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What is rectified ceramic?
Arwana Citramulia (ARNA IJ) (Buy) - Site visit to ARNA: A clearer path ahead
Plantation MW EP 286 10th Dec, 2024
On 6 December, we were invited to visit Arwana Citramulia’s Plant 2 in West Java to observe and learn about ARNA's operations and innovations, while receiving the latest industry updates. During our visit, we had the opportunity to explore various stages of the supply chain, including the process of rectification for its red-body ceramics for its Digi Uno product.
Updates on the industry: Recent regulations are beginning to be seen
In October 2024, the government of Indonesia issued an anti-dumping regulation on Chinese-imported ceramics. This, in addition to the SNI import permit regulations, has boosted the ASP of ceramics producers in the country. Industry utilization, which was previously at ~65% across the board and ~50% for white-body ceramics, has now risen to above 70%. This improvement in utilization serves as positive affirmation that the recent regulations are benefiting local ceramics players, in our view. In the context of ARNA, their Nusantara line of white-body ceramics (low-end white-body product), being priced at IDR69,000/sqm, is now at a lower price point than Chinese imports at IDR75,000/sqm (vs previously at IDR 62,000/sqm). The company has now began producing a larger mix of white-body ceramics, reaching ~13% contribution in 3Q24 (see Fig. 1). With total imports of ~90mn sqm of white-body ceramics in FY23 from China, and domestic production volume only increasing by 45mn sqm for FY25, we believe the industry still has room to grow to meet the gap in demand.
Latest guidance: ARNA is poised to take advanage of positive ASP and volume momentum
ARNA’s operations have been on an uptrend, producing ~6mn sqm of ceramics monthly, with the latest production number indicating a higher trend for November. Furthermore, the company is optimistic on the increase in ASP for both white-body ceramics and rectified red-body ceramics, and is targeting to reach higher utilization levels of above 100% (similar to FY22, see Fig. 2). Overall, the company is guiding for 74mn sqm of sales for FY25 (+11.6% y-y), on the back of: 1) an increase in industry prices due to anti-dumping and SNI regulations, and 2) an increase in demand for its rectified red-body ceramics.
Tour of Plant 2A – Significant margin upside following new machinery with rectification
We began the tour by visiting an old production line being torn down to make space for the new technology (Fig. 5). The originally Italian-made machines were being replaced with new Chinese-made machines which, for the same area, will provide a 30% boost in capacity while using half the gas needed for heating, greatly improving efficiency (Fig. 6). Post this upgrade, with the expected increase in ASP, the company expects to reduce its unit costs due to higher utilization of the plants.
The main goal for ARNA's strategy is to upgrade the machinery in Plant 2 to boost its net margin closer to the near ~20% achieved by Plant 3. Currently, Plant 2's net margin lags in the low teens, largely due to outdated technology, since the line was installed 30 years ago. Following the upgrade in plant 2A, ARNA also plans to install 7 upgraded production lines by 2025, with 3 of the 7 lines in Plant 2 and 4 of the 6 lines in Plant 3 receiving upgrades to provide rectified Digi Uno products.
Despite these significant upgrades, the financial impact on ARNA’s capital expenditure will be minimal, in our view, as the company has secured favorable terms of payment for five years.
Maintain Buy on ARNA with TP of IDR940/sh
We maintain our Buy rating with a DCF-based TP of IDR940, assuming a WACC of 12%. Our TP implies 13.8x/11.9x FY25F/FY26F P/Es, favorable relative to the industry average of FY25 P/E of 25x (based on Bloomberg consensus estimates. ARNA’s swift adaptation to market conditions and resilience in maintaining profitability amid challenging market conditions justify a premium valuation, in our view. ARNA also provides a 5.3% dividend yield for FY25F and a robust ROE of 24.6%, nearly double that of its peers. Risks to our call are: 1) sudden changes in government regulations (i.e., gas price and safeguard import duties), 2) fierce product competition, and 3) a slower demand recovery.
Rectified ceramic or rectified tile refers to a tile where the edges have been ground or sawed after firing so that the overall size of the tile is more precise or exact. By sawing, machining or precisely grinding the tiles after firing, the manufacturer tries to minimize (or rectify) the size variations from tile to tile.
Using rectified ceramic, it beautifies a floor’s look by eliminating the ceramic grout (gap between ceramic; locally known as “Nat keramik”).
While it is common for white body ceramic (porcelain tiles), this treatment process had not been scaled for red body, as it had not been proven in the market. ARNA, as one of the first movers in Indonesia, applied this process to its Digi Uno 50x50 red-body ceramic tiles. Having introduced this new breakthrough, the market demand was immediately substantial, according to management. While the rectification process incurs additional costs, the company has been able to sell it at a higher price compared to regular Digi Uno product.
INVESTMENT RATINGS
A rating of ‘Buy’, indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of ‘Neutral’, indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of ‘Reduce’, indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of ‘Suspended’, indicates that the rating, target price, and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as ‘Not Rated’ or ‘No Rating’ are not in regular research coverage. Benchmark is Indonesia Composite Index (‘IDX Composite’). A ‘Target Price’, if discussed, indicates the analyst’s forecast for the share price with a 12-month time horizon, reflecting in part of the analyst’s estimates for the company’s earnings, and may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market in general.
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| Rating Remains | Buy |
| Target price Remains | IDR 940 |
| Closing price 9 December 2024 | IDR 735 |
Michael Wildon (michael.wildon@verdhana.id) and
Edwaed Prima (Edward.prima@verdhana.id)