-megawatt (MW) geothermal power plant in Gunung Tampomas, West Java. WIKA has guided for IDR1.78trn in capex this year, half of which will finance its investments in Independent Power Plant (IPP) projects. After cost overruns last year, we expect WIKA’s EPC/CIP gross margins to improve in light of the divestment as well as a better portfolio mix through IPP projects with its mandated 18%-22% IRR. We have upgraded our FY13 earnings forecast by 10%/6% for WIKA’s revenue/net profit.

Solid strategies in place
WIKA is definitely not the cheapest buy in the industry, trading at 21.2x 2013 P/E, but quality comes at a price and it remains our top pick as the stock offers the best defensive play in expectedly volatile market. We base this call on WIKA’s strong fundamentals: i) WIKA Beton (the largest pre-cast and concrete producer in Indonesia) helps to ensure the company’s supply of raw materials, ii) the group’s aggressive outreach to Indonesian top universities through scholarships and financial aid and its salary base, the most competitive in the industry, ensures sustainable human capital, iii) its robust investment portfolio ensures a decent rate of wins of construction jobs, as it is an equity holder of some of the projects and thus, is the “right match” offering the lowest bids, and iv) it has the strongest balance sheet among all state-owned construction firms, which enables it to take on larger infrastructure projects with the least financial strain.