Category: Reflection

According to the critics, a decline in terms of trade would indicate that farmers’ economic position is deteriorating and thus that the reform program is ineffective.
While such conclusion might be an intuitive one, it’s not necessarily the right one.

This is because the terms of trade as calculated by the Indonesian Statistics Agency BPS only signals the relative development of input and output prices, but tells nothing about sales quantity and input quality.

As such, it may not say much about farmers’ income either. Let us explain.

Farmers’ output and input price index is calculated based on Laspeyres price index, the formula is as follow:

Qo means the quantity is a constant factor hence increase in crops harvest does not affect the index.

For example, due to larger supply, a year with a good harvest may yield lower average sales prices as compared to the previous year.

This sales price decline would deteriorate the terms of trade. Yet, due to the higher quantity sold, the good harvest is likely to bring in more money for each farmer as compared to a bad harvest sold at higher prices due to shortage of supply.

Also, the terms of trade measure says nothing about the quality of the inputs. For example, the adoption of higher quality inputs – such as the more expensive, but higher yielding hybrid seeds – may increase input costs.

This would deteriorate the terms of trade. Yet, the higher production yields following the use of these higher quality inputs are not captured in the terms of trade calculation.
We believe the efforts made by the government are primarily aimed at improving the three drivers of production: the surface used for agriculture, yields per hectare and the number of plantings per year.

The terms of trade captures exactly none of these drivers. As such, we may quickly dismiss the usage of terms of trade as a suitable measure to assess the effectiveness of the government reform efforts in the agricultural sector.

BPS and The Indonesian Center for Agricultural Socio Economic and Policy Studies are fully aware that this metric does not measure farmer’s income and they are taking steps to improve the methodology to account for this.

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Are farmers in Indonesia a happy lot?

In the past few years, Heyokha team has been traveling to many provinces in Indonesia to meet and talk to people from different walk of life. One group that represents a stand out is farmers.

We believe that the farmers’ good mood has something to do with commitment and efforts by the government to deliver a tangible reform in the agri sector. Following similar steps previously taken by Japan, Korea, Taiwan, and China, Indonesia is currently in the beginning of a long agri reform agenda to lift “small long-forgotten people” out from poverty and towards achieving food self-sufficiency.

Just like any new initiative, you are bound to get criticism from skeptics. Each initiative will have pros and cons. We are not here to debate what works best. There is no perfect solution. Instead, we think it is more meaningful to let the farmers be the judge.

A new survey by a credible political think tank CSIS has some interesting findings.

Of course, the most important finding from the survey is that President Jokowi electability rating went up by 9 percentage points from 41.9% in 2016 to 50.9% in 2017.

Source: CSIS survey in September 2017

Overall public satisfaction is also moving up to 68.3%, the highest ever since President Jokowi took office.

Other than the main obvious findings, one area that we would like to focus on is the fact that President Jokowi has the highest approval rating among farmers across all occupational categories.

Support from farmers is gaining ground, even stronger than the finding from the similar survey in Sept 2016.

Source: CSIS survey in September 2017

It must be recognised that the government reform program is not without its shortcomings. Overall, however, this high approval rate from farmer confirms our on the ground observation that farmers are indeed a happy lot.

If the government is announcing big reforms in agriculture, but the farmers were not seeing the results, you can bet they wouldn’t be happy about it. Pure and simple.

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Jungle night trekking, from anxiety to serenity
Mud-drenched clothes, legs covered by leeches, it didn’t seem to matter anymore after the darkness fell in the jungle. It was pitch black, and only where we pointed our flashlights could we anxiously try figure out what we were seeing. We heard cracking sounds in the dense vegetation around us. Was it coming for us? One thing is for sure, in the dark our mind is impeccable at seeing things that are not there. This didn’t seem to apply to our Dayak guide though, who effortlessly led us over slippery mud paths and deep canyons.

How much longer? We asked him. Oh, it’s just a cigarette smoke away now, he replied. Good, good… Three (!) hours later, we made it to the waters. It was then, when we reached the center of the serene, that we realized the Kalimantan Jungle was like a treasure in the deep sea, a beauty in the darkness…

Spending a lot of time in cities and farmlands, Heyokha team thought it was time to take it to the next level: we made a trip to the virgin forest area of Mahakam Hulu in East Kalimantan, Borneo.

Besides the things we learned during the trip that are relevant for our business, we witnessed wild life in its purest form: we believe we saw the awesome Malayan Porcupine, Rhinoceros Hornbill, Oriental Pied Hornbill, Black Spitting Cobra, Brahminy Kite and, to less high profile – but nevertheless as fascinating – stick insects, giant ants, leeches (sticking to our legs), loudly buzzing insects, and many type of frogs.

While the whole experience was astonishing, it was also very exhausting as most of the trip was made over bumpy muddy paths, either by four-wheel-drive or on foot… We think that if the infrastructure was better developed, this rain forest trip could easily be one of the most popular excursion trips in the world.

Anyway, on a more serious note, the trip enabled us to confirm with locals that the government’s objective to redistribute idle land to the people is already in progress. In addition, we came across the vast assets of a forestry company that may be interesting to look at. We will elaborate more below.

Land redistribution started
As we wrote earlier in this report and in our blog “No title No glory”, the size of idle state-owned company land that is to be redistributed to Indonesian farmers is staggering. Currently, the Environment and Forestry Ministry and the National Land Agency have each earmarked 12.7 million and 9 million hectares respectively to be redistributed.

We further wrote that, to support the redistribution of the land, the government planned to introduce the draft land bill (the first bill to support the Agrarian Law) into the House of Representative in the first week of June 2017 for deliberation. The bill would provide legal certainty on land rights such as the right to use (HGU) and rights to build (HGB) and to introduce new concepts such as rights to the earth below a plot of land called subterranean rights.

June has passed and the bill is still under review. Although no passed yet, it is still expected to be passed later this year. In practice however, the government is already redistributing land, we found out.

During the long trip through Borneo, all the way up to the Malaysian border we met military personnel who were being deployed to watch the border between Indonesia and Malaysia. They were telling us that in the border area, farmland is actively being converted to prevent loss of land to Malaysia as happened in two small islands. A win-win solution that strengthens boarder protection and creates income for farmers.

Can the most distressed asset in Indonesia stage a comeback?
Part of our exiting trip was hosted by SLJ Global (SULI IJ), Indonesia’s largest integrated forestry company. This allowed us to visit their 800,000 ha natural forestry concession area and to stay in their humble camp in the middle of the Borneo rainforest.

An extremely challenging operational landscape

Other than enjoying the astonishing view, we also learned about how the company – active in a heavily regulated industry – managed to survive amid a bombardment of export bans, declining timber prices and hundreds of social and environmental issue cases.

The strongest blow to the company was the log and lumber export ban imposed by the government in 2004. This forced the company to locally process the logs into plywood and medium density fiberboard (MDF), a lower margin business with larger working capital requirements. It was only a matter of time before debt covenants were breached and production facilities were seized by its bankers. At the brink of being decimated, the recovery of plywood prices allowed a great escape, enabling the company to renegotiate with its bankers and restructure its loans in 2014 and early 2017.

With production facilities being back in operation again, the company could generate cash flow that is sufficient to service its debt and interest obligation and fund its working capital expansion.

There are some further upsides that may play out in the future. First of all, the architecture trend moving back towards wooden materials as reported by FT. For practical reasons: timber is beautiful, lightweight, and (learning from our trip to Kalimantan) actually sustainable.

Cross laminated timber (CLT) is expected to stage a comeback for timber as a building material for construction.

Secondly, the plans of the U.S. government to impose import duty on Chinese and Canadian exports (the largest timber exporters in the world) is expected to increase timber prices in the U.S. With the U.S being SULI’s main market, we believe it will boost the company’s profitability.

Thirdly, based on our conversations with Indonesian timber companies, there is the expectation that the government will at some point appreciate that the export bans – that are aimed at increasing value adding activities on Indonesian soil – are actually destroying value in the timber industry.

The thing is that the quality of Indonesian logs and lumber are internationally considered to be of premium quality. Processing it into lower grade products is seen by some as an equivalent to making bakso (meatballs) from Kobe beef. Therefore, industry insiders would not be surprised if the government will lift the export bans at some point. This would propel profits as the logs are now selling at massive discounts in the domestic market.

Lastly, the international scheme for carbon credit trading seems to be lucrative for forestry companies, who can earn money for reducing logging activities. If the Indonesian government was to adopt carbon credit trading, this could be a major upside to the firm’s profitability.

Global timber ETF making a new high as it becomes a popular choice for inflation-hedged

With such upside potential, and current depressed valuation, this company may be worth to be given a second look especially with iShare global timber ETF making a new high.

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We recently attended the Maybank Bali Marathon and couldn’t help but noticing an interesting and recurring phenomenon.

To the credit of the event organiser, a good number of portable toilets was made available to the 10,000+ runners who attended this year.

Oddly, however, we saw some of the portable toilets having very long queues while others seemed abandoned.

Out of curiosity, we asked the people standing in queue around us what was wrong with the abandoned toilets and it appeared that nobody knew the reason.

At the same time, no one was willing to take the risk of losing their spot in the queue only to learn that the abandoned toilets were “undesired” for a good reason.

In contrast to what a believer in the efficient market hypothesis (EMH) would have expected, we found out that the ignored toilets were actually clean and worked perfectly fine.

We have experienced many similar situations in our lives, of course, but time and time again it’s just astonishing to see human’s tendency to follow the crowds.

But, as the large number of people suddenly queuing behind us showed, it sometimes only takes one contrarian – who desperately needed to take leak – to shift the crowds to the other side…

 

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In our fourth quarter 2015 report, we referred to a book titled “How Asia Works” by Joe Studwell. In this insightful book, the author pointed out that with most resources often being concentrated in agriculture, this sector offers poor countries the most direct and immediate opportunity to increase economic output. Yet, (concentrated) land ownership by landlords is often preventing tenant farmers from creating wealth for themselves. For this reason, it is important that land ownership is not too concentrated and that farmer can obtain legal title to the land they farm. Besides increasing farmers’ income, this has also proven to increase production output.

In addition to having a better sense of ownership, farmers can use the legal title to their land to obtain funding for production inputs such as seeds, fertilisers, beasts of burden and machinery. In return, enabling farmers to create wealth initiates a virtuous circle such as higher productivity, higher consumer good demand, better trade balance, and more room for industrial investments.

The importance of land ownership is also stressed in the book “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else” written by the Peruvian economist Hernando de Soto. The author argues that the major stumbling block that keeps the world outside the West from benefiting from capitalism, is its inability to produce capital.

However, de Soto’s extensive research(block by block and farm by farm) in Asia, Africa, the Middle East, and Latin America suggests that most of the poor already possess the assets they need to make a success of capitalism. Even in the poorest countries, the poor save money.

Yet, they hold these resources in defective forms: houses built on land for which ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located in areas where financiers and investors cannot see them.

Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of a narrow local circle where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.

The world outside the West lacks the representational process that allows every parcel of land, every building, every piece of equipment, is represented in a property document. This is the sign of vast hidden process connects all these assets to the rest of the economy. They have houses and land but no titles; crops but no deeds; business but not statutes of incorporation. It is the unavailability of these essential representations that explains why many parts outside the West have not been able to produce sufficient capital to make their domestic capitalism works.

Indonesian government making crucial steps in support of farmers
The administration of President Jokowi appears to agree that agriculture and land reforms are an important stepping stone to Indonesia’s transformation, as the Indonesian land reform program is about to gain momentum.

We have been writing extensively about the agrarian and farming reform programs as being one of the key pillars for the Jokowi administration.

According to data from the Indonesian Coordinating Minister for Economic Affairs, at least 5 million farmer households left the agricultural sector between 2003 and 2013. These people moved to jobs in the informal sector, working in urban areas and abroad. Many farmers who remain in the agricultural sector either own relatively small plots of land or have sold all the land that they owned. This resulted in a low rate of land ownership among the farmers.

President Jokowi is about to redistribute assets and further reform the agrarian sector. The government will begin distributing concessions to the (indigenous) people, cooperatives, and Islamic schools, as well as distributing land certificates to communities.

The size of the land that is to be redistributed is staggering. Currently, the Environment and Forestry Ministry and the National Land Agency are respectively earmarking 12.7 million and 9 million hectares, to support the program. To put this into perspective, the total land to be re-distributed, i.e. 21.7million ha is even bigger than the current total paddy and corn harvest area combined (19.2mn ha). Assuming that all the distributed land will be used to plant rice and corn, the wealth creation would be around some US$ 40 billion (4.6% of Indonesia GDP), just from agriculture output alone.

In support of the land redistribution scheme, the national land agency (BPN) under the Agrarian and Spatial Planning Ministry aims to issue 5 million land ownership certificates this year, while the goals for 2018 and 2019 are 7 million and 9 million certificates, respectively. They have issued about 250,000 land ownership certificates per May 2017. If this program will be executed according to plan, all the land in this country will be registered by 2025.

To support the redistribution of the land, the government plans to introduce the draft land bill (the first bill to support the Agrarian Law) into the House of Representative in the first week of June 2017 for deliberation. The bill would provide legal certainty on land rights such as the right to use (HGU) and rights to build (HGB) and to introduce new concepts such as rights to the earth below a plot of land called subterranean rights. With the land redistribution program and agrarian reforms, President Jokowi provides a way for people to provide secure collateral to the banks.

Heyokha has validated the progress on the ground…
Our post sell-side experience gives us a new meaning to the words “off the beaten track”. We trust that embarking on a journey of discovery and getting our feet dirty provides us with unique first-hand experiences. This allows us to discover new ideas or angles for our investment thesis.

During our trip to West Nusa Tenggara province in Indonesia in the third quarter of 2016, for example, we witnessed how the regent of Dompu (in West Nusa Tenggara), Bambang Yasin, embarked on a program to allow farmers to convert “forest land” into farmland so that they can plant corn.

Together with a pro-farmer infrastructure build-up, the corn planting program transformed the poor Dompu into a high growth area. With this corn belt program, the poverty rate was reduced from 23% in 2010 to only 12% in 2015. Click here for our 3Q 2016 report.

Moreover, during an earlier trip to the fishing villages in Kendal, Central Java, we learned that the Jokowi government has been speeding up the process of granting land certificates to the fishermen as well.

…and we have high expectations about the results
We also learn from attending a recent presentation by the Minister of Villages, Disadvantaged Regions and Transmigration, Mr Eko Putro Sandjojo that 82% of the villages in Indonesia rely on agriculture. As such, it is safe to assume that a solution aimed at making villages prosperous would need to back farmers.

Source: Ministry of Village, Disadvantage Region, and Transmigration
Note: In general, poverty rates are significantly higher in villages as compared to urban areas (14% in village vs. 7.4% in rural). We think that income inequality can be reduced by agriculture and agrarian reforms.

After providing a lot of supports for farmers, the government is now working on the crucial part of the agri puzzle, i.e. access to land and legal title of the land. We expect this to translate into better capital formation and increasing farmers’ productivity.

The Dompu case described above is a good proof of concept to significantly increase employment and wealth. Copy and paste this across Indonesia and imagine what can happen.

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What we learned from Ramayana’s 2016 annual report

A passionate fundamental investor would devour annual reports like warm pastries, as it is a great way to get to understand the company, its sector, its management and financials.

A good example is how much one can learn from reading the annual reports of Ramayana Lestari Sentosa. We find their 2016 annual report very candid and thought provoking. When comparing it to the annual report of 2015, it tells us a lot about how management’s attitude has changed and about the turnaround process that is going on at the company.

Before we discuss further, it is good to know that Ramayana – which once was a darling of investors – became a fallen angel after many years of complacency and (resulting) loss of connection with their customers.

Interesting quotes from Pak Paulus Tumewu, Chairman of Ramayana:

In light of that, let’s take a look at an interesting quote from Paulus Tumewu, the founder and Chairman of Ramayana Lestari Sentosa (please note that since the 2016 report was only available in Bahasa Indonesia at the time of writing, so we are doing a loose translation here):

“In 2015, we found out that our top line did not grow, and this happened not only in our stores in the major cities. To drive more traffic to our stores, we have tried discount, special prices, and more advertising spending – yet none of those efforts managed to stimulate sales and profit. It seems like our traditional customer base has abandoned us.”

To us at Heyokha, the fact that the founder is stating that their customer base is abandoning them an ultimate wake up call. Recognition of the problem is the first step required for a turnaround. Better late than never.

“In 2016, a brave decision has been made to open ourselves up to contemporary influences, to fine tune with young generations’ new taste…”

On their cooperation with Dutch supermarket group SPAR, Pak Paulus doesn’t hold back:

“Frankly, we have been trying to improve our supermarket business, including through foreign partnerships, but we haven’t yet come across the right strategy and approach. Let’s hope that the partnership with SPAR will be profitable for both parties. With a heavy heart, we have to report that within the first 10 months of collaboration (with SPAR), the supermarket business made a loss of 70bn rupiah…”

It sounds like Ramayana is open to exploring a new strategy and approach to turnaround their supermarket operation? We will monitor this closely.

Interesting quotes from Pak Agus Makmur, CEO of Ramayana:

Interestingly, comments made in the 2016 annual report by Pak Agus Makmur – the CEO of the company – are equally candid and admitting a tough reality. This is a marked departure from the company’s old style, so we quote some of his admissions below:

“…our image has been deteriorating and we were considered obsolete and old fashioned.”

“Are our cashiers smiling when servicing our clients? Maybe not.”

“Is our product display always fresh, interesting, and full of energy? Maybe not.”

“Our problem was that our merchandise comprised old stuff, some were five to six month old. So, customers who came back to Ramayana would see old items and lose interest. This has pushed us to embark on transformation.”

Interesting to note that CEO Agus Makmur openly gave credit for the turnaround to Jane Melinda Tumewu, the daughter of the company’s founder and chairman, Paulus Tumewu.

“The phenomena of flat sales growth that has been haunting our business in the past few years has been dealt with, and the credit belongs to our General Merchandise and Marketing Manager, (the daughter of Paulus Tumewu) Jane Melinda Tumewu.“

“Before, our selling process raised furore, but now we do (more) interesting events with top celebrities such as Raffi Ahmad and Nagita Slavina, who attract big crowds to our stores…”

Other interesting quotes from Ramayana 2016 annual report:

On competition from minimart chain:

“…the emergence of minimart chains in the neighbourhood, such as Alfamart and Indomaret, means that urgent customer needs can be fulfilled without them having to travel far. These (minimart) chains took advantage from the big retailers like Ramayana. Spending in these chain stores also means that there is less budget available (for Ramayana).”

On tech disruption:

“Globally, retailers are facing a big shift, thanks to cultural changes (like better education and the emergence of the female customers) and in particular technological progress…”

“Indonesians are addicted to social media; we are the second largest users of Facebook after the USA”

“Naturally, Ramayana would like to exploit new internet-based media, without having to suffer big losses like experienced by others, that will be a good defence, in case our customers are moving away to online channels..”

Some Indonesian tech companies were also mentioned in this annual report (they are watching): mataharimall.com, bukalapak.com, Go-jek, GrabBike, and Uber.

On how mass market consumer class has evolved:

“Ramayana has undertaken a radical adjustment towards a new reality of a much smarter and richer mass market consumer class, compared to a few decades ago.”
On better layout and display:

“Our store upgrades cover display renovation, lighting, toilets, and other facilities. Over the years, our ageing outlets came to appear run down…”

Display with lights off (left); Display with lights on (right). Turning around yet preserving good old core value. Obviously, the product display looks much better with the lights on, but it also costs more. The store manager of Ramayana Cengkareng chooses to turn the lights on during the busy hours with meaningful traffic.

With their awareness of the core issues and challenges – and currently having the second generation’s mindset more in tune with the millennial target market – now it all comes down to execution.

We will track the progress closely. For sure, big challenges and opportunities ahead.

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Heyokha team recently attended the CIMB 11th Indonesia Conference. Admittedly, the venue of the event in Bali is a big pull factor, for obvious reasons. Yet, we also found out that despite Bali’s distractions, the fact that we were being away from hectic Hong Kong or Jakarta helped us to focus and think better. This enables deeper thinking (we discussed this topic in our Q12017 quarterly report).

One key takeaway from the conference, after series of meetings with corporates, is that we noticed how the incumbent businesses are trying hard to embark on – what they believe is a – digital business transformation (DBT). In general, we think the DBT has not been easy for the incumbents.

Before we discuss some examples from these meetings, we would like to point out that a recent McKinsey survey has both the good news and the bad news for the incumbents and their DBT journey.

Let’s start with the good news. Only 35% of companies’ revenues globally are digitised. This means incumbent companies across different industries still have time to act.

The bad news? While 90% of companies indicated that they are engaged in some form of digitalization, only 16% have responded with a bold strategy and at scale. The study also found out that incumbents often respond to disruption forces by engaging in “imitative innovation”.

Imitative innovation unlikely to solve problems in the best possible way Back to the takeaway from the conference, one common “imitative innovation” that we observe during the conference is that many incumbents talked about their apps as a way to embark on DBT.

One auto part company that is part of a big conglomerate is a case in point.

This spare part company tried to justify their app by stating that in some cases, their app will help those whose car battery goes flat in the parking space. Just go to their app, and a new battery will be sent your way.

While we appreciate the thought, we recognised two immediate challenges with this approach. Challenge number one is that to increase the innovator’s odds of success, the app should be able to connect the user’s problem with a company’s solution frequently enough to form a habit.

While flat car battery is annoying or even dangerous, depending on this flat battery situation means a contact with the app once every few years? We can’t even remember the last time we encountered a flat battery situation.

Challenge number two, when facing a dead car battery situation, a customer still has an option to just make a phone call to order a new battery. It appears that the app theoretically solves the problem, but the effort of installing the app while waiting alongside the road is less convenient than just making a simple phone call (to the same company!). More thought is definitely needed for an app to form a daily habit for car owners.

Also, interesting to notice that this auto part company, with their retail and “digital strategy”, opts to sell their merchandise at higher prices than in mom and pop stores. This is in contrary to Jeff Bezos’ disruption philosophy “your margin is my opportunity”.

Unfortunately, this spare part company is not unique in employing a half-baked app strategy. For example, a smartphone retailer/distributor was telling us that only 3-4% of the smartphones in Indonesia are purchased on-line, so according to them e-commerce is not really posing a threat. We think the opposite. Precisely because online smartphone only accounts for 3-4% market share in Indonesia (as opposed to China, about 56%), the incumbents need to be very prepared. There is a huge room for online start-ups to grab market share and they are trying very hard, 24/7 not 7-Eleven style.

No. of app downloads in the Google Playstore.
Note: digital companies are way better at getting their apps downloaded. The app of taxi company Blue Bird was popular compared to those of traditional companies, obviously very decent although nowhere close to the tech companies such as Go-Jek.

Many incumbents in the disrupted industries such as retail, leisure, and transportation have launched their app as part of the DBT strategy but the number of downloads is minuscule in comparison to app download for pure Indonesian tech start-ups.

Among the names above, only leading taxi company Blue Bird who get more than 1mn download on their app. It is worth noting that despite this respectable achievement, Blue Bird still feels the need to form an alliance with Gojek.

A good DBT strategy requires a corresponding organisational, people, and business transformation. Having an app for the sake of having an app is not a sound DBT strategy, in our view. We will incorporate this factor – incumbents’ DBT strategy – in our long-term stock picking (short term strategy can differ as we may encounter massively oversold incumbent stocks in the market).

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