How Indonesian firms could suffer from power tariff hikes

Increases range from 40% to 65%.

In a release, Fitch Ratings says the Indonesian government's decision to increase electricity tariffs for industrial use will have limited impact on the industrial companies that it rates. While the tariff increases will temporarily compress margins, companies will be able to gradually pass through the cost increases because of their strong market positions. In addition, electricity is not a major cost component for most of Fitch's rated industrial portfolio.

The government and the House of Representatives in January 2014 agreed to raise electricity tariffs for industrial use from 1 May 2014. The tariff increases range from 40% to 65%, and will be implemented gradually every two months from May to November 2014. The government expects to save about IDR8.9trn (USD774m) in electricity subsidies once the higher tariffs are fully implemented.

Among Fitch's rated industrial portfolio, industrial gas supplier PT Aneka Gas Industri (AGI; A-(idn)/ Stable) will be most impacted by the tariff increase. Overheads, primarily electricity, account for around 70% of AGI's manufacturing cost. Although AGI's sales contracts allow it to pass through about 60% of its total electricity cost increase to customers, AGI will still need to absorb the remaining 40% of the increase. Nevertheless, Fitch expects AGI's improved efficiency to partially offset the higher electricity cost and allow the company to post stable or slightly narrower margins in 2014.

The impact on manufacturers, such as PT Berlina Tbk (Berlina; A-(idn)/Stable), PT Japfa Comfeed Tbk (Japfa; BB-/A+(idn)/Stable), PT Fajar Surya Wisesa (Fajar; B+/A(idn)/Stable), will be more limited, since electricity cost is not a major component of their production costs. Berlina is a plastic packaging manufacturer, Japfa is an animal feed producer, and Fajar is a paper packaging manufacturer. As of end-2013, overhead costs accounted for about 20% or less of total manufacturing costs for each of these companies. All three also have strong positions in their respective markets - similar to AGI - and Fitch believes this will enable them to gradually pass through the increases to end-customers.

The electricity tariff increase will likely have little impact on palm oil producers because most of the upstream producers run mills with steam-powered generators. Overhead costs account for less than 5% of overall production costs for companies such as PT Sinar Mas Agro Resources and Technology Tbk (AA(idn)/Stable), PT Ivo Mas Tunggal (AA(idn)/Stable), and PT Sawit Mas Sejahtera (AA(idn)/Stable). The three companies are subsidiaries of Golden Agri Resources Ltd.

The higher electricity tariffs will also apply to high-end residences, shopping malls, hotels, and government offices. For PT Lippo Karawaci Tbk (Lippo, BB-/A+(idn)/ Stable), a significant proportion of its recurring income is derived from shopping malls, hospitals and hotels. For its shopping malls, Lippo charges a significant portion of the utility costs to tenants, while its market leadership in the hospital segment will allow it to pass through utility-cost increases to patients. It will have less flexibility in its hotel operations to pass through cost increases because of intense competition. However, the margin compression from the hotel operation will not materially impair Lippo's overall profile because it is not a significant cash flow contributor.

Electricity cost is also not a major operating cost component for rated retailers, PT Sumber Alfaria Trijaya Tbk (Alfamart; AA-(idn)/Stable) and PT Multipolar Tbk (Multipolar; B+/Stable). Electricity typically accounts for about 10% of total operating costs, which primarily consists of employee costs. The tariff hikes will slightly narrow margins, but Fitch believes the steady sales growth from new stores added in recent years will compensate for higher costs and allow both companies to maintain stable profitability.