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Construction Sector Summary

Core Content

The Indonesian construction sector is viewed positively by analysts, with a focus on continued infrastructure development as a key driver of growth. The sector is expected to maintain strong earnings growth, with a forecasted CAGR of 23% from 2014 to 2015. Despite concerns about the presidential election potentially affecting contract awards, the outlook remains stable due to the stability of the domestic economy and the robust existing order books.

Main Points

• Infrastructure Development as a Priority: The government remains committed to infrastructure development to support economic growth and remove bottlenecks.
• Election Impact: While the election may cause delays in new contract awards, the impact is expected to be short-lived and marginal. Historical evidence from 2009 suggests that despite delays, earnings and share prices of construction companies still outperformed.
• Earnings Growth: The sector is expected to see double-digit earnings growth in 2014 and 2015, supported by strong carry-over projects and a large government infrastructure budget of over IDR200 trn.
• Valuation and Performance: The sector's current valuation of 14.8x is lower than its peak of over 25x, indicating potential upside. Share prices are still 36% below their historic peak, suggesting room for growth.

Key Information

Top Picks

• WIKA (Wijaya Karya): Highest earnings visibility, most diversified business portfolio, and likely to meet its target. It is the most expensive among the SOE contractors but serves as a proxy for the sector.
• PTPP (Perusahaan Perumahan): Strong position in mega-port projects and expected to benefit from new government infrastructure initiatives.
• WSKT (Waskita Karya): Main beneficiary of government infrastructure spending, with a significant portion of its portfolio dedicated to public sector projects.
• ADHI (Adhi Karya): Set to roll out its turnaround strategy, with a focus on higher margin projects and better risk mitigation.
• ACST (Acset Indonusa): Small-cap company with expertise in foundation projects and a high-margin profile, making it a preferred choice for a small-cap idea.

Investment Thesis

• Earnings Growth: The sector is expected to maintain a double-digit earnings growth rate due to solid order books and new projects.
• Valuation: The sector's valuation is undervalued compared to its historical peak, providing an opportunity for upside.
• Risk Mitigation: Contractors are better equipped to handle risks, with multi-year contracts and joint-operation schemes helping to mitigate the impact of raw material price fluctuations.
• ROE and Dividend Yield: ROE is expected to improve, and dividend yields are seen as attractive, particularly for larger companies.

Key Risks

• Delays in Projects: Potential delays in the development of Jakarta Monorail and ACT Monorail in East Java.
• Private Sector Slowdown: Slower-than-expected development from the private sector due to high exposure to high-rise building projects.
• Government Budget Disbursement: Possible delays in the disbursement of government infrastructure budgets.
• Competition: Intensifying competition from SOEs in the building projects segment.
• Currency and Labour Costs: Further currency weakening and rising labour costs could impact margins.

Outlook for 2014-2015

• Earnings Growth: Expected to grow by 23% CAGR, supported by existing and new projects.
• Order Books: Strong order books from 2013 are expected to underpin 2014 earnings, with an estimated 24% YoY growth in new contract awards.
• Project Execution: The ability to execute projects efficiently will be crucial for maintaining profitability and meeting earnings targets.
• Valuation Re-rating: With the sector's share prices significantly below their historic peak, there is potential for re-rating as earnings growth continues.

Conclusion

The Indonesian construction sector is well-positioned for continued growth due to government-driven infrastructure development, strong order books, and improved risk mitigation strategies. While the 2014 presidential election may cause temporary delays in contract awards, the sector is expected to maintain its momentum. The top picks are based on earnings visibility, project execution, and market position, with a focus on both large and small-cap companies.