EQUITY RESEARCH. A secular growth story. Construction Sector. Initiating Coverage. 22 January 2014

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1 22 January 2014 EQUITY RESEARCH Construction Sector Initiating Coverage Stocks Adhi Karya Jaya Konstruksi Manggala Pratama Pembangunan Perumahan Wijaya Karya Waskita Karya Share Performance Ticker ADHI IJ JKON IJ PTPP IJ WIKA IJ WSKT IJ 3 M 6 M 12 M Absolute (%) Relative to JCI (%) WK range (Rp) 4,571 8,276 Price Chart Jan 16-Apr 16-Jul 16-Oct 16-Jan JCI IP Construction Basket Index IP Construction Basket is an index that consists of ADHI, JKON,PTPP, WIKA and WSKT Source: Bloomberg A secular growth story Indonesia has huge infrastructure development needs over the next decade. The MP3EI master plan identified c.usd150bn in infra spending. 3 CAGR of new contracts in F should sustain revenue growth. We prefer companies with strong earnings visibility. Top picks: PTPP, WIKA We initiate coverage on the construction sector with a bullish view. We believe Indonesia s infrastructure spending needs of USD150bn, as identified under the MP3EI master plan, will sustain earnings growth of the five construction companies in our coverage. Rising material costs, due to inflation and a weakening currency, have increased uncertainty over near-term earnings, but we believe those companies with improved risk management will see limited negative impact. We prefer companies with stronger earnings visibility arising from a more diversified revenue base, exposure to multi-year projects and/or higher contribution from 2013 carry-over. Top picks: PTPP, WIKA. Indonesia s huge infrastructure development needs. The government s Master Plan for Acceleration and Expansion of Indonesia Economic Development (MP3EI) has identified investment needs of >Rp4,000tn (USD335bn) for the country to realize its full economic growth potential, of which c.usd150bn is the required spending for basic infrastructure (power, roads, railways, air/sea ports, etc). The government plans to contribute 1 of the total investments, with SOEs and private investors contributing the balance. Implementation of this plan is picking up, contributing to an uptick in infrastructure spending in the fiscal budget to 1.7% of GDP in F, from 1.3% in Under this plan, total infrastructure spending in the country will rise to 5% of GDP, from c.4% prior to the MP3EI launch in Construction companies are key beneficiaries. We expect the aggregate new contracts of the five construction companies to reach Rp71tn (c.usd6bn) in 2013F, or a 3-year CAGR of 3, and the value of contracts on hand and revenues to rise to IDR125tn and IDR49tn, respectively, a doubling during the same period. With a strong pipeline of multi-year projects, carry-overs from 2013 and growth of new contracts, we forecast the aggregate construction revenues to grow at 19% p.a. in the next two years. We see limited impact from rising material costs. Rising material costs, due to inflation and weakening currency, have increased uncertainty over the sector s near-term earnings. However, we believe the inability to pass on cost increases will have only a one-off negative impact on near-term earnings, and will be limited to companies with exposure to single-year projects or private sector clients. This is reflected in our preference for companies with stronger earnings visibility arising from a more diversified revenue base (such as contribution from a property/pre-cast business), lower exposure to single-year projects or private sector clients, and larger project carry-overs from Valuation undemanding given secular growth prospects. We initiate coverage on WIKA, PTPP, ADHI, WSKT and JKON with BUY ratings. Excluding JKON, the sector trades at FY14F P/E of 14.3x (11.5x for FY15F), which is in line with the broader market. We view this valuation as undemanding given secular earnings growth prospects arising from Indonesia s huge infrastructure development needs. Our BUY call on JKON (owned by the Jakarta local government), despite its high P/E multiple, reflects potential upside from the Jakarta Six Inner Ring Toll Road project and the city s infrastructure development, which could lift its long-term earnings outlook. Our top picks: PTPP and WIKA. 1 Natalia Sutanto natalia.sutanto@ipc.co.id Ticker Rec Price (Rp) Target (Rp) Upside (%) Refer to important disclosures on the last of this report P/E EPS growth FY13F FY14F FY13F FY14F ADHI IJ BUY 1,685 2, JKON IJ BUY PTPP IJ BUY 1,320 1, WIKA IJ BUY 1,930 2, WSKT IJ BUY Sector Exclude JKON Source: IndoPremier, Bloomberg. Closing price: 16 Jan 2014

2 Quick Comparisons PTPP booked the highest new contracts in F... and most project carry-overs to support revenue visibility in 2014F Rp tn Rp tn JKON ADHI WSKT WIKA PTPP F 2014F - JKON ADHI WSKT WIKA PTPP 2014F Carry-over 2014F Revenue Source: Companies, IndoPremier Source: Companies, IndoPremier WIKA has diversified revenue in 2014F and balanced GP* contribution from precast/property division 7% 2% % 64% 64% 36% 93% 98% WIKA JKON ADHI PTPP WSKT Construction, EPC, ME Precast/Property JKON WIKA ADHI PTPP WSKT Construction, EPC, ME Precast/Property Source: IndoPremier Source: IndoPremier * GP: Gross profit Debt to equity, F Source of contracts, 2013F JKON WIKA WSKT ADHI PTPP ADHI JKON WSKT WIKA PTPP Govt Single year Govt Multi-year SOE Private F 2014F Source: Companies, IndoPremier Source: Companies, IndoPremier 2

3 Indonesia has huge infrastructure development needs The government s Masterplan for Acceleration and Expansion of Indonesia Economic Development (MP3EI) identifies investment needs totaling more than Rp4,000tn (USD335bn) for Indonesia to realize its full economic growth potential, of which c.usd150bn is the required spending for basic infrastructure (power, roads, railways, air/sea ports, etc). Of this amount, the government will contribute 1 of total investments, with SOEs and private investors contributing the balance. Implementation of this plan is slowly picking up, contributing to an uptick in infrastructure spending in the fiscal budget to c.1.7% of GDP in F, from an average of 1.3% in Under this plan, total infrastructure spending in the country will rise to 5% of GDP, from c.4% prior to the MP3EI launch in Exhibit 1. Six corridors of economic development 6 corridors of economic development Based on competitive and strategic advantages F ood produc tion and proc es s ing c entre, National B arn Mining produc tion and proc es s ing c entre, National B arn F arming, Ag ric ulture and F is hery produc tion and proc es s ing c entre, National Nickel mining Indus try s upport and national s ervices F ood, fis hery, energ y and mining national development The g ate of touris m and s upport national food s upply Source: Bappenas Exhibit 2. Infrastructure captures 44% of the total MP3EI budget Source: MP3EI Exhibit 3. Govt infrastructure spending/allocation ( F) Exhibit 4. Indonesia infrastructure spending to GDP Rptn F (10) % Source: APBN * F are budget allocation Source: Bappenas, MP3EI 3

4 Construction companies are key beneficiaries We expect aggregate new contracts of the five construction companies under coverage to reach Rp71tn (c.usd6bn) in 2013F, or 3 CAGR in the past three years, in turn doubling the value of contracts on hand and construction revenues to Rp125tn and Rp49tn, respectively. With a strong pipeline of multi-year projects, carry-overs from 2013 and our expectation of sustained growth of new contracts, we forecast construction revenues for the five companies to grow at around 19% p.a. in the next two years. Exhibit 5. Total new contracts, F Exhibit 6. Total contracts on hand, F Rp tn Rp tn F 2014F 2015F F 2014F 2015F Source: Companies, Indopremier Source: Companies, Indopremier We see limited impact from rising material costs Rising material costs, due to weakening currency and rising inflation, have increased uncertainty over the near-term earnings outlook of the construction sector. However, we believe the inability to pass on cost increases will only have a one-off negative impact on near-term earnings, and will be limited to companies with exposure to single-year projects or private sector clients. As such, we prefer construction companies with better earnings visibility arising from more diversified revenues (due to contribution of property/pre-cast businesses), lower exposure to single-year projects and/or private sector clients and larger carry-overs from Exhibit 7. Source of contracts, 2013F ADHI JKON WSKT WIKA PTPP Govt Single year Govt Multi-year SOE Private Source: Companies, Indopremier 4

5 Valuation undemanding given secular growth prospect We initiate coverage on five construction stocks (WIKA, PTPP, ADHI, WSKT and JKON) with BUY ratings. Excluding JKON, the sector trades at FY14F P/E of 14.3x (11.5x in FY15F), which is in line with the broader market. We view this valuation as undemanding given secular earnings growth potential from Indonesia s huge infrastructure development needs. Our BUY call on JKON (owned by the local government of Jakarta), despite its high P/E multiple, reflects the potential upside from the Jakarta Six Inner Ring Toll Road project and the city s infrastructure development, which could significantly boost its long-term earnings outlook. Our top picks: PTPP and WIKA. Peer comparison, 2014F WIKA PTPP WSKT ADHI JKON Sector Recommendation BUY BUY BUY BUY BUY Target Price (Rp) 2,400 1, , Current Price (Rp) 1,930 1, , Upside (%) Market cap (Rptn) Avg daily turnover (RpBn) Market cap (USDMn) ,846 Avg daily turnover (USDMn) Float (%) 34.6% 42.8% % Majority shareholder Govt of Indonesia (65.2%) Govt of Indonesia (51%) Govt of Indonesia (68%) Govt of Indonesia (51%) Pembangunan Jaya (61%) PE (FY14F) at TP (x) * PE (FY14F) at CP (x) ** ROE (%) GPM after JO (%) OPM (%) NPM (%) Debt to equity (%) Interest coverage (x) Earnings growth (%) Source: IndoPremier, Bloomberg. *Excluding JKON: 17.9x ** Excluding JKON: 14.3x Closing price: 16 January

6 Pembangunan Perumahan Strongest earnings growth High 2013F carry-over, 2014F new contracts to support revenue visibility Strong F earnings CAGR of 32% Diversification into property and precast ahead for margin improvement Initiate BUY with TP Rp1,750, implying 2014F PE of 16.1x PTPP IJ BUY Target Price Rp 1,750 Current Price Rp 1,320 Upside (downside) 32% Share Performance 3 M 6 M 12 M Absolute (%) Relative to JCI (%) WK range (Rp) 830 1,780 Price Chart Jan 16-Apr 16-Jul 16-Oct 16-Jan JCI PTPP Source: Bloomberg Share Data Out shares (m) 4,842 Market Cap (US$ m) M avg. daily (US$) 3,115,799 Shareholder information Government of Indonesia 51. Employees Cooperative 6.1% Free float 42.9% PTPP has greater revenue visibility than its peers, given its high level of 2013F carry-over and 2014F new contracts. Increasing projects from private, SOEs and government as well as the realization of MP3EI projects should bring its 2014 new contracts to Rp23tn, +15% yoy, translating to a robust F earnings CAGR of 32%. Further diversification into property projects and precast plants should also pave the way for margin improvement going forward. Initiate with BUY and TP of Rp1,750/share. Highest revenue visibility For 10M13, PTPP reported new contracts worth Rp13.9tn, with major contributions from buildings (64%), roads & bridges (15%), and EPCs (15%), respectively. This should support our 2013 new contracts target for PTPP of Rp20tn. Our 2014 top-line estimate of Rp12tn, on the other hand, should be helped by the estimated 2013 carry-over of a high Rp19.6tn. Combined with our 2014 new contracts estimate of Rp23tn, we believe PTPP has the highest 2014F revenue visibility among its peers F earnings CAGR of 32% Strong F new contracts should support continued significant earnings growth, translating to 32% CAGR in F. We estimate PTPP will book 2014 top line of Rp14.7tn, +23% yoy, with major contribution from construction service and EPC (97.6%), and the remainder from property/realty. At the bottom line, we estimate PTPP will Rp527bn in 2014F, +28% yoy, translating into an improved net margin of 3.6% (2013F: 3.4%). Diversification to support margin improvement ahead Supported by a strong track record in high-rise/residential development, PTPP plans to venture further into the property business. In , PTPP will launch several property projects, with the aim of booking Rp1tn marketing sales, double the 2012 level. For the pre-cast division, PTPP will consolidate revenue from the pre-cast plant (located in Bojonegara, Banten, with estimated annual revenue of Rp500bn,) to its 2014 top line, following the recent acquisition of an affiliated company, PTPP Dirganeka. The property and pre-cast divisions generate higher gross margins (at 17-3 and 10-15%, respectively), and thus should support the company s margin improvement story going forward. Strongest 2014F earnings growth; initiate with BUY We expect PTPP to book the strongest 2014F earnings growth (28%) in the sector (16.3%), given sustainable growth through contract acquisition. We initiate coverage with a BUY rating and a TP of Rp1,750/share, translating to 2014F PE of 16.1x, a 1 discount to the sector s (excluding JKON) 17.9x. Key Financial F 2014F 2015F Revenue and sales (Rp bn) 8,004 12,020 14,752 18,052 Gross Profit (Rp bn) 855 1,208 1,511 1,852 Operating Profit (Rp bn) 853 1,174 1,483 1,843 Net Income (Rp bn) EPS (Rp) EPS Growth 29% 33% 28% 35% P/E (x) P/BV (x) EV/EBITDA (x) ROE (%) 19% 21% 22% 24%, IndoPremier 21

7 Significant 10M13 new contracts of Rp13.9tn For 10M13, PTPP reported new contracts of Rp13.9tn, with major contributions from buildings (64%), roads & bridges (15%), and EPCs (15%), respectively. We believe PTPP will achieve our FY13 new contracts target of Rp20tn. This also means that PTPP should carry over Rp19.6tn worth of projects, thereby supporting 2014 revenue visibility. In 9M13, the company booked bigger contribution from the private sector, which accounted for 52% of total new contracts (FY12: 25%). Among the big projects that PTPP won in 2013 are EPC projects in Tanjung Uncang, Muara Tawar, and Bangkanai totaling Rp2tn; apartment/high-rise buildings in Surabaya, Makassar, Jakarta, Bali and Serpong totaling to Rp1.5tn; road projects in Java island and Timor Leste (Rp718bn); and airports (Rp641bn). We believe the company will maintain earnings growth over following its policy to lock in several key raw material requirements over a six-month period. Exhibit 1. New contracts, F Exhibit 2. Source of contracts, FY10 9M13 Rptn % 68% 24% 76% 38% 62% 32% 68% 25% 75% 52% 48% M M F SOE and Government Private, IndoPremier Exhibit 3. Revenue vs previous year carry-over, F Exhibit 4. Big projects obtained in 2013 Rptn F 2014F 2015F Carry over - previous year Revenue Rp bn Tanjung Uncang - EPC 1,106 CNG Muara Tawar - EPC 462 Gas Turbine Power Plant 160 MW - Bangkanai (EPC) 461 Vida view apartment - Makassar 349 GTU Izzara apartment - Simatupang 345 Intermark apartments - Serpong 325 Pakuwon Supermall - Surabaya 247 Uluwatu Resort Hotel 267 Cikampek toll road 454 Gleno road - Tibar Timor Leste 264 Soekarno Hatta Airport Terminal 3 - Ultimate 641, IndoPremier 22

8 F earnings CAGR of 32% Strong F new contracts should support continued significant earnings growth, translating to 32% CAGR in F. We estimate PTPP will book 2014 new contracts of Rp23tn, +15% yoy, as well as Rp19.6tn in carry-over projects. This should help the company book 2014F top line of Rp14.7tn, +23% yoy. Construction should remain the major contributor to PTPP s F revenue, making up of total revenue; EPC should contribute 17%. While property/realty contribution revenue should remain low in to F, the company is targeting to launch several property projects during this period to bring revenue contribution to 19% by The strong 2014 revenue growth should spill over into the company s bottom line, which we estimate will reach Rp527bn, +28% yoy, translating into an improved net margin of 3.6%. Exhibit 5. Revenue breakdown, F Exhibit 6. Revenue & net margin F % 17% 17% 17% 17% 97% 89% 82% 81% F 2014F 2015F Rp tn % 3.9% 3.9% 3.6% 3.4% F 2014F 2015F Revenues Net Profit Margin 4.5% % % 2. Construction EPC Realty Property, IndoPremier, IndoPremier Property and pre-cast to support margin improvement PTTP has a track record in high-rise/residential development, and hopes to venture further into this business going forward. The property/real estate division comprising office, hotels, retail malls, and housing/apartments - currently contributes around 2% to 2013F revenue. Over , PTPP will launch several property projects, with the aim of booking Rp1tn marketing sales, double the 2012 level. As for the pre-cast division, PTPP recently acquired affiliated PTPP Dirganeka, and will start consolidating revenue from the pre-cast plant (located in Bojonegara, Banten, with an estimated annual revenue of Rp500bn) to its 2014F top line. With their higher gross margins of 17-3 and 10-15%, the property and pre-cast divisions should help support the company s margin improvement story. Exhibit 7. Gross profit contribution, F 95% 9% 4% 4% 5% 6% 6% 9 85% 14% 14% 14% 75% 91% 96% 7 65% 77% 81% F 2014F 2015F Construction EPC Realty/property, IndoPremier 23

9 VALUATION We value PTPP at Rp1,750/share. We derive our valuation using 10-year DCF with 4% terminal growth rate, 25% tax rate, and 13.5% WACC (12% kd and 15.7% ke). DCF Valuation 2014F 2015F 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F Rp mn EBITDA 1,482,683 1,842,841 2,180,945 2,577,250 3,041,950 3,525,167 4,046,108 4,640,046 5,024,204 5,434,589 Tax (401,298) (542,260) (653,324) (778,755) (959,008) (1,115,394) (1,280,207) (1,468,178) (1,586,959) (1,713,468) NOPLAT 1,081,385 1,300,581 1,527,620 1,798,495 2,082,942 2,409,773 2,765,901 3,171,867 3,437,245 3,721,121 Depreciation 24,296 30,322 36,348 42,374 48,401 54,427 60,453 66,479 72,505 78,532 Changes in working capital (208,682) (312,176) (48,933) (831,911) (1,005,512) (977,684) (1,091,807) (1,241,745) (846,838) (908,681) Gross investments 896,998 1,018,728 1,515,035 1,008,958 1,125,831 1,486,516 1,734,547 1,996,602 2,662,913 2,890,972 Capex (261,458) (261,230) (261,241) (261,501) (261,818) (262,036) (262,281) (262,554) (262,861) (263,204) FCFF 635, ,498 1,253, , ,013 1,224,480 1,472,267 1,734,047 2,400,052 2,627,768 Discount factor PV 560, , , , , , , , , ,679 PV of terminal value 8,180,873 Total PV 11,098,866 Net Debt 2,640,039 Equity value 8,458,827 Number of shares 4,842 Fair value per share 1,750 Source: IndoPremier Key assumptions Our revenue growth rate assumptions are derived from the multiplier of nominal GDP growth, which we estimate at 3x 5x in , 3-4x in the next three years, and then decline to around 1.5x 3x until Taking this into account, we estimate new contracts to grow by around 15% in 2014 and in 2015F, and then decrease by around 1 in Forecast assumption 2014F 2015F 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F GDP Growth Inflation Growth multiplier (x nom GDP growth) Construction EPC Realty Property Gross profit margin Construction 10.2% 10.2% 10.2% 10.2% 10.2% 10.3% 10.3% 10.3% 10.3% 10.3% EPC 8.5% 8.5% 8.5% 8.5% 8.5% 8.7% 8.7% 8.7% 8.7% 8.7% Realty % 33.5% 33.5% 33.5% 33.5% Property 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% Source: IndoPremier Sensitivity analysis Every 1% change in our WACC assumptions results in a 18-22% change in our fair value for the company. For terminal growth, every 1% change in our terminal growth assumption impacts our fair value by 10-12%. WACC sensitivity Terminal growth 12.5% 13.5% 14.5% 3% 4% 4% Fair value 2,137 1,750 1,442 1,571 1,750 1,965 PE 2014F PE 2015F Source: IndoPremier 24

10 Risks Risks to our valuation include: (i) slower-than-expected revenue realization from new contracts and carried-over projects; (ii) increasing impairment allowance, which would curb earnings growth; (iii) worsening macro-economic conditions, and (iv) increasing competition, which would lead to lower profitability. Exhibit 8. EPC projects Exhibit 9. EPC projects Exhibit 10. Kalibaru Port, a big project obtained in 2012 Exhibit 11. Airport projects obtained by PTPP Rpbn Kualanamu airport - Medan 283 Sultan Taha airport - Jambi 96 Sepinggan airport - Balikpapan 335 Pontianak airport 47 Ngurah Rai airport - Bali 391 Juata Tarakan - Samarinda 22 Exhibit 12. Property projects Exhibit 13. Property project 25

11 Financial Summary Profit and Loss Balance Sheet Year to 31 Dec (Rp bn) 2012A 2013F 2014F 2015F Year to 31 Dec (Rp bn) 2012A 2013F 2014F 2015F Revenue and sales 8,004 12,020 14,752 18,052 Cash 1, COGS 7,149 10,812 13,241 16,199 Receivables 4,323 7,064 8,265 9,620 Gross profit 855 1,208 1,511 1,852 Inventories 1,566 2,368 2,539 2,885 Operating income 853 1,174 1,483 1,843 Investments Interest expense Fixed assets ,100 Impairment expense Other 863 1,151 1,436 1,835 EBT ,255 Total assets 8,551 12,469 14,171 16,585 Tax Payables 4,527 6,071 7,445 9,141 EAT Bank loans 1,116 2,093 2,062 2,519 Non-controlling interest MTN Net profit Shareholders' equity 1,656 1,975 2,378 2,933 Non-controlling interest Other ,056 1,292 Total liabilities & equity 8,551 11,769 13,471 15,885 Cash Flow Key Metrics Year to 31 Dec (Rp bn) 2012A 2013F 2014F 2015F Year to 31 Dec 2012A 2013F 2014F 2015F Net income Profitability Depreciation EBITDA margin Non-cash adjustments Pre-tax margin Net interest effect Net margin Changes in net working capital , ROA CFO , ROE Capex Change in non-current assets Interest income Growth CFI Revenue and sales Debts 402 1, EBITDA Equity issuance Pre-tax profit Interest expenses Net profit Dividends EPS Other CFF 180 1, Leverage Cash flow Debt to asset Beginning cash balance 1,306 1, Debt to equity Ending cash balance 1, Net debt/(cash) to equity Interest cover (x) , IndoPremier 26