Long memories in Indonesia
Anyone cursorily analysing the last 15 years would be amazed to see how central banks, commercial banks and money managers have, in their own ways, cheered the suppression of interest rates or manipulation of currencies. These experiments seem to bring only a surreal sense of progress on the economy. After 12-18 months, we recognise it’s doomed for failure. But then we conduct another monetary experiment. (I am writing this a couple of days after the Bank of Japan announced it will adopt negative interest rates; I wonder what the People’s Bank of China must be thinking.)
Fortunately, not all of us fall in that same category. From time to time, I do come across entrepreneurs in Asia for whom the effects of the 1997-8 financial crisis are seared into their memories. Despite all the madness around them, they are prudent in their businesses and prefer to do something old-fashioned and build businesses for the long run.
I have written about Indonesia a couple of times in the past year. Our screens are starting to show up some opportunities to invest in. As a general comment on Indonesian corporates, most of them even today hold surplus cash in US dollars. However, there are some groups, such as the Bakries, that I would never touch even with a barge pole. But close to two decades after the Asian financial crisis, most companies here still remember the events of May 1998. That experience keeps them conservative for the most part.
You may note that we own two Indonesian stocks in the portfolio’s top ten: AKR Corporation and Indofood, collectively representing 6% of the portfolio. It is quite possible that I could (if I do find the right businesses) increase my Indonesian exposure in 2016. What I observe in Indonesia today is very similar to what we found in India in 2012. An appropriate cost of capital has imposed rationality and discipline on errant businesses. Competitive dynamics have changed; companies that survive this downturn will take increasingly larger spoils of the profits in Indonesia.
AKR Corporation has been my longest-standing Indonesian holding. This is a profitable and sustainable business that, in my opinion, can survive tough conditions. The quality management team strives to create long-term growth opportunities for shareholders with their new business expansion and excellent capital management.
AKR Corporation: Strong financials despite tough times
AKR started as a distributor of chemicals, but the first transformative business it expanded into was fuel distribution. This is a very capital-intensive business that requires infrastructure such as storage tanks, pipelines, barges and last-mile delivery of fuel to customers to be set up well in advance of revenues. Once customers have confidence and build trust in the availability of fuel, it can become an annuity-type business as long as AKR’s customers’ businesses do well. Not dissimilar to cellular phone networks, scale creates a network effect. But unlike cellular networks, where spectrum is regulated, AKR experiences no government interference on its assets. From time to time fuel prices are regulated and subsidised, but that does not affect the long-term viability. For fuel distribution, winners are determined by service levels and scale of network.
On management quality, one episode captures the essence of AKR’s approach. It used to own 60% of a sorbitol (sugar alcohol) manufacturing business, listed separately on the Indonesian stock exchange. It was founded by the father of the current CEO, and there was certainly some sentimental attachment to the business. Yet the AKR management team was aware that this business was cyclical in nature and had little in common with what they were trying to build. They ended up selling the business at 29x EV/EBITDA, and structured it as a sale on the stock market, which, under Indonesian law, did not attract capital gains. They distributed the total proceeds as a special dividend.
2015 was tough for the mining industry, and some of the large coal and copper miners in Indonesia are AKR’s customers. Yet they managed to grow volume sales and deliver margins that are close to all-time highs. Think about how HDFC Bank has chipped away at market share from the public sector banks in India. AKR is doing something similar to Pertamina, which is the only other player in fuel distribution. Pertamina is state-owned and starved of capital. AKR has superior technology and service and keeps expanding its network. 2016 looks to be muted for growth, but the government has reduced subsidies for fuel sold to individuals, which could result in AKR expanding its franchised petrol stations to take advantage of that opportunity.
Indonesia is lacking in infrastructure. Three years ago, in partnership with Pelindo, a state-owned port operator, AKR started developing a deep-water port and industrial estate in Surabaya. This construction was completed in December 2015, well in time and on budget. What impressed me most, though, was that AKR borrowed funds for the project by raising a fixed tenor bond in rupiah in 2013. This was at a time when many bankers were advising Indonesian companies to borrow in US dollars, since the cost of borrowing was optically so cheap. But AKR’s prudence, combined with the fact that management wanted to match the asset-liability duration, has put it on a solid financial footing. The port is now commercially operational and the industrial estate is starting to see sale of land parcels. Things are tough, but I am convinced that this project will create value over the next 5-10 years.
AKR Corporation’s share price: Local currency returns have been overshadowed by US dollar appreciation