Indocement (INTP IJ)
10-yr bear market and 15% distribution yield - a local duopoly at 70% discount to replacement costs...
Introduction
Indocement (US$1.2b mkt cap, 8x P/E ex-cash) is a long-cycle hold/trade that easily has 3-5x potential over 5-7 years. If you are new to Apeconomics, my investment framework seeks out confluence in macro, fundamentals and technicals for the best r/r set-ups as outlined here.
Fundamentally, Indocement is the cheapest cement company (globally) in the >= US$1b market cap range, and the only one in Asia with share cannibal characteristics (9% share reduction since 2021) + lowest governance risk and highest shareholder friendliness given their cash distribution history and majority ownership by Heidelberg Materials. Within Indonesia, they are undisputably the best operators. At 5,150 IDR/share today, they trade at 6.5x EV/FCF, 4.5x EV/EBITDA on bottom cycle earnings, with a 15% distribution yield. Using a reverse DCF, current valuation implies 0 terminal growth/6x FCF exit multiple, 0 FCF growth over 10 years, on a 15% discount rate.
In other words, peak pessimism is already baked in with no volume/demand recovery in Indonesia over the long run, for an industry with no disruption/substitution risk in the foreseeable future and which typically operates as a local monopoly/oligopoly given the unit economics.
Macro: Whilst Indonesian macro under the new Prabowo administration could get worse over the next 1-3 years (and consequently cement volumes may continue to stagnate) before it gets better, on a 5-year+ horizon the odds of at least LSD p.a. volume growth is high
In May, Indocement resumed their capital return program (used to payout 100% of profits from 2016-2021 prior to a strategic acquisition in 2023), with an aggressive 12% buyback authorisation (or 30% free float) for 1 year initiated, and dividends (5% yield) announced at the AGM on 21st May. Looking ahead, large M&A is a low likelihood event (which is also signalled by the resumption of significant capital returns) given their footprint focus/area of ops. The range to accumulate is <= 5,500 IDR/share, which represents >=10% distribution yield assuming 1-2% IDR depreciation p.a. Given the resumption of sustainable and significant capital returns, this warrants a starter/half-position today.
Why the Opportunity Exists
Invisible/unfashionable industry (cement) within a neglected market (Indonesia), whilst earnings have been flat vs 2020 (as superior operators they have retained and grown market share marginally to offset industry volume contraction), the multiple has compressed drastically (-65%)
Perfect storm of supply addition and demand compression: Capacity expansions between 2015-2022 combined with a pullback in/lacklustre infrastructural spend relative to early/pre-2010s (government spending shifted focus towards non-infra projects) crushed prices for cement, peak industry utilisation of 90% in 2012 bled to low 50s in 2020 before stabilising since
Thesis/Set-up
Pre-conditions for supply discipline is here, ASPs will rise as volume picks up
In July 2023, Indonesia government introduced a non-binding moratorium on new cement plants in west & central Java where urban development is highest and where Indocement’s footprint lies
Indocement’s locality focus is concentrated in central Indonesia where urban activity and supply restrictions are the highest, which is precisely where one wants to be
Whilst non-binding, channel checks indicate no new licenses have been issued/plants are in the pipeline for Java since moratorium was introduced, with the last new capacity commissioning in 2022 (from a Chinese strategic, but that stemmed from delayed construction process due to Covid)
Volume/Demand is dependent on fiscal and real economic growth, hard to predict when volume catalyst arrives especially under the current administration. But on a 5-year view, volume growing > LSD p.a. is a high probability outcome given Indonesia’s cement per capita penetration today, which means utilisation and ASPs will slow grind upwards
One is paid to wait for demand recovery at 10-15% cash distribution yield in the interim
Indocement is by far the best managed within Indonesia, governance & capital misallocation risk are also the lowest with Heidelberg as the parent and shareholder distribution history over last decade
Brief Introduction to Cement/Aggregates
Before outlining the case for Indocement, this is a brief summary of cement/aggregates and why the industry is one of the few “cyclical compounders” within the materials space.
The unit economics parallel that of glass bottlers – essential for construction but makes up <=5% of total project spend, high weight to value ratio which makes long haul transportation economics unfavourable and hence, industry exists as local monopoly/oligopoly.
With that said, it is also important to highlight the differences between DM cement & EM cement – all else equal, pricing strength of cement in DMs is structurally higher than cement in EMs (more reliant on demand/volume pull):
As one can imagine, “not-in-my-backyard” (NIMBY) mentality is correlated with developmental stage of a country. Correspondingly, supply restrictions/barriers to entry are higher in developed markets vs emerging markets
eg. Environmental regulations pertaining to new limestone quarries in the US became much stricter post-2012 (A whole host of new regulations making it harder to open greenfield cement/aggregate facilities were rolled out between 2012-2015)
Within EMs, environmental regulations are less stringent, lower barriers to greenfield establishments and capacity additions
Ie. How cement glut arose in Indonesia, when ASEAN/Indonesia was a hot growth market in the pre/early 2010s, international strategics entered and expanded aggressively (esp. Chinese) expecting linear demand/volume growth as the government back then focused on massive infrastructural projects -> classic capital cycle when capacity came on with a 2 to 3 year lag post-2012 into the face of infra-spending scaling back (on a relative basis)
*** This is why DM cement compounds LDD p.a. with less volatility (growth algorithm = LSD volume growth + MSD-HSD pricing growth)
The industry characteristics and DM market nuances explain the following trend in cement/aggregates/limestone prices within the US – up and to the right
Contrasted with cement prices in Indonesia (2010-2024):
Business Overview
Indocement is the Indonesian subsidiary of Heidelberg Materials, they have 33.5mn tons of cement capacity across 14-integrated plants (28% capacity share within Indonesia, 60% utilisation today vs 53% industry avg.). In terms of operational footprint, they are concentrated in Java/Central Indonesia (30% market share overall -> 38% market share in Java, 21% outside Java)
Shareholders: 51% owned by Heidelberg Materials, 8% owned by Salim Group (largest Indonesian conglomerate). Effectively, 40% remaining free-float.
Investment Case
The thesis boils down to (1) Preconditions for long-cycle recovery in place, (2) Indocement are the best operators fully concentrated within major GDP contributing localities, (3) Sustainable and significant ramp-up of capital returns
(1) Supply Discipline and Pre-conditions for Long-Cycle Recovery
Capacity expansions announced during 2010-2015 when Indonesia was a hot frontier growth market resulted in the glut post-2015 as capacity came online with a lag into the face of cooling infra-spending trends relative to expectations (demand CAGR since 2016 in LSD-MSD p.a. vs LDD p.a. between 2010-2015). Today, industry is highly consolidated with top-4 accounting for 93% mkt share.
If all industry players were rational, none would consider capacity expansion at these utilisation rates and cement prices (US$55/ton), when they are trading at a fraction of replacement costs (ie. one could buy existing capacity at < 50% the cost for building a new plant). Indocement is trading at 26% of replacement costs, Semen Indonesia (SMGR) is trading at 24% of replacement costs.
It costs US$120-150/ton to for brownfield construction (based on precedents + Indocement estimate) and US$150-200/ton for greenfield, Indocement is trading at $31/ton (EV of $1b, cement capacity of 33.5mn tons)
Put simply, cement prices would need to 2x for rational actors to be incentivised to add new capacity
This is where the presence of Chinese strategics (Chinese subsidiaries of Conch cement and Hongshi Group) in Indonesia and their incremental expansions post-2018 has contributed to prolonging the glut and delaying industry recovery. However, with the moratorium imposed on construction of new cement capacity (except for East Indonesia which has little cement capacity, but an area Indocement does not operate in) by the central government in place since end-2023, I believe this will serve as a sustainable curb on any new capacity additions going forward.
Channel checks with experts confirm that there have been no new licenses granted/capacity additions within the major economic areas/where Indocement operates. It takes ~3 years for start-up of new plants, which gives credence to flat supply over medium term
Game theory perspective, SMGR (Indonesian SOE) has 50% capacity share and is a key player today -> central government has a vested interest in protecting their profit pool especially when they are barely making any net profits currently. Odds going forward of increased restrictions or at least maintenance of the moratorium status quo over 5-years until industry utilisation picks up is high
Indonesian lobby has been calling for further restrictions to ensure industry utilisation improves by 3% p.a., till a healthy 85% utilisation rate is reached (link)
(2) Indocement are the best operators in Indonesia with a strict focus within localities of greatest economic activity
As local monopolies, one wants to be with cement players that dominate localities with the highest economic activity. Indocement is the clear standout, whilst their market share within Indonesia stands at 30%, their market share within Java is closer to 40%, where they have retained and strengthened their footprint (with Semen Grobogan acquisition in Dec ’23 in central Java -> crucially enhances distribution within Java whilst also connecting West Java stronghold to Central & East Java)
Having spoken with ex-employees at Indocement, it is clear that post-covid, Indocement have also revamped their sales and distribution with various supply chain initiatives, helping them defend and gain incremental market share vs peers even as industry volumes remain challenged. Takeaways:
Restructured sales organisation to gain better data/visibility at the retailer level. Previously, they had no field sales agents gathering data to understand where the local demand resided
Today, Indocement have their own field sales agent sitting at the distributors’ and retailer level to gather and assess the local demand as well as what/how their competitors’ brands are doing. With visibility into the channels, they can direct warehouse inventory/SKUs where local demand is highest to optimise availability and enhance road to market
Their superior execution translates to superior margins, with differentials vs their main competitors seen below. Excluding acquisition, market share also crept up by 1% since Covid whilst Semen Indonesia (largest player) lost 4% market share:
(3) Significant Ramp-up in Capital Returns
Prior to acquiring Grobogan in November 2023, Indocement paid out >= 100% of profits, and that has returned with the 12% share buyback authorisation + yet to be decided dividend pending AGM.
Having spoken with IR, I do buy their rationale for acquiring Grobogan, and postponing capital returns in the interim. Whilst the headline acquisition price (1x replacement cost, US$120/ton as implied by US$357m purchase price) was not great given where Indocement is trading at, the integrated plant was newly commissioned in early 2022 and came with a limestone quarry with >50 years of reserves and resources. It was also a strategically located plant which they had targeted as early as the construction phase in 2020/21 (communicated to seller they would be interested if it ever came to the market, opportunity arose when the owner/conglomerate needed to de-lever and decided to divest the cement business after 1 year of operations).
Acquisition has strong synergies with their operational footprint both in terms of logistical costs and the distribution network (direct penetration in Central Java which they did not have previously).
Over the last few quarters, this has contributed to their costs and relative market share gain even as industry volumes remain challenged (eg. local market is right at the Grobogan plant’s doorstep, now distributes Indocement’s premium brand Tiga Roda. Previously, they had to transport cement by rail from their West Java plant which runs at 90-100% capacity for sale in Central Java. After acquisition, local market can be served directly with rail contract terminated saving on logistics cost)
There remains one other acquisition that would fit Indocement’s footprint and that is the Bosowa plant in south Sulawesi (3.5m ton capacity), which they have been leasing from the Bosowa group (conglomerate) since 2022 and currently operate. From the details of the last call and resumption of significant capital returns, both parties seem to be contented with extending the current arrangement (lease renews end of 2025 for another 3 years) and another M&A is unlikely within next 3 years.
Financials and Valuation
For estimated return profile, we can reference replacement costs and the time it takes for cycle recovery, which implies 3-4x in 5-7 years without assuming any capital returns. For reference, Holcim Indonesia was acquired by Semen Indonesia with transaction value implying US$130/ton in 2018 (when cement prices were -12% from today), thus assuming convergence to replacement costs amidst a long-cycle recovery is not just a theoretical exercise.
If we assume it takes 5 years for cycle recovery to play out (and EV of Indocement to converge to replacement costs of ~US$120/ton), that yields IRR of ~30%, without any capital returns in the interim
If we assume it takes 7 years for cycle recovery to play out (and EV of Indocement to converge to replacement costs of ~US$120/ton), that yields IRR of ~20%, without any capital returns in the interim
***Note: Consensus has sales effectively flat over 5 years (2% p.a. growth), EPS +10% over 3 years (which implies no earnings growth/cycle recovery considering the recently announced 10% share buyback)
Great thesis, really great. simple, contrarian.
It has a secondary listing in Germany too?