Fitch Ratings-Jakarta-24 October 2018: Indonesia’s cement producers have experienced strong growth in exports, which comes at a time when a persistent oversupply in the domestic market is likely to last for the next three to four years, Fitch Ratings says.

Fitch expects domestic demand to increase by 5%-6% per year in the next four years, but this will not enough to soak up the increased production capacity. Cement producers are therefore looking to exports to boost capacity utilisation, increase their geographical distribution, naturally hedge against some of their costs and improve revenue, even though exports have lower margins due to higher logistical costs.

Cement exports from Indonesia rose about 104% in 9M18 to nearly 3 million tonnes (mt), data from the Indonesian Cement Association (ASI) show, although the increase is from a small base. The export volume was equivalent to 8% of total cement sales in the period, up from 0.4% in 2014, indicating the potential for further increase and that Indonesian cement producers are making progress in overcoming hurdles, such as establishing brands overseas, and securing logistics and distribution channels.

More geographically diverse sources of income would be positive for cement companies’ credit profile as they can limit exposure to downturns in individual countries and offset some of the effects of prolonged domestic oversupply. Indonesia’s top export destinations are Australia, Sri Lanka, and Bangladesh. We expect Indonesia to expand in those countries and explore opportunities in other markets. PT Semen Indonesia Tbk, the nation’s largest cement producer with 36 mt of capacity, has led the way overseas and accounts for 50% of the nation’s total export sales. Other companies are beginning to follow in its wake.

Fuel costs, especially coal, are usually linked to the US dollar and account for 20%-25% of Indonesian cement makers’ production costs. Some companies also import clinkers while their investments are mainly US dollar-linked as the machinery for factories are usually imported. Increasing export sales will help Indonesian producers naturally hedge these costs and reduce their currency risks as their focus on the domestic market means revenue would otherwise be denominated only in rupiah.

Indonesian producers, however, face stiff competition from neighbouring countries also experiencing domestic oversupply, such as Thailand and Vietnam. In addition, Fitch believes exports will not be able to completely resolve the current industry utilisation rate of only 65%.

ASI’s data showed domestic cement demand grew by 4.9% yoy in 9M18, lower than 2017’s 7.8% growth to 66 mt. We estimate potential overcapacity of nearly 40% by end-2018 based on current growth and total capacity of 107 mt. Fitch expects domestic demand to increase by 5%-6%, in line with our GDP growth forecast, in the medium term with support from the acceleration of the government’s infrastructure projects and the spill-over effects on the property sector, especially after the general elections in April 2019.

We therefore expect the domestic oversupply to continue for at least another three to four years, provided producers do not add any significant capacity that will continue to pressure their profitability. The increase in export volumes will probably not result in improved profitability for producers, whose margins have been pulled down by lower prices due to oversupply and heightened competition from imports and among domestic companies, and soaring energy costs. Better-than-expected GDP growth, a faster property-sector recovery, or implementation of regulations such as an increase in cement and clinker import tax or a moratorium on new capacity may improve the balance, although this is not our base case.

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