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Construction sector in Indonesia, an island of opportunities

  • Population growth and rising per capita income driving infrastructure and construction
  • The lack of infrastructure in the nation
  • Opportunities for housing construction sector

 

Indonesia is one of the world’s fastest-growing economies (as of 2017), it was the 16th largest economy globally. It was also the 4th most populated country in the world and had more than 33% of ASEAN’s (Association of Southeast Asian Nations) GDP. There are a total 55 million skilled workers in the country. The numbers ensure a continued robust growth especially because of a high youth population density, strong domestic consumption and increased productivity. 

The economy has seen its share of ups and downs. The growth was reasonable in much of last 4 decades up to the year 2000, wherein between 1965 and 1997 the economy grew at an average annual rate of around 7%. This enabled the nation to move from 'low-income country' to 'lower middle-income country'. However, the growth was dented by the Asian Financial Crisis in the late 1990s, this resulted in a decline of the GDP to negative 13.6% (1998) and a limited growth of 0.3% (1999). Although, after the financial crisis, there was a remarkable recovery, particularly since the mid-2000s. This was mainly led by a prudent fiscal management and strengthening economic fundamentals.

According to the current forecast by 2030, Indonesia is expected to be the 7th largest economy in the world. Moreover, roughly 71% of its people live in cities and generate nearly 81% of the GDP. The strong overall economic growth is anticipated to be mutually backed by a strong development in infrastructure and construction sector in the country. 

The nominal GDP of Indonesia is projected to increase at a CAGR of 9.34% (from 2017 to 2022) according to Statista, which is one of the fastest for emerging economies around the globe.  

At present, Indonesia's construction industry accounts for almost 10% of its GDP. The construction industry outpaced the overall economic growth for several years and the trend is likely to continue (Source: GBG Indonesia). 

Furthermore, population growth is expected to be a prime factor driving the construction industry’s value proposition. According to the United Nations 2015 World Population Prospects report, Indonesia’s population will grow to 295 million by 2030.

The population structure of Indonesia is that of a young country with the median age of 28.38 years.

This number suggests that a healthy growth will be experienced by the middle-class, which will indirectly promote domestic consumption. A rise in the income levels requires improvement in infrastructure facilities and rapid urbanisation, which needs better power and availability of energy, mid to high-quality housing, construction of roads and healthy logistics facilities amongst other in a nation. All these aspects provide a great potential for construction companies in Indonesia both domestic and foreign.

Further, as per the data by GBG, Indonesia has a backlog of approximately 13.5 million homes. Hence, each year 800,000 new housing units are needed to meet the demand. According to a World Bank report, currently, 20% of the 64.1 million housing units in Indonesia are in poor state. Additionally, the private sector provides only 400,000 units per year. The public sector offers an extra 150,000 to 200,000 units. However, still, there is a deficit of 220,000 to 370,000 houses. Badan Pusat Statistik (BPS), a government-backed institute conducted a statistical survey in the nation and found that the number of people per household was 3.9 in 2014. This number is projected to decline as high number of people are moving towards middle and consumer class, wherein the demand for housing units (residential constructions) in the upcoming years is further going to increase. This provides a great opportunity for developers and suppliers of construction materials and services. A growing consumer class will drive the demand for consumer goods, which, in turn, will increase the retail sales and the demand for retail spaces. Thus, retail construction is also expected to increase in the future.

Infrastructure is another area which is expected to see a huge investment in the future. Indonesia is severely lacking in infrastructure development despite its size and is one of the major emerging Asian economies. If infrastructure concern is not addressed, it could greatly hamper the country’s future growth. The nation lacks roads, railways and sourcing of effective and reliable electric supply. But the incumbent President has promised to increase the government’s spending on infrastructure. Addedly, Indonesia is expected to meet certain benchmarks in order to achieve the 'middle-income' status. The middle-income benchmarks are; approximately 2,650 km of roads, 1,000 km of toll roads, 15 airports, 24 seaports, 3,258 km of railways and a combined 35,000 MW of installed electricity generation capacity.  The Master Plan for the Acceleration and Expansion of Indonesia's Economic Development (MP3EI) 2011-25, pledged a mixture of government investments along with support from the private sector via public-private partnerships (PPPs). A significant spending is planned by the government under MP3EI by 2025. In addition, foreign investment is likely to increase.

In the past few years, the government’s spending on infrastructure as a percentage of the GDP has also increased from 8.5% (2010) to 16.25% (2017). This focus on infrastructure is expected to continue in the near future.

But the promised infrastructure growth has its share of challenges. One of which is the time taken on land acquisition. Another challenge is the lack of private sector involvement. The government want that 30% of the country's infrastructure should be developed by the private players, but, at present, this number is only 15%.

Political risks also impact the infrastructure development since these types of projects take a long time to complete and are somewhat susceptible to the regime change. A nation's diversity, size and inequality further increase the complexity. Further, foreign investors face a major challenge competing with the dominant state-owned firms in construction and infrastructure sectors.

Thus, in order to assess the landscape of the construction industry in Indonesia, Televisory used the Porter Five Forces Model. The results are summarised below:

1) Suppliers Power
Suppliers in this industry, supply building materials and have a low bargaining power. Hence, most items are supplied at a stated price and there is no room for price flexibility for suppliers. The switching cost to a new supplier is also low.

2) Buyer Power
The customers in this industry are large-scale infrastructure companies, State-Owned Enterprises (SOEs) or government. All these organizations have a huge bargaining power and a low switching cost. Further, all construction contracts are issued through a tender process. This cuts a part of the margins for the construction companies.

3) Threat of New Entrants
Barriers to entry in the industry are high. The existing companies generally have a working relationship and contacts with government. Also, the new participant in the industry requires a huge amount of capital to work on large projects. 

4) Threat of Substitutes
Largely, the scale of projects in the industry are big and due to the size customers do not have substitutes for construction services.

5) Competitive Rivalry
There are more than 100 large scale construction companies across Indonesia and due to the tendering process for big projects no company in the country dominate the market or possess a high bargaining power.

Overall, the industry is highly competitive wherein no single player dominates the market as stated above. The tender process helps the government to find the best bidder, though the exercise on few occasions effects the profitability of players. The pricing power lies with project owners than contractors. Nevertheless, the size of the market is big and there is enough room for existing contractors, this provides tremendous opportunities.

Televisory examined few of the top construction companies in Indonesia:

The revenue for all the companies has been rising over the years as seen from the above chart. Televisory expect the trend to continue in the future mainly due to the volume and a healthy order book of these companies.

The margins are likely to tighten in the industry due to the tendering process on project allocations and high buyer power as shown through the Porter Five Forces Model. Nevertheless, a slight increase in margins was achieved over the years and the trend is expected to continue as companies diversify their projects.

Thus, based on the analysis, Televisory believe that the revenue and net profit for WIKA and WSKT will remain strong. WSKT's order book size (~IDR 126 trillion) is well above its peers and should secure revenue growth for another 3 to 4 years. It is also a favourite to secure Indonesia's upcoming toll-road related contracts. WIKA also has a significant order book (~IDR77 trillion), which should cover their revenue estimates for the next 5 years (based on the 2016 revenue).

In the past few years, WSKT and WIKA have been able to increase their level of new contracts. WSKT seem to be in a healthy position to secure new contracts like the toll-road related contracts which are expected to be in high supply.

Hence, on the basis of the analysis, it can be concluded that the construction sector in Indonesia has a huge potential and the companies in this sector are bound to benefit from the volume of development that is yet to happen, especially in terms of infrastructure, which is highly lacking compared to peer nations. The growth in population, middle and consumer class along with government spending on infrastructure are primary drivers for optimistic projections on the construction market. A long waiting period for land acquisition, change in government focus and lack of participation from the private sector are few of the negatives that can be detrimental to the growth. Televisory presume a medium level of competitive rivalry will exist in the industry, but the companies with a large capital, contacts and healthy relations with the government and SOEs will have better chances of securing big projects, which would ensure that these firms will outperform other entities.

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