The plan to revise the minimum wage formula (news) presents an opportunity to enhance purchasing power, which has been notably weak. This weakness in purchasing power can be largely attributed to minimum wage increases not keeping pace with cost of living, a key reason for the loss of 10mn middle income consumers, in our view.

Minimal cost impact

2024's minimum wage hike was 3.4%. For 2025, labor unions are demanding 8-10% growth. We use a scenario analysis to assess the impact based on a hypothetical increase of around 5-7%

A 5-7% wage increase next year (vs 3.4% this year) could boost purchasing power and economic growth with manageable impact on corporate profitability. Our scenario analysis of a 6.0% wage hike shows that only a 0.6% price increase would be required for companies to maintain profit levels. A nationwide cost increase allows a better chance to pass on, albeit some industries like commodities may be unable to pass on the cost, and thus could face slight margin declines (around 40bp) – although with a healthy 22% EBITDA margin. The garment sector might need special government attention given the structural challenge.

Our wallet size analysis suggests that a higher wage increase could potentially add up to 3.0% to the economy, considering the high marginal propensity to consume at the grassroots level (multiplier of 4-5x). We estimate the wallet size for formal workers (where the minimum wage is applied) to be around IDR2,257tn, with the total wallet size – including informal workers – reaching approximately IDR5,600tn. It is also worth noting that the exceedingly low inflation environment, partly due to weak purchasing power, should help limit the risk of higher inflation.

Merit to high wage increase

Indonesia has lost 10 million middle-income individuals because minimum wage increases (CAGR +4% from 2019-2024) have not kept pace with the cost of living (CAGR +6.3%). The ramifications of a weakening wallet size include rising non-performing loans (NPLs), low individual deposit growth, and weakest GDP and domestic private consumption growth over the past eight years. We believe a sizeable increase in the minimum wage should positively impact purchasing power and help address these issues.

Lesson learnt from previous hikes and scenario analysis

Based on our study of previous wage hike cycles, there was limited impact on company profitability. Companies that can pass on the wage hike (i.e., non-commodity sectors) during periods of 7-8% minimum wage growth were still able to maintain stable EBITDA margins around 17-18%. We estimate that a price pass-through of just 0.6% is sufficient to maintain profit.

A case in point is AMRT, the EBITDA margin of which in fact increased by 100bp between 2017 to 2019 during a period of 8% p.a. wage hikes. We believe companies in sectors such as retail, FMCGs, transport, and healthcare are better positioned to pass on wage hikes compared to commodity sectors.

Stock picks: picking winners amid uncertainties

We continue to recommend FMCG as our preferred sector pick, while retailers, hospitals, and logistics also remain favored sectors due to their ability to pass on costs – though selective bottom-up assessments are needed to identify the winners. We prefer companies that can pass on costs, have pricing power, and are relatively inexpensive.

Our top picks for large-cap stocks are BBCA, AMRT, MYOR, ICBP, HEAL, and NCKL (all rated Buy), while for small-to-mid caps, we favor CLEO, ASSA, and MIDI (all rated Buy).

Study on prior wage hike impact

We break the sectors down into two segments:

Those able to pass on wage hike costs: consumer FMCGs, retailers, autos, property, contractors, transport, healthcare, IT, telcos, leisure
Those unable to pass on wage hike costs: CPO, coal. Mining, pulp and paper, garment, utility, and oil & gas

Fig. 1: According to our analysis, companies that have been able to pass on cost in average only need to hike price of about 0.6% to maintain the same level of EBITDA margin.

Fig. 2: … while for the companies that have been unable to pass on cost, the impact has been relatively muted – with EBITDA margin dropping by around 40bps to 21.8% – a relatively healthy level

Fig. 3: During previous wage hikes of about 8% pa, companies that were able to pass on cost were also able to maintain stable EBITDA margin

Fig. 4: Case in point, AMRT EBITDA margin increased during the previous period of wage hikes

Fig. 5: Indonesia shrinking number of middle income earners — lost 10mn over the past five years

Fig. 6: Indonesia wallet size – slowest growth in a decade if cost of living is taken into account

Fig. 7: NPLs across loan segments, consumers are the one with increasing NPL

Fig. 8: Verdhana Macro-Micro Index (VMMI) – consumer transactions significantly weak

Fig. 9: Individual deposits – slowest growth in a decade

Fig. 10: Real GDP growth and domestic private consumption – slowest since 2015 and 2010, respectively

Fig. 11: Indonesia garment industry faces structurally challenging environment and losing market share globally

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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Jupriadi Tan (jupriadi.tan@verdhana.id) 

Gerald Hugo (gerald.hugo@verdhana.id)