Global retailers flock to the Indonesian market

Although Indonesia’s retail sector was officially added to the government’s negative investment list in April 2014, thereby prohibiting foreign ownership of smallscale enterprises, foreign investment in large-scale operations – particularly in the fast-moving consumer goods (FMCG) segment – has seen a sharp rise in recent years. Most recently, global equity investor Warburg Pincus announced plans to invest $125m in a joint venture to build shopping malls across several Indonesian cities. The nation’s 250m-strong consumer base, expanding middle class, concurrent increase in urbanisation and considerable growth in domestic consumption all offer lucrative opportunities to retail investors and should underpin strong expansion in 2015.

Chain Reaction

In April 2014 the Indonesian government officially added small-scale retail business lines to its negative investment list, closing the sector to foreign ownership. Although large-scale retail businesses were not included, new foreign retailers hoping to enter the market will now need to utilise joint ventures in franchise agreements. However, this is unlikely to deter foreign firms that have been attracted by the country’s massive consumer base, rising middle class and sector growth that reached a projected 10% in 2014. This was mainly driven by the FMCG segment, which comprised 60% of total retail demand, according to the Association of Indonesian Retailers.

These positive fundamentals are likely to bolster significant growth in the coming years, particularly in franchise FMCG outlets and big-box department stores. According to projections from research consultancy Euromonitor, sales from mini-markets and convenience stores are expected to grow at an average of 16% per year from 2013 to 2015. In the decade to 2014 the minimarket and hypermarket segments reported annual growth of 17.4% and 17.9%, respectively, according to the Jakarta Post, easily outpacing supermarkets, at just 3% per annum over the period.

Shifing Sales

According to data analytics firm Nielsen, South-east Asia’s traditional retail market, which comprises small roadside vendors and stalls, will see its 54% market share dwindle, with big retail chains and supermarkets expected to account for 53% of the regional market by 2020. Meanwhile, modern chain stores account for just 14% of sales, versus 53% in Malaysia and 63% in China, leaving room for growth.

All these factors make Indonesia’s retail market an ideal investment segment. Indeed, the country rose four spots to reach 15th place among 30 developing countries in A.T. Kearney’s 2014 Global Retail Development Index, which ranks nations based on their investment attractiveness. Indonesia stands as one of the top retail investment destinations in South Asia, ranking below Malaysia (9th) but above Sri Lanka (18th), India (20th), the Philippines (23rd) and Vietnam (28th).

Rising Inflows

Foreign investment in the sector has grown steadily in recent years, and 2013 saw several new players enter the market, including South Korea’s Lotte Shopping, France’s Galeries Lafayette and Japan’s Uniqlo. Foreign retail expansion gained momentum in late 2014, when major retailers like Swedish home store IKEA, Singapore’s Courts Asia and Thailand’s Central Department Store opened.

Indonesia has also garnered significant private equity attention over the past few years as one of Asia's prime emerging markets. US-based Kohlberg Kravis Roberts, for example, paid $42m for a 9.5% stake in listed snack food maker Tiga Pilar Sejahera Food in July 2013. In February of the same year, Singapore’s state investor Temasek Holdings announced plans to indirectly purchase a stake in Matahari Putra Prima – Indonesia’s second-largest hypermarket chain after Carrefour – in a deal worth an estimated $300m. Anderson Investments, a wholly owned unit of Temasek, signed an exchangeable rights subscription agreement with Indonesian investment company Multipolar, Matahari’s majority shareholder. The rights can be converted into a 26.1% stake in the chain, allowing Anderson Investments to stave off fierce competition from major international retailers like Wal-Mart, which reportedly had been trying to buy into the company for years. In 2010 the UK’s CVC Capital Partners led a $770m buyout of Matahari, which left the company and the Lippo-family-owned Multipolar in an 80:20 joint venture, controlling approximately 98% of the company. CVC later raised $1.55bn by trimming its stake in Matahari, first via a $1.3bn share sale in March 2013 and again in 2014 with a $215m sale of a 6.5% stake.

New Deals

Private equity investment has gathered pace in recent months. In October 2014 Malaysia’s CIMB Private Equity announced it had acquired a private stake in Modern Internasional, a retail operator and owner of the 7-Eleven convenience store franchise in Indonesia, in a deal worth an estimated $25m. The investment was made via a subscription of newly issued shares representing 10% of share capital, with the proceeds expected to be used for capital expenditure on new store openings and infrastructure upgrades.

More recently, in February 2015 the American firm Warburg Pincus announced it would enter the market with a $125m investment in a joint venture with local real estate developer Nirvana Development. The venture will focus on developing shopping centres anchored by hypermarkets across Indonesia’s second- and third-tier cities, with the option to invest an additional $75m.

Dotting the Map

Expansion into second- and third-tier cities seems to be an increasingly important factor for investors in listed Indonesian retailers, with Reuters reporting in May 2014 that although Indonesian retail stocks are trading at big premiums, investors are beginning to differentiate between companies whose earnings are sourced mainly in Jakarta, and those that are expanding outside of the capital city.

Second- and third-tier cities are projected to grow more quickly than Jakarta in the next 35 years, with the UN reporting that the country’s urban population will expand by 70% by 2050, compared to 35% for Jakarta. A 2013 Boston Consulting Group report found that growth in the middle-class and affluent consumer segment will be faster outside of Java, with the number of locations with over 500,000 such consumers expected to rise from 25 at present to 54 by 2020.

Furthermore, rising rental costs in Jakarta have eaten into retailers’ profits, while investors are increasingly avoiding Jakarta-centric firms in favour of those with a strategy that extends beyond Java. Department store and specialty retailer Mitra Adiperkasa, for example, derives 70% of its revenues from Jakarta. Although the company was trading at 21.4 times its projected annual earnings in May 2014, shares dropped by 20% between February and May of that year, whereas the Jakarta Stock Exchange was up 16% year to date. Meanwhile, Matahari, which planned to invest $43m to open 15 new outlets in 2014, half outside of Java, was pegged as a preferred investment, as evidenced by the 30% yearto-date increase in its share price as of May 2014.

Restrictions

A.T. Kearney has labelled Indonesia a promising retail market despite stringent government regulations, such as the Ministry of Trade Regulation No. 7 of 2013, which restricted the total number of stores in any food and beverage franchise to 250, as well as local content laws requiring retailers to source at least 80% of their stock from local suppliers in a bid to reduce the flow of cheap Chinese imports that have had a negative impact on domestic industry.

Retailers had faced setbacks as a result of these regulations; Mitra Adiperkasa, Burger King’s master franchise contract holder, has reported it will not be able to locally source enough beef for all its outlets, and IKEA had to have its dining plates specially manufactured in Indonesia. While this is conducive to local industry, it presents a challenge for retailers’ bottom lines.

Ease the Burden

Recognising the challenges these regulations present to the expansion of existing businesses, as well as new foreign direct investment, authorities have relaxed some restrictions in recent months. In August 2014 the government announced it would eliminate its 250-store cap on food and beverage franchises, provided the stores were already established in the country. It is also reconsidering requirements that 80% of retail products at any store are sourced locally, a move that will be welcomed by potential new entrants.

This paves the way for future expansion, and growth is on the horizon for a number of retailers. Modern Internasional plans to expand plans its portfolio of 7-Eleven stores from 176 to about 2500 by 2025, while Courts Asia has announced plans to build 10 new stores. For its part, IKEA announced in 2014 that there were some 9.5m people in greater Jakarta who could afford to shop at its stores – the same population as the entire country of Sweden, where there are 19 IKEA locations. This underscores opportunities for further expansion.