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Staying competitive in an oversupplied marketOverview of Indonesia’s cement industryOctober 2016

ContentsIndonesia’s cement industry in 2016 3

Market overview and competitive landscape 5

Industry competitiveness and profitability 9

Industry growth drivers 15

Key contacts 22

2 | Staying competitive in an oversupplied market: Overview of Indonesia’s cement industry

Indonesia’s cement industry in 2016

| 3Staying competitive in an oversupplied market: Overview of Indonesia’s cement industry

Indonesia’s cement industry in 2016

Driven by the rapid increase in production facility, Indonesia’s cement market is getting more competitive. The average profitability margin has been in downward trend in the past 4 years, as the new players are offering much lower selling price in a market that is already oversupplied in an effort to penetrate the market. Year-to-date (YTD) sales as of September 2016 is amounting to 44.7 million tons, increased slightly (2.95%) compared to last year YTD sales in the same period. However, month-to-month sales in September 2016 is declining -3.3% compared to September 2015.

By perforce, the existing players is being forced to forgo the high profit margin that they used to enjoy in the past as they have to reduce their selling price in order to defend their market share. While maintaining brand awareness should remain to be a priority, the existing players need to look after the importance of pricing strategy. In 4 months period from December 2015 to April 2016, the big three players market share have decreased by 3% from 85% as of to 82%, most notably in the region where the new entrants’ production facilities are located.

In an environment where pricing decision is a critical factor to survive in the market, it is important for the players to keep their production costs efficient as it will determined the selling price they can offer. Fortunately, the energy costs, which accounts for significant portion of the production cost, has been in downward trend.

Amid the low growth in property sector, the increase in government infrastructure spending could provide a silver lining to the cement demand. The planned infrastructure development in the Eastern Indonesia can also lead to a higher cement consumption in the anticipated future. However, it will depend whether or not the government can ensure that the increase in budget is followed by high level of absorption.

In addition to the infrastructure projects, a relief to the oversupplied condition might also come from export market, as some of the neighboring countries are still short in cement supply.


Market overview and competitive landscape


Indonesia’s property boom over the past 5 years has contributed to the surge of cement demand. Owing to its growth prospect coupled with the high margin, Indonesia has become one of the most attractive markets in the global cement industry and lured many new entrants to enter. Consequently, Indonesia was experiencing a significant increase in cement production capacity, most notably in the past couple of years. However, due to the recent slowdown in economy and property sector, cement demand was growing in much slower rate (5-6%) compared to its supply (15-18%). The property sector accounted for almost 80% of the total cement consumption in Indonesia, while the remaining comes from infrastructure projects. This resulted in an oversupplied market condition.

Rapid growth of production capacity and the slowdown in property sector growth resulting in an oversupplied condition in cement market

48.0 54.9 58.0 59.9 60.4 63.7 67.9 54.3 57.7 61.0 68.9 78.4

92.1 107.4

2011 2012 2013 2014 2015 2016F 2017F

Consumption Installed capacity

Figure 1. Indonesia domestic cement consumption

Source: BNP Paribas, DBS Vickers, Morgan Stanley, EY analysis

Figure 2. Production capacity in Indonesia’s cement industry

Market overview and competitive landscape


In ’000 tons 2014 2015 2016F 2017F

SMGR 28,600 30,450 32,700 37,200 Gresik Tuban - Jawa 14,000 15,100 15,850 18,100 Padang - Sumatera 7,300 7,300 8,050 10,300 Tonasa - Sulawesi 7,300 8,050 8,800 8,800 INTP 20,025 20,500 22,700 24,900 Bogor (9 plants) 13,325 13,800 16,000 18,200 Palimantan - West Java (2 plants) 4,100 4,100 4,100 4,100 Tarjun - Kalsel (1 plants) 2,600 2,600 2,600 2,600 Holcim 9,550 11,250 11,250 11,250 Naragong + Ciwadan, West Java 5,700 5,700 5,700 5,700 Cilacap, Central Java 3,000 3,000 3,000 3,000 Tuban, Java 850 2,550 2,550 2,550 Bosowa 3,800 5,300 6,425 6,800 Maros, South Sulawesi 2,500 2,500 2,500 2,500 Kampung Baru Batam, Riau 1,000 1,000 1,000 1,000 Banyuwangi, East Java 300 1,800 1,800 1,800 Cilegon, Banten Java 1,125 1,500 Andalas (Lafarge) 1,600 1,600 1,600 1,600 Lhok Nga, Aceh 1,600 1,600 1,600 1,600 Baturaja 2,000 2,000 2,000 2,925 South Sumatera, Lampung & Palembang 2,000 2,000 2,000 2,000 Central Sumatera, Jambi 925Kupang (NTT area) 550 850 850 850 Anhui Conch - 1,500 2,975 9,300 South Kalimatan, Tanjung 1,500 1,875 3,000 West papua 1,500 Merak, West java 1,100 3,300 South Sulawesi Maros 1,500 SCG 450 1,800 1,800 West Java, Sukabumi 450 1,800 1,800 Semen Merah Putih 750 2,000 5,750 6,750 Ganda Group - Ciwandan, Banten 750 1,750 1,750 1,750 Ganda Group - Bayah, Banten 3,000 4,000 Gresik, Jawa 250 1,000 1,000 Semen Puger - Jember, East Java 500 500 500 500 Panasia - Central Java, Banyumas 500 2,000 2,000 Jui Shin - Karawang, West Java 1,500 1,500 1,500 1,500 Total 68,875 78,400 92,050 107,375

41.6%

26.9%

13.7%

4.9% 3.0% 2.5% 2.2% 1.8% 1.5% 1.1% 0.5% 0.4%

Market share 4M16Y

Others= 18%

43.0%

27.8%

14.3%

5.2% 3.0% 2.5% 2.4% 1.4% 0.4%

SemenIndonesia

Indocement Holcim Bosowa Lafarge SemenBaturaja

Cemindo Jui Shin SemenKupang

Market share 12M15YOthers = 15%

With the addition of new entrants in the market, Indonesia’s cement market is becoming more competitive. Although the market share is still dominated by the big three players (Semen Indonesia Group, Indocementand Holcim), the new entrants have acquired 5% market share from the big 3 players since their capacities were completed in 2014–2015. In 4 months period, the big three players market share have decreased by 3% from 85% as of December 2015 to 82% as of April 2016 according to Indonesian Cement Association data.

The presence of new entrants has also driven the price competition stiffer, especially in regions outside of Java where the customers are more price sensitive and brand recognition outside of the players’ home market is low. While maintaining strong brand image might still top the cement companies’ strategy priority chart, the existing players need to put more attention to the importance of the pricing strategy and increasing utilization.

Though the market share is still dominated by the big three players,the presence of new entrants has driven the price competition stiffer

Figure 3. Market share of cement players

Big 3 = 85%

Big 3 = 82%

Source: Indonesian Cement Association (ASI)


Market overview and competitive landscape (continued)

8| Staying competitive in an oversupplied market: Overview of Indonesia’s cement industry


Industry competitiveness and profitability

In an effort to penetrate into the market, new entrants often come with significantly lower price. Accordingly, the existing market players are forced to reduce its sales price in order to defend their market share. This has resulted in lower margin and profitability of the existing market players, especially for the big three players which have been enjoying an exceptional profitability resulting from a high margin in the past.

New players have started price discounts since Q2 2015 due to increase in capacity. Prices offered by the 5 new players: Anhui Conch, Panasia, Siam Cement, Cemindo Gemilang and Jui Shin are approximately 20% lower than the big three.

Looking at the historical trend, it was evident that addition of new players had increased the competition in the market, as indicated by the fact that the gross margin of Indonesian public cement companies has been declining for 4 consecutive years while the average cement selling price was decreasing for the first time in 5 years period in 2015 as shown in the graph below.

46.3%47.7%

46.2% 45.5% 44.4%45.1% 46.9% 44.3% 42.5% 39.1%42.4% 44.1%38.9%

30.1% 33.0%37.9% 36.4%

34.6%29.2%

24.7%

42.9% 43.8%41.0%

36.8% 35.3%

2011 2012 2013 2014 2015

Indocement Semen Indonesia Semen Baturaja Holcim Average gross margin

Due to price competition, the players have been reducing their sales price resulting in a downward trend of average selling price and gross margin

Source: BNP Paribas, DBS Vickers

Figure 5. Gross margin of Indonesian public cement companies

Figure 4. Average selling price of Indonesian public cement companies

Source: CapitalIQ

902966 1,027 1,072 1,029

853 884 881947 939838 890 926 962 950

689772 828 874

777820 878 916 964 924

2011 2012 2013 2014 2015

Indocement Semen Indonesia Semen Baturaja Holcim Average selling price

-4.1%

Industry profitability and sales by segments


Source: Annual reports, EY analysis

19% 20% 21% 22% 24%

81% 80% 79% 78% 76%

2011 2012 2013 2014 2015

Bulk Bag

55.3% 55.3% 56.4% 56.3% 55.7%

23.0% 21.8% 21.0% 20.9% 21.6%

7.0% 7.4% 7.6% 7.6% 6.7%7.3% 7.5% 7.4% 7.6% 7.9%7.4% 8.0% 7.6% 7.6% 8.1%

2011 2012 2013 2014 2015

Java Sumatera Kalimantan Sulawesi Others

By type, bag cement product holds the majority of cement sales in Indonesia. In 2015, bag product accounted for 76% of the total cement sales, while bulk product only accounted for 24%. However, there was an increasing trend in bulk product sales, of which the proportion has been increasing significantly from 19% in 2011 to 24% in 2015 and is expected to reach 29% in 2017.

In term of geographical market, cement sales in Indonesia are still concentrated in Java region which in 2015 accounted for more than a half of total cement sales in Indonesia (55.7%), followed by Sumatera (21.6%), Sulawesi (7.9%) and Kalimantan, respectively.

Figure 6. Cement sales by product type

Source: Indonesia Cement Association (ASI)

Figure 7. Cement sales by geographical market

Source: Indonesia Cement Association (ASI)

Majority of cement sales in Indonesia are of bag products and mostly concentrated in Java region


Industry profitability and sales by segments (continued)

Despite of the small share in terms of percentage of sales in 2015, the regions outside of Java managed to maintain a strong growth rate amid the slowdown in economic activities with exception for Kalimantan region which was negatively affected by the plummeting commodity prices. Except for Kalimantan region, the cement sales growth is expected to gradually recover in the upcoming years. While Java region is still expected to continue its firm domination in the future, the growth rate of regions outside of Java (except Kalimantan) is forecasted to be two times faster in average.

While Java region is still expected to continue to be the main cement market, the growth rate in regions outside of Java (except Kalimantan) is forecasted to be two times faster

Figure 8. New and possible entrants in Indonesia cement industry

-10.6%

-0.2%

4.5% 5.7% 5.1%

-5.0%

4.0%

9.0%10.0% 9.0%

0.0%

5.0%

10.0% 10.0% 9.0%

Kalimantan Java Sumatra Sulawesi Others

2015 2016F 2017F

Industry profitability and sales by segments (continued)


Source: DBS Vickers

As new entrants are struggling to gain market share, we expect that the players will engage in more intense price war in the future. The ability to survive the competition is determined by how far can the players lower its selling price. Therefore, it is important for the players to achieve high utilization level as cost will decline in line with the increase in production. Through cost optimization, the players will gain pricing advantage which is the key to survive the competitive market.

However, given the continuous increase in supply and the persistent oversupplied market condition, achieving high utilization level will turn out to be a challenging task. As a matter of fact, the average utilization rate is forecasted to decline 69% in 2016 and 65% in 2017. EBITDA/ton of Semen Indonesia and Indocement are also forecasted to decline from USD19/ton and USD26/ton in 2015 to USD18/ton and USD24/ton respectively. Nonetheless, Semen Indonesia and Indocement are forecasted to perform better with utilization rate of 75%-77% by 2017E, compared to the non-big three players with utilization rate of 45% by 2017E.1)

The declining energy prices and appreciation of Rupiah against US Dollar could reduce the loss of profit resulting from lower selling price

Utilization rate


Figure 10. EBITDA/Ton (USD)

Figure 9. Indonesia cement domestic utilization

1) Morgan Stanley estimates

Source: Morgan Stanley

90% 94% 93%87%

77%69% 65%

0%

20%

40%

60%

80%

100%

2011 2012 2013 2014 2015 2016E 2017E

31 31 33 28

24 19 18

36 39 37

31 26 25 24

05

1015202530354045

2011 2012 2013 2014 2015 2016E 2017E

Semen Indonesia Indocement


Quarterly average USD/IDR Coal price

(IDR/ton)

ElectricityI-4 tariff

(IDR/kwh)

Gasoline/ diesel average

price (IDR/litre)

1Q14 11,989 957,000 732 6,000

2Q14 11,576 857,000 790 6,000

3Q14 11,798 835,000 969 6,000

4Q14 12,197 803,000 1,145 7,333

1Q15 12,717 825,000 990 6,700

2Q15 13,088 808,000 1,042 7,150

3Q15 13,667 803,000 1,081 7,150

4Q15 14,010 773,000 1,059 7,050

1Q16 13,563 704,000 954 6,350

1Q16 % q-o-q -3% -9% -10% -10%

1Q16 % y-o-y 7% -15% -4% -5%

Cost factors

Amid many pressures that restrain growth, the declining energy costs (including electricity) seem to be a lifeline for the cement industry. Considering the fact that electricity accounts for almost half of the cement manufacturers’ cost of production, the reduction in energy prices could somewhat compensate the loss of revenue resulting from lower selling price.

As of the first quarter of 2016, average coal price has been declining -15% y-o-y while average electricity tariff for I-4 class and average gasoline have been declining for -10% y-o-y in the same period.

In addition to declining energy prices, Rupiah is also appreciating against US Dollar. As of September 2016, Rupiah is held stable at around IDR13,000/USD. The appreciation should also have a positive impact as most of the manufacturing cost components are in US Dollar denomination.

The declining energy prices and appreciation of Rupiah against US Dollar could compensate the loss of revenue from lower selling price


Figure 11. Selected cement cost components



Industry growth drivers

Property growth

The weak macroeconomic condition and the long-running tight interest rate policy imposed by the Central Bank (Bank Indonesia or “BI”) has negatively affected the growth in property sector. Accordingly, the demand growth for cement products was significantly decreasing, especially in Java region where the property sector boom occurred prior to the interest rate tightening.

In an effort to stimulate economy and recover the growth in property sector, BI have cut the interest rate gradually from its peak at 7.75% as of November 2015 to 6.50% as of July 2016. However, the property price index that was barely increasing in 6 months period from December 2015 to June 2016, indicating that the sector might be lagging in responding the monetary stimulus. Thereof, the bleak outlook is likely to continue for a while until the policy takes effect.

The bleak outlook in property sector is likely to continue for a while until the decision to cut the interest rate takes effect

113.83

144.20 139.76

167.79 165.30

153.58170.90

181.64 190.02 193.13

2012 2013 2014 2015 Q2 2016

Commercial Residential (Primary Market)

Figure 13. Property Price Index

5.75%

7.75%

6.50%

4.00%4.50%5.00%5.50%6.00%6.50%7.00%7.50%8.00%

Jan-

12

Apr

-12

Jul-1

2

Oct

-12

Jan-

13

Apr

-13

Jul-1

3

Oct

-13

Jan-

14

Apr

-14

Jul-1

4

Oct

-14

Jan-

15

Apr

-15

Jul-1

5

Oct

-15

Jan-

16

Apr

-16

Jul-1

6

Figure 12. BI rate


Source: Bank Indonesia

Source: Bank Indonesia

While slow growth in property sector’s growth might seem dreadful to the cement industry, the government’s infrastructure development plan might provide a relief for the slow growth in demand.

President Joko Widodo’s administration has risen the infrastructure spending budget from IDR161 trillion in 2014 to IDR 276 trillion in 2015 as the administration campaigned to close the infrastructure quality gap with the neighboring countries. While this might sound like a good news, the government has to strive to ensure that the increase in infrastructure budget is accompanied by high level of realization.

Figure 14. Government infrastructure budget

Government capital expenditure budget

(IDR tn)

Realization of spending(IDR tn)

Absorption(%)

2011 128.7 114.2 89%

2012 174.9 145.5 83%

2013 184.3 155.9 85%

2014 177.9 154.6 87%

2015 290.3 256.31) 88%

2016 313.5 n/a n/a

The increase in government infrastructure spending could provide a relief to the demand of cement product amid the low growth in property sector

► 2,560 km new road► 1,000 km new toll road► 46,770 km existing road

Infrastructure Investment in 2015-2019

► 2,159 km inter-city train► 1,099 km commuter train

► 24 new seaports► 60 crossing port

► 15 new airports► 6 air cargo facilities

► BRT in 29 cities► MRT in 6 metropolitan

cities and 17 major cities

► New oil refinery (2 x 300k barrels capacity)

► Expansion of Cilacap and Balongan oil refineries

► 35,000 MW electricity generation program

► 33 new dams 30 hydroelectric power plants

► 1 million ha irrigation system

Figure 15. Infrastructure investment plan

Infrastructure spending


1) Temporary figure

Source: Committee for Infrastructure Provision Acceleration (KPPIP)

Source: Ministry of Finance

Overseas export market

During the last 5 years, cement demand in Sri Lanka was growing fast due to the rapid development in the services, tourism, and construction sectors. Based on data from Sri Lankan Central Bank, the cement demand in Sri Lanka has been growing from 3.8 million metric tons in 2010 to 6.3 million metric tons in 2014. However due to low domestic production, Sri Lanka is experiencing shortage of cement supply, where 70% of its cement needs is fulfilled through import.


Sri Lanka

Myanmar is one of the region’s most promising emerging markets. The growth of Myanmar's GDP and GDP/capita after the country opened up for foreign investments in recent years has resulted in an increase in consumer demand and foreign investments.

The imports are needed due to under-supply in the local market and because of the reported low-quality and high prices of domestic cement. Domestic cement demand in Myanmar is around 8 million tons/year with half of this figure imported from abroad.

Myanmar

Cambodia's demand is significantly higher than its domestic production capacity. The shortfall is made up by imports, mainly from Vietnam, and the remaining comes from Thailand and Laos. Cambodia’s demand for cement has reached 8 million tons/year and the existing three cement plants in Kampot province can only supply about half of this amount.

Cambodia

Source: Globalcement.com, Cemnet.com

Fast-growing demand, driven by development in construction sectors

Increasing foreign investment and high domestic prices

Half of the cement needs are imported from Thailand and Laos

Export market could be seen as one of the solutions to the oversupply condition as some of the neighboring countries is still short in cement supply


Brunei has one 550,000 tons/year capacity grinding plant in Muara. The country has an excess of domestic cement demand as it only has one production facility. Around 13% of the total cement needs were imported from China and Thailand.

Brunei

Cement sales have risen by 10.7% year-on-year to 13.2 million tons in the first half of 2016 due to increased government spending on infrastructure and improved private sector involvement in construction. Cement Manufacturers Association of the Philippines data shows that imports of cement grew from 4,000 tons in 2014 to 314,000 tons in 2015. Cement imports of 161,000 tons were recorded for the first quarter of 2016.

Philippines

13% of the total cement needs were imported from China and Thailand

Imports of cement grew from 4,000 tons in 2014 to 314,000 tons in 2015

Opportunity in Eastern Indonesia


69%

31%

93%

7%

90%

10%

12M15Y

12M15Y

12M15Y

68%

32%4M16Y

Sumatera

87%

13%

4M16Y

Kalimantan

77%

23%

4M16Y

Java

Big three players

Others

Tabalong, South Kalimantan

Cilegon, Banten

Ajibarang, Central Java

Sukabumi, West Java

Bekasi, West Java

Market shares of the big three players were declining 13% in Kalimantan, where Anhui Conch opened its facility. Meanwhile, in Java region where CemindoGemilang, Siam Cement Group, JuiShin and Panasia opened its facilities, the market share was only down 6%. The reason of lower decline of the big three players’ market share was possibly due to their stronger brand awareness in Java, which was their home market, compared to the other regions.

Eastern part of Indonesia (especially Irian Jaya region) might bring some opportunity as there is no cement player who has set a production facility in that area. While the demand is still low, the planned infrastructure development in the Eastern Indonesia can lead to a higher cement consumption in the near future.

Source: Indonesian Cement Association (ASI), Trimegah Securities

ConchSemen Garuda

Semen MerahPutih

SCGPT Semen Jawa Semen

Bima

While the demand remains low, the planned infrastructure development in the Eastern Indonesia can lead to a higher cement consumption in the anticipated future.


76%

24%

12M15Y

74%

26%

4M16YSulawesi

76%

24%

12M15YEastern Indonesia

77%

23%

4M16Y


Key contacts


Key Contacts

Deden RiyadiPartnerAssuranceEY Indonesia

Tel : +62 21 5289 4564Email : [email protected]

Sahala Situmorang PartnerTransaction Advisory ServicesEY Indonesia


Reuben Tirtawidjaja Senior ManagerTransaction Advisory ServicesEY Indonesia


mailto:[email protected]



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