We remain OVERWEIGHT on the sector with a blanket BUY on all four state-owned contractors. Our confidence is backed by the government’s initiatives to accelerate the development of much-needed infrastructure in the country. The new government will not only boost the number of projects going forward but may also undertake capital injection in infrastructure-related state-owned companies to better leverage their balance sheets. Thus, if the government can deliver on its promises, the state-owned contractors stand to enjoy multi-year expansion growth. All in all, our Top Picks are PTPP and WSKT.
Structural changes are coming
The new government led by President Jokowi is intent on accelerating the nation’s infrastructure development to ease logistical costs. The first initiative taken by the government was the reduction in fuel subsidies which has freed up around Rp100tn of state funds. Going forward, the government will undertake other initiatives to support infrastructure development: 1) the plan to almost double the combined budget of the Public Works and Transportation Ministry from Rp111tn in FY14F to Rp205tn in the FY15F revised state budget coupled with plans to hasten project tenders by March-April 2015; 2) the State-owned Ministry’s proposal to lower dividend payouts for state-owned companies; and 3) potential capital injection from the government to state-owned companies which is directly related to infrastructure development. All in all, confidence among state-owned contractors is high and their guidance of 25-30% growth in earnings in FY15F is sensible following the flattish performance in 2014.
Capital for leverage
As state-owned contractors will see a strong multi-year supply of government projects, equity size might become a key consideration for state-owned contractors in the future. The company with the largest equity will obtain the biggest opportunity to win sizeable projects given its greater leverage. In our view, the government’s initiative to lower dividend payouts will have only a marginal impact although the government’s proposal to undertake capital injections will be the game changer, especially for PTPP and ADHI given the government’s ownership already limited at 51%. Even so, without any equity raising, we believe that the state-owned contractors are still able to handle up to Rp200tn in their order books given that the current leverage during the peak quarter is still at 2.0x (vs. covenants of 3.5-4.0x).
Valuations moving towards the peak of the cycle
With the government’s strong commitment toward infrastructure spending coupled with better execution, we believe that the state-owned contractors stand to be the direct beneficiaries of the expected infrastructure developments in the future. At current valuations, investors already appear to price in this bullish scenario of multi-year growth. Thus, valuations might move towards the peak of the cycle (+2sd above mean – 29x PE) to account for the high growth expectations. All in all, we reiterate our OVERWEIGHT call on the sector. Our Top Picks in our construction universe are PTPP (BUY, TP Rp4,100) given its strong earnings visibility and credibility in water projects that have strong potential given Jokowi’s emphasis on maritime development and WSKT (BUY, TP Rp Rp1,650) given its huge carry-over projects and the government intention of capital injection in the company. Potential upside comes from better-than-expected new contracts achievement that would directly lead to higher earnings growth. Key risks include lower-than-expected infrastructure budgets, poor government execution, and potential increases in interest rates.