Pricey expressways? Let the train take the strain!

Yenwy Wongso, Research Analyst

The government finally implemented an average 20 percent toll increase on 13 turnpikes Tuesday. This is consistent with a 2004 regulation that requires toll adjustments to be carried out every two years based on the average inflation rate in the relevant region.

Despite criticism, the government has little choice but to hike tolls in order to assuage turnpike investors and attract new investors. The development of tollways has been an integral part of the government's agenda in recent years. But only a few investment deals have been clinched so far.

The complexity of land acquisition problems and the failure to integrate expressways with the existing public road network represent major challenges, and have resulted in delays in the construction of many proposed tollways.

There is currently no government masterplan for integrating the national highway network with the tollway network.

Given all these complexities, the government would do well to look at the available transportation alternatives.

Let's take a look abroad. For the third time this year, billionaire investor Warren Buffett's Berkshire Hathaway holding company has reportedly boosted its stake in railroad stocks. Buffett once said that the railroad business would never be sensational, yet its prospects have improved immensely.

Why is Warren Buffett so interested in the railroad industry?

Despite the large amounts of capital needed for the maintenance and expansion of railroads, Buffet sees the railroad industry as having a competitive advantage, as the U.S. has huge quantities of freight that need to be sent across the country.

The prevailing consensus says that the favorable uptrends in the transportation of people, major commodities (coal, oil, cement), containers and finished goods from producers to consumers will continue.

Furthermore, rising fuel prices will affect bus and truck operators more than the railroads. Hence, rail travel will increase in importance as it becomes a more efficient method of transporting people and freight across the country.

In this regard, investing in railroads and related stocks is worth considering. But do Buffett's actions indicate that investing in Indonesian railroads is worth considering?

The railroads in Java and Sumatra currently have a total length of 6,529 km, but only 4,692 km (around 72 percent) were in operation as of the end of June 2007.

In Java, passenger traffic is much more important than freight traffic. But in West and South Sumatra, trains are primarily used to haul coal to the ports or cement factories.

The current legislation stipulates that the Indonesian railroads be managed by state-owned operator PT Kereta Api Indonesia. The barriers to entry in the railroad industry in Indonesia are incredibly high, as it is highly regulated and requires massive capital expenditure, although less than the construction of expressways.

Railroads also require less land compared to expressways.

Although the safety record of Indonesian railroads in recent years leaves a lot to be desired, rail travel provides many advantages compared to expressways. As a mass transportation mode, trains can be used by all segments of society.

Meanwhile, commuter services could be expanded so as to ease traffic and pollution in major urban areas where the roads are clogged by cars, motorcycles and ageing, smoke-belching buses.

Indonesia's growing economy, particularly in Java and Sumatra, results in the need to transport large quantities of goods from the ports to locations throughout these islands.

Due to the government's budgetary constraints, new lines are unlikely to be laid anytime soon. Hence, the government needs to open the doors to private and overseas investors to start developing the Indonesian railroad network.

New investment could be used to reopen abandoned lines, double-tracking projects (which may not necessarily require land acquisition), the procurement of more locomotives and rolling stock, and the construction of new lines.

Regardless of what Buffett sees in the railroads, it will be somewhat surprising if the Indonesian railroad industry, which for so many years has been viewed as tired and uninspiring, actually becomes an appealing investment target.

However, if investors can be convinced that substantial improvements in the Indonesian railroad industry are forthcoming, then the outlook for the industry, as well as the sectors that directly benefit from it, such as coal, cement and oil, would become more appetizing.
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