• SPTO is the sole distributor of TOTO sanitary products. Its 51%-owned East Java subsidiary plans to boost its capacity by c.500k pieces (pcs) p.a.
  • An opportune time to Add as a bottoming property market will lead a demand recovery while demographics fuel secular growth in the sanitary ware market.
  • We believe product repositioning catering to the rising middle class will further ignite demand, underpinning 20% core profit CAGR over 2017-20F

Sole distributor of market-leading sanitary wares…

PT Surya Pertiwi (SPTO) is the sole distributor of TOTO sanitaryand bathroom wares in Indonesia. Euromonitor ranks TOTO the leader in sanitarywares and bathroom fittings, with 55.1% and 49.8% market share, respectively inIndonesia in 2016. SPTO distributes its products through 11 exclusivedistributors and more than 100 dealers in Jakarta and Surabaya. It also sellsto projects by established property developers.

… with exposure to the manufacturing business

SPTO sources most of itsproducts from sister company STI, based in Greater Jakarta. The group plans to expand its manufacturing capacity, namely SPTO’s 51%-owned Surya Pertiwi Nusantara (SPN), which started operations in East Java in Apr. SPN currently has one production line with annual capacity of more than 500k pcs and some nine spare lines. Recent demand from China may lift STI’s current export contribution of 30% (c.2.8m pcs p.a. capacity), necessitating a quick ramp up in SPN’s output.

A proxy for the burgeoning middle class and property recovery

Favourable demographics and a growing middle class are causing a shift from traditional toiletsto more upmarket versions. The government’s target to build 1m affordable homessuggests robust secular demand growth given Indonesia’s c.260m population andc.67m households. We project theproperty market to recover in the near term, thanks to economic, political andstimulus measures. In our view, SPTO is a good proxy for emerging middle-classconsumption and a property sector recovery.

Opportune time to Add; 20% CAGR over 2017-20F, with upside risk

We project net profit to recover, posting 20% CAGR over 2017-20F (vs. -0.7% CAGR in 2015-17). This should serve as a strong potential re-rating catalyst for the stock. We forecast margin improvement and cost savings from lower freight cost following the commencement of commercial operations of SPN’s Gresik plant in Apr 2018.

Initiating coverage with an Add and DCF-based TP of Rp1,400

With a minimum 40% payout dividend policy, we expect ROE tostabilise at an average of 21.2% over 2018-20F. SPTO was in a net cash positionat end-9M18. We initiate coverage with an Add and DCF-based TP of Rp1,400(WACC: 13.9%, beta: 1.0, LTG: 3.0%), which implies 12.8x 2019F P/E. Risks toour call are delayed property market recovery and delayed completion of SPN’sproduction lines.

PT Surya Pertiwi (SPTO) is the leading distributor of sanitarywares, bathroom fittings, and other bathroom- and kitchen-related products inIndonesia. It is the exclusive sole distributor of TOTO Ltd (5332 JT, NotRated) products in Indonesia. TOTO is a leading Japanese and globalmanufacturer of sanitary wares, bathroom fittings and related products. TOTOproducts account for more than 90% of SPTO’s sales portfolio, with theremainder made up by European brands such as Villeroy & Boch, Kaldewei, Geberit,Stiebel Eltron and Franke.

In 1968, PT MultifortunaAsindo and PT Suryaparamitra Abadi founded CV Surya, a distributor of buildingmaterials, including sanitary wares, in Indonesia. In the same year, CV Suryawas appointed the sole agent of TOTO Japan in Indonesia. In 1977, PT Multifortuna Asindo and PTSuryaparamitra Abadi, together with TOTO Japan, established a joint-venturecompany, PT Surya Toto Indonesia (STI, TOTO IJ, Not Rated), to manufacture andsell TOTO-brand products in Indonesia. In 1978, CV Surya was transformed intoits current form – PT Surya Pertiwi (SPTO).

Sanitary wares accounted for 48.2% of SPTO’s total sales in9M18, followed by bathroom fittings with 47.9% sales contribution, and 3.8%from other bathroom- and kitchen-related products. In 3Q18, SPTO gained anadditional source of rental income from its subsidiary Surya Graha Pertiwi (SGP).

SPTO distributes itsproducts through three channels: 1) more than 100 dealers in Greater Jakartaand Surabaya (contributed 42.1% to 9M18 revenue); 2) 11 exclusive distributorsin 14 major Indonesian cities outside of Greater Jakarta and Surabaya (25.1% of9M18 revenue); and 3) project-based sales to property developers e.g. CiputraGroup (CTRA IJ, Add, TP Rp1,600) and Agung Podomoro Group (APLN IJ, Not Rated)which collectively contributed 31.0% to revenue in 9M18

Wellestablished manufacturing supply chain

SPTO currently purchases c.90% of its products from its sister company PT Surya Toto Indonesia (STI, TOTO IJ, Not Rated). STI manufactures TOTO- branded sanitary wares and bathroom fittings at its facility in Tangerang. This facility is currently one of the largest sanitary ware manufacturing plants in the world; it has a total of seven production lines, with production capacity of around 2.8m pieces of sanitary wares annually.

Along with its sole domestic distributor agreement, SPTO purchased its products from STI at a fixed discount to the latter’s retail prices. STI has the sole right to determine both the retail list price and the discounts provided to SPTO; with changes to the retail list price given with two months’ prior notice, if any. Terms of payment are 90 days.

STI generally increases its retail prices annually, broadly in line with inflation. SPTO is able to pass on the price increases to its customers at most times.

We believe one of TOTO’s main strengths against its competitors is its long track record in providing better after-sales services, in addition to its huge production capacity relative to its peers.

SPTO procures c.5% of its products directly from TOTO  Overseas  Group, mostly higher-end products (e.g. Neorest ‘smart’ toilets). Similarly, TOTO Overseas Group has the sole right to determine the retail list price of its products.

The remaining c.5% are non-TOTO products that SPTO procures from other import suppliers, wherein SPTO purchases products at discounts mutually agreed on by both parties, with the retail price lists similarly solely determined by the import suppliers.

Ventured into manufacturing via Surabaya factory

Through its 51%-owned subsidiary PT Surya Pertiwi Nusantara (SPN), SPTO constructed and operates a manufacturing facility in Gresik, East Java. STI  holds the balance 49% stake in SPN. Its first production line started commercial operations at end-Apr 2018, producing approximately 500,000 pieces of sanitary wares p.a. As of Sep 2018, utilisation rate of the plant’s first production line reached c.95%, with an admirable average yield of c.83%.

In the initial stages, the Gresik factory will manufacture moremiddle-to-lower- end products, at a a cheaper price range, taking fulladvantage of the  burgeoning middle classin Indonesia and the phenomena of consumers upgrading from squatting toilets tositting ones. SPN’s first production line produces 14 types of sanitary ware.

The manufacturing facility is on 34ha of land, with capacity to house up to 10 production lines. SPN is currently constructing a second production line with similar production capacity as the first line. It aims to complete construction work in 4Q19 and have the line commercially operational by 1Q20. This second production line will produce c.23 types of sanitary ware, with approximate capacity of 500k pcs annually.

We believe construction of subsequent production lines may accelerate, in view of consistent domestic demand from both homeowners and property developers, coupled with increasing demand from TOTO China.

Currently all of SPN’s finished products are distributed for domestic use by SPTO as the sole distributor. Nevertheless, in future, SPN shall be able to  export directly upon approval from TOTO Japan, such as to TOTO China or TOTO United States of America.

We expect SPN to generate a higher EBITDA margin than STI, thanks to its much lower labour cost. Though SPN’s monthly minimum wage of Rp3.6m (Gresik, East Java) is on par with STI’s monthly minimum wage in Tangerang, STI’s labour cost is significantly higher than SPN’s as most of its employees have been working at the Tangerang factory since it began operations more  than 30 years ago and are hence paid higher than the minimum wage. In addition, STI is not allowed to hire part-time workers. We estimate that labour cost accounts for c.20% of SPN’s COGS, in stark comparison with STI’s labour cost which accounted for c.36% of STI’s COGS in 2017.

As a TOTO distributor, SPTOis not required to pay any fees to TOTO Japan. On the other hand, as a manufacturing company, SPN, like STI, isrequired to pay a royalty fee to TOTO Japan.


Shift to sitting toilets should continue, in tandem with growing middle-class

While the developed nations may have mostly converted their toilets to sitting ones, many traditional Indonesian toilets are still either simple holes on the ground in the rural areas, or at most squatting toilets in the slightly more developed areas. With urbanisation and the enormous growth of Indonesian middle class, these traditional Indonesian toilets are slowly but surely making way for more upmarket versions, e.g. from holes to squatting toilets; and from squatting toilets to sitting toilets.

In a survey by Boston Consulting Group (BCG) in 2014, 88mIndonesians were designated as affluent middle-class consumers who regularlyspent more than Rp2m per month on household expenditure. Affluent middle-classconsumers constituted c.35% of Indonesia’s population in 2014. BCG projectsthat by 2020F, this figure will almost double to 141m or 53% of Indonesia’spopulation.

Acording to Euromonitor,sitting toilets, squatting toilets, and toilet sinks and basins are the topthree largest categories by sales among sanitary wares, accounting fortwo-thirds of the total retail sales of sanitary wares in 2016. Furthermore,they are the strongest growing categories in 2012-16, with sales CAGR of 13.5%,12.9%, and 10.4%, respectively, during the period.

A similar sales growth trend was observed within SPTO, wheresales volume of sitting toilets outpaced those of squatting toilets in 2010-17– 6.8% CAGR vs. 3.4% CAGR. This shows that sitting toilets are gainingpopularity. This is a clear shift from the 2005-10 period when sitting toilets’sales volume CAGR was 9.2% vs. squatting toilets’ 12.3%.

Improving macroeconomic conditions

With Indonesia enjoying afew consecutive years of low inflation, for food in particular, supported bydecent minimum wage hikes, we believe its consumption will continue to recover, despite the risk of a one-off subsidisedfuel tariff hike which we expect to happen in 2H19F. With less concern of beingchased by tax officers post tax amnesty, middle- to upper-class consumptionshould continue to rise, which should be felt to some extent in the propertymarket.

Expectation of a better property market post presidential election

SPTO is a clear beneficiary of a recovery in the property market, especially as 31.0% of its sales (as of 9M18) are project-based, commissioned by property developers. In addition to the likelihood of the property market recovering after the presidential election, the stimulus measures that Bank of Indonesia (BI) introduced for the property sector earlier this year provide hope for the property developers.

Furthermore, despite lacklustre pre-sales in the past fewyears, the residential property price index showed no decline, just slowergrowth (Figure 23). Mortgages have also recently started to slowly pick up andshould improve further on the back of BI’s stimulus measures, in our view.

The stimulus measuresintroduced in Jul 2018 include: 1) relaxation of loan-to- value (LTV)requirements to 100% for the homebuyer’s first mortgage (zero down payment) and80-85% for subsequent mortgages; 2) raising maximum  limit of number of properties owned usingoff-plan mortgage facilities to five from two previously; and 3) acceleratingmortgage disbursements to developers on landed properties (30% of mortgagevalue disbursed upfront after loan agreement vs. 40% disbursement aftercompletion of foundation previously), effective Aug 2018.

These measures will be positive for developers, especially for their cash flow. The new mortgage disbursement requirement (c.35-40% upfront) will allow them to fully cover construction costs (30-35% of unit value), which may make them change their product mix and launches to cater more to mortgage buyers. Note that property developers’ gearing has continuously increased since 2012.

Concurrently, buyers willbenefit from a slightly lower down payment (5-10% pts lower) and mortgage price(down c.4-5% pts based on our estimate).

Benefiting from 1m housing programme and TAPERA savings programme

The One Million Houses programme is part of the government’s efforts to reduce the current housing backlog in Indonesia, and in anticipation of additional annual housing backlog of c.800,000 units. The government targets to reduce the low- cost housing backlog to 5.4m units in 2019F.

Since 2015, the governmenthas made steady progress in achieving the programme’s goal. We expect continualimprovement, supported by implementation of the TAPERA savings programme(public housing savings) in 2019.

SPTO’s move towards middle- to low class products should enableit to further benefit from the government’s 1m housing programme.

Implementation of the TAPERAsavings programme (Tabungan Perumahan Takyat or public housing savings)starting 2019, under BP TAPERA (TAPERA governing body), should speed up theimplementation of the One Million Houses programme, in our view.

The role of BP TAPERA includes the collection of TAPERA savings from employees in Indonesia, managing the TAPERA fund, and disbursing the funds to banking or financial institutions to purchase, renovate and build low-cost housing. The investment management (reinvestment) of TAPERA fund could be done with the help of investment managers and asset securitisation (or collective investment contracts) (see Figure 47).

The government has proposed that 3% be automatically deducted from each employee’s monthly salary and put into the TAPERA savings programme (each employee would have his/her own account), of which 2.5% would be contributed by the employee and the remaining 0.5% by the employer.

In the initial stage, thegovernment will only deduct savings from civil servants and employees ofgovernment agencies. The government has proposed that the scheme be expanded toemployees in the private sector within the first seven years of itsimplementation.

To optimise TAPERA’s implementation, thegovernment proposed two principles:

The value capture principle

There are two concepts proposed under the value capture principle: mixed-use and cross subsidy development. Based on our understanding, these concepts are to provide incentives for private developers to participate in the development of low-cost housing.

Local news media reported that the government might offer participating developers tax incentives, in the form of lower sales tax of 1% vs. the typical 2.5%.

·        The capex scheduling principle

There are two concepts proposed under the capex scheduling principle: availability payment scheme and mortgage-backed security.

We think the availability payment scheme is not sufficiently attractive to entice developers to join the TAPERA housing development. Under the scheme, the government will pay developers in instalments, for which the first payment will only take place after 100% project delivery. The instalment period will be as long as the concession period.

The mortgage-backed security option could be more effective, in our view. Under this scheme, the government proposes to securitise running TAPERA mortgages through Sarana Multigriya Finansial (SMF). In other words, it will put the running TAPERA mortgage payments as underlying assets to issue a mortgage-backed security. Proceeds from the mortgage-backed security issuance could be utilised to finance the next property development’s capex needs.

Sarana Mutligriya Finansial (SMF) is a 100% government-ownedstate- owned enterprise (SOE) established in 2005. It is a secondary housingfinancial institution. Going forward, the Ministry of Finance expects SMF’srole to include: 1) supporting housing programmes in touristy areas; 2)cooperating intensively in the TAPERA programme to support public housingprojects; and 3) repairing housing units, facilities, and infrastructure in theslums.

Competition dominated by a few big players

In Indonesia, the sanitary ware market is comparatively consolidated and dominated by only a few well-known international brands, such as TOTO, American Standards, and INA. According to Euromonitor, SPTO is the market leader in both sanitary wares and bathroom fittings, with 55.1% and 49.8% market share in 2016, respectively, in Indonesia.

TOTO-brand has a total of seven production lines in Indonesia, with an  estimated total annual output capacity of 2.8m units. One of its main competitors, American Standard, has a manufacturing plant in  Bogor,  with  reportedly 1m units produced annually (source: Swa magazine, 2015).

Another key competitor for TOTO in the premium sanitary ware segment is Kohler, an American brand focusing on the premium market. As reported by  local media, Kohler is in the midst of constructing its first manufacturing plant in Indonesia, located in the industrial area of Deltamas in West Java, with a total investment of around US$100m. The manufacturing plant is slated to start its operation by end-2019 and have a production capacity of around 1m units annually, targeting mainly premium hotels and condominiums.

In contrast, competition in the bathroom fittings market is more fragmented with  a large number of products imported from China. This is because consumers are less brand-conscious when choosing bathroom fittings. The top five brands of bathroom fittings in Indonesia are TOTO, Hansgrohe, Grohe, Duravit, and San- Ei.

Despite continuous growth in the totalretail value of sanitary wares and bathroom fittings, imports of these items shrunk 4.6% CAGR in 2012-16.This is likely due to the fact that manufacturers with their own manufacturingplants in Indonesia, e.g. TOTO, have continued to increase their localproduction capacity, and hence reduced the need to import.More interestingly, the majority of importedsanitary wares and bathroom fittings are from China, which cater to the lowersegment and compete based on prices. With established players such as TOTO,which command top-of-mind brand awareness, keeping price increases in line withinflation, the saleability of these Chinese products have declined. On theother hand, imports of premium products (e.g. from Germany) continue to increase


Projecting 6.5% sales CAGR in 2017-20F

SPTO posted a stable -0.7% revenue CAGR in 2015-17 amid slowing growth in consumer purchasing power and lacklustre property pre-sales. While the ASPs of its sanitary wares and bathroom fittings increased, sales volume declined in general.

Channel wise, project-based sales to property developers were the main culprit following weak demand in the property market, declining 7.6% CAGR in 2015-17, while sales to distributors and dealers held up with a positive 2.4% and 2.0% CAGR, respectively, over the same period.

We note that from 2010, SPTO’s declining sales were generally in line with the weakening discretionary spending in Indonesia (signified by retailers’ same- store-sales-growth, SSSG) and falling property pre-sales. SPTO posted an encouraging 5.7% yoy sales growth rate in 9M18, supported by the  revival  of   project-based  sales  from   property  developers  (+19%  yoy).

Meanwhile, sales to distributors were a bit slow, declining 4% yoy in 9M18, while sales to dealers were relatively flat, with 5% yoy growth.

As we expect both consumer purchasing power and demand from the property market to continue to recover slowly over the next few years, we project SPTO’s sales to improve 5.2% in 2018F, 6.6% in 2019F, and 7.8% in 2020F (6.5% sales CAGR 2017-20F). Our projections are conservative vs. company’s sales growth target of 10% p.a. over 2019-20F.

In Aug 2018, SPTO gained an additional income stream – rental income from 50%-owned Surya Graha Pertiwi’s (SGP) new office building in West Jakarta. The new office building has a total area of around 15,000 sq m spread across 15 floors, and is exclusively occupied by STI and SPTO. The first six floors of the building is used as showrooms to showcase all the branded sanitary wares carried by the group.

Strong demand for sanitary wares from China

Similar to Indonesia, many homes in the countryside of China still rely on simple open-air  pit  toilets,  while  many public  toilets  throughout  the  country  still use squatting toilets. This, and a burgeoning middle class society, should drive TOTO’s sales in the country.

Currently STI exports roughly 800k pieces of sanitary ware annually to various countries, including China. With the increasing demand from China, we estimate that STI may export around 1.0m-1.2m pieces of sanitary ware annually starting next year.

As we do not expect domestic demand to slow down anytime soon, we believe it is then necessary for SPN to continue adding a new production line every year. Furthermore, in the future, SPN shall be able to sell directly to export markets upon approval from TOTO Japan.

Though SPN’s revenue is eliminated from SPTO’s financial statement (as SPN sells its products to be distributed by SPTO), its earnings will still be consolidated. Note, however, that 49% of SPN’s earnings will be transferred to STI.

As SPN has one production line operating commercially since Apr 2018, we estimate SPTO to procure c.350k pieces of sanitary ware from SPN starting this year. Assuming an ASP of Rp350k per piece, we estimate SPN to generate Rp124bn revenue in 2018F.

Essentially SPN should be able to generate GPM of 25-30%, in our estimate, higher than STI’s 3-year average GPM of 23.8%. Nevertheless, we conservatively expect a 23% GPM for SPN in 2018F, on the back of lower production yield (higher rate of rejected products) in the first 2-3 months of its commercial operation. With estimated Rp22bn depreciation, Rp10bn interest expenses, and Rp15bn fixed cost, we project SPN to book a Rp19bn net loss in 2018F.

Nevertheless, as SPN should be able to fully utilise its first production line in 2019F, producing no less than 600k pieces of sanitary ware, we expect the company to book Rp223bn revenue, assuming a c.6% increase in ASP during the year. As its operating leverage allows fixed cost to trend down to 7.0% as percentage of sales in 2019F (12.1% of sales in 2018F), we expect SPN to be able to break even with Rp1bn net profit in 2019F.

Assuming SPN’s second production line commences commercial operation by 1Q20F, according to the company’s target, we estimate SPN’s total production capacity to reach 1.1m pieces of sanitary ware by 2020F (c.500k pieces of sanitary ware from the second line).

The second production line will produce more sophisticated items than the first line, hence the lower number of pieces produced each year. On the flipside, we project ASP to significantly increase by 10% yoy to Rp408k per unit, leading to a 102% yoy increase in revenue. With economies of scale, SPN should book Rp41bn net profit in 2020F, in our estimate. While an estimated Rp20bn (49%) shall go to STI, a Rp21bn net profit going to SPTO implies 6.1% of its 2020F earnings.

Strong 19.5% earnings CAGR in 2017-20F

As 1H18 volume growth is mainly supported by strong project-based sales instead of retail (distributors and dealers), gross profit margin declined by 0.9% pt from 24.8% in 1H17 to 23.9% in 1H18. We estimate that project-based sales earn the lowest GPM of 10-15%, while distributors’ GPM may reach 25-30% and dealers’ GPM may be close to 30%.

Nevertheless, 9M18 gross profit margin improved by 0.2% pt to 24.4%, despite project-based sales rising faster than sales from other channels. Project-based sales contributed 31.0% of 9M18 sales (vs. 27.6% in 9M17), while distributors and dealers contributed 25.1% and 42.1% of total sales in 9M18, respectively (vs. 27.6% and 42.4% in 9M17). We think that this was supported by additional margin generated from SPN’s production line.

All in, we estimate distribution GPM to narrow from 23.9% in FY17 to 22.9% in FY18F mainly due to change in customer mix. Nevertheless, with additional gross profit from SPN’s sanitaryware production, we expect blended GPM to increase by 0.8% pt yoy to 24.7% in FY18F.

As SPN gears up production, sanitaryware will be delivered from the Surabaya factory to the Eastern parts of Indonesia. We estimate that the delivery of goods from Surabaya will be c.30% cheaper per cubic meter compared to delivery from Jakarta. We expect freight cost to decline from 2.7% of sales in FY17 to 2.4% in FY18F, 2.1% in FY19F and 1.7% in FY20F.

We expect depreciation to jump from Rp2bn (0.1% of sales) in FY17 to Rp25bn (1.1% of sales) in FY18F, Rp41bn (1.7% of sales) in FY19F and Rp58bn (2.2% of sales) in FY20F, due to expansion of production lines.

Excluding the impact of the significantly higher depreciation expenses, we estimate EBITDA margin to increase by 110/210/350bp to 14.6%/16.7%/20.1% in FY18F/19F/20F, respectively.

Following its 40% free-float shares, we also see a lower tax rate of 20% in  2019F and 2020F, from 25% in 2018F. As such, we project core net profit  margin to improve by 60/250/170bp to 10.5%/12.3%/14.1% in 2018/19/20F, respectively, with core net profit increased by 19.5% CAGR in 2017-20F.

Currency risk

Around 80% of the raw materials used to manufacture sanitaryware and bathroom fittings are sourced internationally from countries such as the United Kingdom, France, Thailand, Korea, and Malaysia. These materials include industrial clay, feldspar, pottery stone, kaolin and silica sand.

As a distribution company, SPTO is not directly exposed to any currency risk as it typically passes on any price increases to the customers. In general, STI does not aggressively increase its retail price to preserve customers’ purchasing power and maintain its price competitiveness in order to discourage new entrants.

As SPTO started manufacturing its own TOTO-branded products through SPN’s Surabaya factory, we will see limited exposure to currency risk starting in 2018. In addition, the equipment used in the Surabaya factory was mostly procured internationally in US$.

Balance sheet and cash flow outlook

SPTO has a healthy 69 receivable days as of end-FY17, as it typically provides its distributors and dealers (27.9% and 46.7% of sales in FY17) with credit terms of up to 60 days, while project customers (24.6% of sales in FY17) receive longer credit terms of 60-90 days or more. Meanwhile, SPTO had a total of 101 payable days at end-FY17, mostly to its sister company and largest supplier STI. We project receivable days to increase slightly to 74 days in FY18F as  we expect project-based sales contribution to increase as a percentage of total sales, vs. distributors and dealers. Meanwhile, we expect payable days to be maintained at 101 days going forward.

As for inventory, SPTO orderes most of its products from STI two to three months in advance to be stored in SPTO’s warehouses. In FY17, SPTO had an average of 66 inventory days, which is an increase from 59 days in 2016,  notably due to consumers’ weaker than expected purchasing power. We project inventory days to rise to 106 days in 2018F following company’s policy to increase its inventory days from c.2 months to c.2.5 months as the company had mistakenly anticipated a stronger sales recovery.

As such, we expect cash cycle to lengthen to 79 days in FY18F (from 34 days in 2017) but improve to 74 days in FY19F and 69 days in FY20F.

As a distribution company, SPTO has agenerally low maintenance capex, as its three warehouses (one in Jakarta andtwo in Surabaya) are leased. Nevertheless, as its subsidiary SPN  is developing a manufacturing facility,   we estimate that SPTO will incur Rp303bn capexin FY18, Rp353bn in FY19 and Rp315bn in FY20F to develop SPN’s second and thirdproduction lines.

We expect SPTO’s FCFF to turn net positive in FY20F, with an estimated FCFF of Rp144bn (4.0% of sales). We estimate –Rp227bn FCFF in FY18F, following a significant rise in inventory days. We believe that FCFF should normalise to – Rp20bn in FY19F.

SPTO has used some of its IPO proceeds torepay a big chunk of its debt amounting to c.Rp300bn. As at end-1H18, thecompany returned to a net cash position of Rp179bn (from Rp285bn net debt atend-2017), with a net gearing  of -0.07x (net cash = negative net gearing)(from 0.98x at end-2017).

At end-9M18, SPTO’s net cash position declined to Rp95bn, with a net gearing of -0.04x, as the company took on Rp123bn short term debt (mainly for working capital), despite paying Rp43bn of its long term debt.

We are optimistic that SPTO will continue to repay its debt, with an estimated  net cash position of Rp258bn at end-FY18F (-0.21x net gearing), Rp302bn net cash at end-FY19F (-0.22x net gearing) and Rp455bn net cash at end 2020F (- 0.28x net gearing).

Historically, SPTO was always in a net cash position with the exception of 2017, when huge capex was needed for the construction of SPN Surabaya factory.

The company has set a dividend policy to distribute a minimum of 40% of its net profit, starting in FY18F. It will distribute the cash dividend on an interim basis. We expect dividend yield of 3.5-5.7% in FY18-20F, which could potentially be higher

We expect SPTO to post an average ROE of 21.2% in FY18-20F, i.e. well above most of its building material distributor and manufacturer peers, e.g. CSAP and ARNA.

This should be supported by its rising core net profit margin. (from 10.0% in  2017 to 14.1% in 2020F). However, its asset turnover should decline (from 1.1x in 2017 to 0.7x in 2020F) due to SPN’s manufacturing facility and elimination of intercompany sales, in our estimate.

Peer comparison

We compare SPTO’s historical financial performance with other Indonesian building manufacturers or distributors, such as Surya Toto Indonesia (TOTO IJ), Catur Sentosa Adiprana (CSAP IJ), Arwana Citra Mulia (ARNA IJ), Mulia Industrindo (MLIA IJ), and Kokoh Inti Arebama (KOIN IJ), from 2015-17.

Among its peers, SPTO notably has a relatively high GPM (more than 20%) alongside TOTO and ARNA. SPTO’s operations are also considerably efficient among its distribution peers, with an average EBITDA margin of 13.5% in FY15- 17, only lower than the manufacturing peers, TOTO and ARNA, with average EBITDA margins of 20.3% and 15.6%, respectively.

Similarly, SPTO’s net profit margin is also considerably high among peers with an average of 10.1% in FY15-17, only lower than TOTO’s average net profit margin of 11.2%, higher than ARNA’s 6.1% average as ARNA has higher depreciation and interest expenses.

We expect SPTO to have an average ROE of 20.4% in FY18-20F, higher than all of its peers.

Nevertheless, SPTO and TOTO experienced lacklustre sales and earnings growth in FY15-17, in contrast with ARNA and CSAP which experienced strong double-digit growth during the same period. MLIA and KOIN also reported decent mid-single digit sales CAGR, although both reported net losses in 2017.

Initiating coverage with an Add call and TPof Rp1,400

We derive our TP of Rp1,400 by using a 10-year discounted cash flow (DCF) methodology, with a 13.9% WACC, 1.0x beta, and 3.0% LTG. Our Rp1,400 TP implies an attractive 12.8x FY19 P/E.

We believe SPTO is currently undervalued at 8.7x FY19 P/E. It is trading at a 37% discount to ARNA which is currently trading at 13.9x FY19 P/E.   Moreover, the building materials manufacturers and/or distributors were valued at 18.9x 2017 P/E.

As a proxy to the property sector, SPTO is also trading at c.2% discount to the property sector valued at 9.4x FY19 P/E. Note that building materials manufacturer, Arwana Citramulia’s (ARNA IJ, Add, TP: Rp635) valuation is also positively correlated with the property sector’s valuation, which peaked at end- 2014. ARNA’s 3-year average P/E of 27.5x is at 85% premium to the property sector’s 5-year average P/E of 14.9x. Meanwhile, ARNA is currently trading at 15.6x 12M forward P/E, or a 67% premium to property sector at 9.4x 12M forward P/E.


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