Indonesia’s face of recovery

COVID-19 restrictions disturbed the Indonesian cement market last year, with demand and utilisation levels falling as the country continues to exhibit a significant capacity overhang. LEK Consulting provides a summary of 2020’s implications on the local cement scene and identifies key emerging themes that will shape the face of its recovery. By Manas Tamotia, LEK Consulting, Singapore.

A rapidly-developing nation with a growing population of ~271m, Indonesia’s cement demand has significantly grown in the past decade, driven by large infrastructure and development projects. Like the global cement sector, Indonesia has seen a rush of M&A activity and expansion activities consolidating the market. With 16 players, operating a capacity of ~120Mta, the Indonesian cement sector is fairly bolstered by the presence of large operators. However, like global markets, the domestic cement sector has not been precluded from the impact of the COVID-19 pandemic.

Background

From 2009-19, cement demand in Indonesia grew at a CAGR of 6.2 per cent. With ~69.9Mt of cement consumption in 2019, demand growth stemmed from large infrastructure projects and industry development. However, Indonesia exhibits significant capacity overhang as historical demand growth has been below expectations. In the last decade, capacity building has outstripped consumption growth, causing industry utilisation levels to fall from over 90 per cent in 2011 to around 60 per cent in 2019 before the onset of the pandemic.

From a supply standpoint, the industry is fairly consolidated with the top two cement companies – Semen Indonesia and Indocement – representing two-thirds of capacity. Yet the industry is quite fragmented with Chinese and domestic competitors entering the market. New entrants such as Panasia, Conch and Cemindo have also considerably contributed to capacity share, thus growing output even through the pandemic year (see Figure 1).

2020: year in review

The past year disrupted the Indonesian cement sector, as COVID-19-induced lockdowns and movement control orders stalled all public and private construction. With domestic demand witnessing significant declines (over 10 per cent lower YoY) and capacity share simultaneously growing slightly (at about a one per cent increase), industry utilisation has collapsed to the mid-50s. This level of demand contraction and industry utilisation was last seen during the Asian Financial Crisis of the late 1990s (see Figure 2).

Even though the demand outlook remained bleak, there were certain mitigating factors that offset the overall impact of COVID-19. Despite lower demand, the sector saw only a minor decline in prices. For example, Indocement reported only a 1.4 per cent price drop in 2020 even with such significant demand destruction. This may be because of the ongoing domestic price maintenance measures undertaken by cement players to ensure profitability. The focus of Tier 2 players especially seemed to be on profitability rather than just market share. Furthermore, the Indonesian antitrust committee (KPPU) recently fined industry player Conch for selling at below break-even price, which has deterred new entrants and smaller players from undercutting prices aggressively.

The market has also witnessed some compensation in exports. Semen Indonesia increased exports from 6.3Mt in 2019 to 7.7Mt in 2020, with new markets including Myanmar, Brunei Darussalam and Taiwan, while increasing sales to existing export destinations such as China, Australia, Bangladesh and others.

Lastly, lower costs also helped to reverse some of the losses caused by the pandemic. By August 2020, coal prices had declined by ~30 per cent YoY. Growth in the use of alternative fuels at key manufacturers also contributed to a reduction in production costs.

As a result, some operators maintained strong profit levels in 2020 despite the industry contractions caused by a less optimal demand landscape. Indocement, the industry giant, is indicative of this trend, as its revenues contracted 11 per cent, yet EBITDA grew 4.9 per cent and annual profit declined only 1.6 per cent. Another example is Semen Indonesia with its revenue contracting 13 per cent but EBITDA growing by 4.3 per cent.

2021: key trends

As cement plant operators and government bodies rise to the challenge of the ongoing pandemic, a few key themes will shape the Indonesian cement sector going forward. This response will be instrumental in shaping the industry outlook, even in a post-pandemic world.

Some volume recovery is to be expected within the domestic market. As the government expands its infrastructure budget by 47 per cent in 2021, some of the lost demand for cement is set to be recaptured by public sector initiatives. While in 2020 a significant portion of the infrastructure budget was redirected to the pandemic response, the 2021 budget is set to hit IDR417trn (US$28.75bn).

Moreover, the Indonesia Sovereign Wealth Fund will spend US$15-20bn on infrastructure, which is expected to improve sentiment and balance sheets of state-owned contractors. Therefore, with robust government expenditure set to reinvigorate cement demand, operators can count on the public sector facilitating some of their recovery.

However, demand from the private sector is still expected to remain subdued, which will impact players in the market as the residential and property segment accounted for ~77 per cent of total FY20 cement demand. The private property market, specifically for the small and medium-sized enterprises (SME) residential  segment (ie, less than IDR1bn) is expected to recover only in the second half of 2021.

The road to recovery will be paved by government measures, such as accelerated loan disbursement, allowing property developers to receive 90 per cent of the loan amount upfront as opposed to receiving the funds upon project completion. The government will also potentially lower mortgage rates driven by a lower policy rate and relax the loan-to-value (LTV) ratio to 100 per cent (zero per cent down payment) for mortgages.

Market expectations

Operators like Semen Indonesia and Indocement expect domestic cement volume to grow 3-5 per cent YoY in 2021. The demand is driven more by bulk sales (6-7 per cent expected growth) than bagged (2-3 per cent), given that government spending is expected to be a greater driver as opposed to private sector expenditure. Despite all the demand stimulation led by the government, volumes are unlikely to fully recover to pre-COVID-19 levels until 2023.

Apart from capturing demand, the cement industry will also continue focussing on domestic price maintenance as it did in 2020. With profitability as a key focal point for Tier 2 players, competitive practices will remain in check and regulated to discourage pricing wars which would bring down market sentiment.

As Figure 3 shows, EBITDA margins are closely linked to industry utilisation. In a bid to improve respective bottom lines, producers will also undertake operational improvements to reduce costs. These include increasing utilisation, which would consequently help industry profitability.

This article was first published in International Cement Review in June 2021.