Higher budgets and major plans to expand Indonesia's construction sector

As a major contributor to the country’s economy, as well as a vital part of Indonesia’s future development, the construction sector today faces some major responsibilities, as well as major challenges. The segment has experienced continuous growth in recent years on the back of economic and population expansion, while also seeing an enlargement of its expertise and overall capability – with foreign partnerships also often helping this growth in capacity. This progress has been secured in the face of major supply chain bottlenecks, with the country’s transport infrastructure marked as a key limiting factor; however, improving connectivity has long been recognised as a priority by successive governments and recent moves look set to improve conditions.

Now, that long-term recognition may be leading to a major leap forward in project roll-out. The new government is seeking to ramp up spending on infrastructure, while also undertaking a major reorganisation of the legal and administrative framework surrounding this vital work. As such, there is much for the sector to do in the years ahead, and to a large extent the success of the country’s economy depends greatly on the success of the construction sector in implementing the ambitious schemes now being outlined.

Facts & Figures

The most recent available figures from Statistics Indonesia (BPS) show that construction contributed 10.66% of GDP at current market prices in the fourth quarter of 2014. This made it the fifthlargest sector out of nine main sectors in the economy, and also represented the increasing importance of the industry, up from 9.85% in the fourth quarter of 2013 and near the recent peak of 10.75% in the last quarter of 2012. Looked at in the longer term, the overall trend has been upwards, from around 8% at the start of 2008.

As in other economies, construction very much reflects overall economic performance, although often with a time lag, with GDP itself fluctuating from 6% in 2008 to 4.5% a year later, then back up to 6.5% in 2011, 5.8% in 2013 and around 5% in 2014. The sector is also responsible for a significant share of employment. The most recent BPS data show that in August 2014, 7.28m people were employed in construction, which accounted for around 6.3% of total employment and was up from 6.35m the same month the year before. The numbers have in fact been steadily increasing over the last decade, from 4.6m in August 2004.

The Players

In terms of the number of firms in the sector, statistics for this vary due to differing definitions. The figure is usually around 100,000 companies, with a November 2014 report from the Indonesian Contractors Association (AKI) showing a total of 131,319 firms, only 131 of which were members of the association. Most of these outfits are geographically concentrated on Java. The AKI report shows only three provinces in the country with more than 10,000 construction companies registered: West, Central and East Java. Elsewhere, Sumatra, Kalimantan and Sulawesi also had substantial local construction sectors.

The AKI report states that in 2013 there were 302 foreign construction companies in Indonesia, 16 of them from other ASEAN countries and 286 non-ASEAN. This number has been on the rise in recent years, with the total number now nearly triple the 103 foreign construction companies registered in 2004. Japanese and Korean companies are the leading foreign entities, with 81 each in 2013, followed by China, with 53.

When it comes to major infrastructure projects, however, the sector is dominated by state-owned enterprises (SOEs). Leading examples of these are Wijaya Karya (WIKA), Waskita Karya, Pembangunan Perumahan and Adhi Karya. These SOEs are listed on the stock exchange, although the state holds a majority stake in each. WIKA has a 65.05% government stake, with its public shareholding divided between local (14.47%) and foreign (19.14%) investors.

The remaining 1.33% is held by WIKA’s employees. Waskita Karya has a 67.3% government share, with other stakeholders including JP Morgan Asset Management (Singapore), with 0.37%, and Amundi Singapore with 0.26% in May 2015. Pembangunan Perumahan has 51% government control, with Norges Bank Investment Management (3.86%) and Schroder Investment Management (1.67%) among the shareholders in May 2015. Adhi Karya is also 51% owned by the government, with Dimensional Fund Advisors LP (1.40%) and Schroder Investment Management (1.04%) among the company’s large individual shareholders.

Estimates for the size of the sector in 2013 also show that around 89.8% of Indonesia’s construction companies were small in size, with 9.4% considered medium and 0.8% large. At the same time, the larger groups held an estimated 85% of the contracts in 2012.

This picture is unlikely to have changed much since, with large contractors – mainly the SOEs – able to leverage their government contacts as well as economies of scale, wide ranging expertise and larger project capacity to win the most lucrative, largely government-funded contracts.

At the same time, most of the big contractors are considered generalists, rather than specialists, with project fragmentation often being the result, as contract winners find themselves having to subcontract more specialised parts of an operation. At times this subcontracting can be a cost cutting measure, with implementation being left in the hands of contractors not mentioned in the original contracts. This also leads to supply chain management issues in some cases.

Materials & Labour

Indonesia has a substantial building materials sub-sector, producing a range of products. Yet, “to a large extent, Indonesia is dominated by low-end products. Margins for local players are therefore under pressure due to imports from Vietnam and China,” Simon Linge, president-director of BlueScope Steel Indonesia, told OBG.

Many specialist products, such as high-quality steel for the railway tracks of the mass rapid transit (MRT) system, must be imported. Nonetheless, the country has resources locally to fall on, with foreign direct investment (FDI) in building materials ramping up in recent years. According to the Indonesia Investment Coordinating Board (BKPM), FDI in the non-metallic mineral industry, which includes the production of building materials and their ingredients, rose from $28.4m in 2010 to $153.8m in the fourth quarter of 2014. The number of projects invested in rose, from eight to 51.

Another valuable resource is Indonesia’s labour force, which is known for its provision of relatively low-cost services. This, along with low-cost construction materials, gives the sector a regional advantage. A survey conducted by global design, engineering and management consultancy ARCADIS in 2014 put construction costs in Indonesia at a level below that of ASEAN peers Malaysia, Thailand and the Philippines, with only Vietnam offering labour at a lower cost within the association. The report also suggested that construction price inflation was 5-6% in 2014, similar to Malaysia, but higher than Thailand or the Philippines, which were both at 3-5%. Construction cost inflation was expected to rise in Indonesia in 2015 to some 7-8% – higher than the ASEAN average – due to potential fluctuations in commodity prices and exchange rates at a time of major infrastructure programme outlay. Indeed, surging demand has placed a strain on supply, with BPS statistics suggesting wholesale prices of construction materials more than doubled between 2005 and 2012.

The November 2014 AKI report, meanwhile, states that most of the labour force (60%) is semi- or unskilled, with around 10% of the total in the “skilled experts” class and 30% as “skilled labour”. Furthermore, among the skilled classes, few have recognised certifications, with only 7.17% of skilled experts and 5.38% of skilled labourers holding accreditation.

Another issue affecting the Indonesian labour market is the hiring of workers by overseas companies, with neighbouring markets, such as Malaysia and more distant ones like the Gulf countries, recruiting Indonesians for their own construction projects. Offering higher wages, these overseas projects can drain Indonesia of skilled workers. However, over the longer run these foreign opportunities can also add to the sector’s level of experience and expertise as these workers return home. Nevertheless, the overall number of Indonesian workers going abroad has been falling in recent years, as local economic growth absorbs capacity, and controversy has grown over the conditions and treatment of some workers who go abroad.

Cementing Changes

Cement supplies are key to any construction materials sector, with the Indonesian Cement Association (ASI) representing this market segment in the country. According to ASI, cement sales in the country in 2014 stood at 60m tonnes, up 3.3% on 2013. In early 2015 sales were lower than expected in the first month, dropping 2.9% year-on-year (y-o-y) due to heavy rains. Construction activity in the country is generally influenced by the weather, with the building cycle tending to follow the tropical monsoon cycle, with January seeing the heaviest rains on Java, at an average rainfall of 335 mm, with this dropping to around 50 mm in August.

The largest cement producer in the country is the SOE Semen Indonesia, which has 11 consolidated subsidiaries in the construction materials and equipment trade. These subsidiaries include two other major cement producers, Semen Padang and Semen Tonasa. The company’s revenue for 2014 was Rp26.9trn ($2.22bn), according to its fourth-quarter 2014 report, up 10.1% y-o-y, while gross profit rose 6% over the same period, to Rp11trn ($909.26m). The company’s total sales volume also rose over the 12 months, by 2.6%, to reach 28.5m tonnes of cement, with 26.1m tonnes of that sold domestically, a rise of 2.8%.

Meeting Demand

According to the report, Indonesia’s 2014 domestic cement consumption increased by 3.3% y-o-y, to reach approximately 59.9m tonnes, giving Semen Indonesia a 43.6% local market share. Over the period, Indonesia’s cement and clinker exports fell from some 575,000 tonnes to about 265,000 tonnes, largely due to higher domestic demand. In terms of demand, Java is Semen Indonesia’s main market, accounting for 56.3% of the firm’s domestic business.

Sumatra comes second at 20.9%, with Kalimantan and Sulawesi at 7.6% each. As an indicator of construction activity – as well as logistical issues – the whole of eastern Indonesia (principally Maluku and Papua) accounts for 2.1% of total consumption.

The second-largest cement producer is Indocement Tunggal Prakarsa (INTP), which had a 30.3% market share in 2014. INTP’s largest shareholder is the British-based Heidelberg Cement subsidiary, Birchwood Omnia, which has a 51% stake. Mekar Perkasa has 13.03%, with the rest of the shares traded publically. Total annual production capacity is 20.5m tonnes of cement from 12 plants, with 11 in West Java and one in Kalimantan.

Holcim holds third position, with 14.6%, giving the big three cement sector companies 88.5% of the Indonesian market between them, making it highly concentrated. Holcim has a total annual capacity of 11m tonnes of cement and clinker, produced by three plants in west, central and east Java, plus a grinding facility at Ciwandan-Banten and two aggregate quarries, one in west and the other in east Java. It has a wholly owned subsidiary in Holcim Beton, and was one of the first firms listed on the Indonesia Stock Exchange.

Despite these three giants, Indonesia’s per capita cement consumption remains below that of its regional peers. According to figures from INTP for 2013, consumption was 229 kg per person that year – up 60% from the figure of 143 kg per person recorded in 2005, but still less than the 493 kg per person average for Thailand, and 664 kg per person for Vietnam. This indicates a considerable amount of upside, with plans for infrastructure development in the years ahead likely to see some of this come into play.

Iron in the Soul

In terms of construction metals, the largest firm is state-owned Krakatau Steel. The company held an initial public offering in 2010, and according to its most recent annual report in 2013, has an annual steel production capacity of 3.15m tonnes. The firm produces hot-rolled carbon steel (HRC), cold-rolled carbon steel (CRC) and wire rods, while its subsidiaries produce spiral and electrical resistant welding pipes, reinforcing bars (rebar) and section steel. The firm is boosting annual HRC capacity, targeting an addition of 1.5m tonnes by 2017 in an expansion project.

As with other materials producers, the company has seen a decline in sales value in recent times, even as volumes have increased, due to general deflation in commodity prices. In volume terms, 2013 sales were up by 3% y-o-y, to 2.38m tonnes, but in dollar terms they fell by 8.9% to $2.08bn. This trend continued in 2014, according to press reports, with the company suffering a net loss of $149.8m.

This was largely derived from the operations of the company’s Cilegon-Banten plant, Krakatau-Posco, a $2.66bn joint venture with South Korea’s Posco. Karkatau officials put the growing losses, with the 2014 figure 10 times that of 2013, to a decline in both slab and plate selling prices and weak global steel demand at a time of oversupply. South-east Asian steel prices fell by around 17.5% in 2014, to $460 per tonne, with China dropping its prices still further.

This is a challenge for the sub-sector, particularly as the need for steel is rising, with a shortfall between domestic steel production and domestic demand. Falling prices make returns on investments to cover the gap less attractive, with contractors increasingly relying on imports to make up the difference. In 2013, for example, domestic steel demand totalled about 14m tonnes, while domestic production was around 7m tonnes.

This gap, however, has presented opportunities and, indeed, has attracted foreign players to the market, with a good example being Japan’s Mitsubishi Steel Manufacturing and Nippon Steel & Sumitomo Metal’s acquisition of Indonesia’s Jatim Steel Manufacturing.

Yet, for the steel industry to meet the challenge of the major new infrastructure roll-out programme, some wider action may need to be taken. “The government needs to take measures looking at the whole value chain in the local steel industry,” Linge told OBG.

Ceramics & More

Indonesia has good quantities of silicas, clays and feldspar, giving it a strong domestic ceramics industry. This produced 3.3% of the entire world’s ceramics in 2013, according to Ceramic World Review, while the country also consumed 3.1% of global supply. Much of this is connected to the boom in real estate. In 2013 Indonesia produced 390m sq metres of ceramic tiles, consuming 360m sq metres. Both figures were up on the previous year’s totals of 360m sq metres and 340m sq metres, respectively. The ceramics sector is also less concentrated than cement or steel, with more than 20 large-scale manufacturers. The largest is Muliakeramik Indahraya, which has an annual production capacity of 62m sq metres, followed by Arwana Citramulia, with 50m sq metres.

As with steel, however, oversupply has weakened ceramic tile prices in recent times, with figures from the Indonesian Ceramic Industry Association (ASAKI) suggesting a recent 30% fall in prices in East Java in particular, where demand and competition is highest.

A particular challenge faced by the ceramics segment is energy, with gas-fired kilns requiring a reliable, plentiful supply of natural gas. While Indonesia has plenty of its own natural gas, the challenge is in distribution, with pipe networks part of the infrastructure that the country needs to develop (see Energy chapter). This concentrates the ceramics sector in particular areas, where a supply can be guaranteed, leaving distribution, usually by road, as an additional logistical cost.

Another challenge is the refining of raw materials, with a lack of higher-end facilities meaning that ceramics producers often have to rely on imported refined products, such as zirconium silicate.

Many of these constraints – and opportunities – also apply to the domestic glass, paints and plastics industries, with demand growing as the country’s economy and population expands. These segments have benefitted from rising demand for real estate, as well as from growing demand in the automotive sector.

Top-Down Support

With the election of Indonesia’s new president, Joko Widodo, in 2014 the government indicated a major shift towards infrastructure spend, with transport in particular the focus. The revised annual budget for 2015 thus sets state spending at an historic high of Rp1980trn ($163.7bn).

Capital expenditure is almost doubled under the plan, with the Ministries of Public Works and Transportation both receiving budget increases, while the central government allocation for infrastructure was up nearly 50%, at Rp290trn ($24bn). Cuts in fuel subsidies are providing much of the revenue boost for this, creating some $18bn in savings for these investments. Publicprivate partnerships (PPP) are also expected to bring private sector investment.

The construction sector thus faces the enormous challenge of implementing this programme. The signs are that local capacity is growing to meet this demand. “The building construction industry in Indonesia is slowly moving towards a full service kind of solution,” Linge said. “The market is becoming more sophisticated.”

An increasing focus on green construction is also attracting more attention across the sector. Artha Debang, president-director of local developer Jendriko Silalahi, told OBG, “Developing energy-efficient buildings is more of a moral issue that needs to be encouraged from the regulating bodies. More support from the government will help give green construction projects a push in this market.”

Outlook

The year ahead will likely see Indonesian construction companies taking on increasingly large and complex projects. Yet, the need for foreign expertise and investment remains strong. Many of these projects require the import of higher-end building materials, with many new supply contracts likely to be signed. Indonesia is also looking to boost its PPP success rate, with a recognition that the government will have to do more of the heavy lifting this time around to boost confidence.