Concurrent with the announcement of the second fuel-price cut on Jan. 16, President Joko '€œJokowi'€ Widodo dropped a bombshell on Indonesia'€™s cement industry by declaring a price reduction on state-controlled Semen Indonesia'€™s (SMGR) cement selling price, which ranges from Rp 51,000 (US$4.08) and Rp 53,000 depending on the region, by Rp 3,000 per 50-kilogram bag, translating to around a 6 percent average selling price (ASP) decline, effective Jan. 19.

We believe that this government'€™s intervention on cement prices was aimed at supporting Indonesia'€™s infrastructure development in the hope of achieving 7 percent gross domestic product (GDP) growth for the country.

As SMGR has the biggest domestic market share (44 percent in 2014) and broadest distribution network across the archipelago, other players have followed SMGR'€™s move and dropped their prices accordingly. This would create earlier-than-expected price competition, which we previously expected only to occur in 2016, following a 25.9 million capacity increase (26 percent of the enlarged capacity, 99.2 million tons) in 2015-16.

Consequently, we revise down our 2015 ASP assumptions on the four listed companies under our coverage by an average 4 percent.

Following our lower price assumptions, we have reduced the cement industry'€™s gross margin estimates by 2-4 percent to 27-40 percent.

Previously, Indonesia had a relatively robust average earnings before interest, taxes, depreciation and amortization (EBITDA) margin (2015 forecast of 32 percent) compared to other Asian countries (24 percent), although post this announcement, the country'€™s EBITDA would decrease to 28 percent. Note that every 1 percent change in price carries an adverse impact to earnings of 2-10 percent with Indocement Tunggal Prakarsa (INTP) being the least impacted and Holcim Indonesia (SMCB) being the worst hit.

Following the consolidation in cement volume growth of 3.3 percent year-on-year (y-o-y) in 2014, we expect a gradual pickup this year before further volume acceleration in following years. That said, 2015-2016 domestic volumes are expected to grow 4.8 percent and 6.0 percent respectively, helped by increased infrastructure spending and pickup in property sales. However, the expected increase in demand is unlikely to provide price support as new additional supplies start to kick in, coming from both existing and new players. Hence, lower production utilization is anticipated, leading to further pressure in selling prices ahead (table 1).

On a brighter note, the recent subsidized-fuel price reduction from Rp 7,600 per liter to Rp 6,600 would result in lower transportation costs, about 17 percent of cost of goods sold (COGS).

Additionally, the current global oil price downtrend has helped cement producers to secure lower cost of packaging (some 7 percent of COGS). Extended low coal (around 22 percent of COGS) prices in the past 12 months, down by over 20 percent, would also provide some support in margins. Note that this transportation, packaging and coal accounts for approximately 50 percent of production costs.

The cement industry landscape following the price-cut announcement will become more beneficial for bigger players such as SMGR and INTP on the back of their higher production capacity (SMGR'€™s 2015 capacity is 33 million tons; INTP'€™s is 21 million tons), having nearly 64 percent of the industry'€™s total capacity. Despite potential volume growth, margin pressures would result in earnings contractions over the next two years.

This lower-than-expected price cut signals unfavorable operating conditions within the cement sector. Meanwhile, the accelerated growth in capacity, exceeding growth in consumption, would continue to result in selling-price pressures, spelling bad news for margins ahead. This challenging outlook has made valuations less attractive, leading us to underweight the sector.

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Teguh Hartanto and Bob Setiadi are associate director and research analyst, respectively, of PT Bahana Securities research department.