Indonesia Market Strategy

■ High valuations deter marginal buyers: We just completed a 10-day road show and marketing in the US. We believe investors recognise the robust structural story of Indonesia. However, many investors are deterred by current valuations of the Indonesia equity market. We thus find very few
marginal buyers and see the risk of Indonesia lagging regional peers.
■ Inflation does not help: As of today, inflation has not yet reached an alarming level that may curb purchasing power. However, the central bank.s relax stance, an uptick in core inflation and the recent weakening of the IDR mean that further inflation improvement is limited. Meanwhile, feedbacks from our road show and marketing indicate that investors will likely take it as the absence of another positive catalyst for the Indonesia equity market which may further support our thesis that Indonesia may lag its regional peers going forward.
■ Stock calls: We have highlighted the four most expensive stocks in our coverage based on P/B less ROE relative to MSCI Indonesia: UNVR, TOWR, KLBF and GGRM. In addition, names like GGRM are trading at over 2x standard deviation higher than its historical average P/B less ROE relative to MSCI Indonesia. In addition, we also see the potential downside pressure from the blue-chips stocks, such as ASII, that have been utilised as the country.s proxy.


Trapped by its own success
Indonesia: Last man standing
The Indonesia equity market has been resilient, outperforming its regional peers over the past three months. During this period, the Indonesia equity market has remained relatively flat, outperforming most of its regional peers except for Thailand and the Philippines. Indonesia has been the second best performing market YTD. Indeed, despite a weaker global financial market in the recent past, the Indonesia equity market remains trading at the higher end of its historical valuation range.

Potentially lagging ahead?
Indonesia.s robust performance in the recent past may lead the country.s equity market to lag its regional peers in times ahead. Given its current valuation premium, investors may favour its regional peers relative to Indonesia when the dust of the global market uncertainty settles. In our recent 10-day road show and marketing in the US, we somewhat struggled to find incremental buyers for Indonesia. The country.s current high valuation premium may deter many potential new entrants into the market who see the absolute upside potential to be limited. At the same time, the massive pull-back of Indonesian equity market would not do much good either. The current valuation of Indonesian equity market indicates significant inflows in the recent past. The market.s massive pull-back should now hurt the investors that recently entered the market; it may induce negative sentiment and result in these investors staying away from the Indonesia equity market in the coming days.
Inflation does not help
The rally in the Indonesia equity market for much of 2011 has partly been supported by the country.s robust headline inflation. However, the recent pick-up in core inflation despite declining headline inflation implies that the excess capacity of Indonesia may be relatively limited. Thus, we believe that Indonesia is in need of new investments to boost its capacity in order to prevent the country from suffering from stretched capacity. In addition, the IDR strengthening in 2011 has largely contributed to Indonesia.s declining headline inflation despite upticks in core inflation rates. Thus, the recent weakening in the IDR implies that support for further headline inflation improvements may be relatively
limited. As we highlighted in our Indonesia strategy report, The green lights and the red flags, 16 August 2011, the absence of inflation improvements may lead to some outflows from Indonesian.s bond market which may lead to weaker currency given the larger contribution of foreign capital in the bond market compared to the equity market.

We believe that current inflation in Indonesia is not yet alarming and unlikely to curb purchasing power as it remains relatively at the lower end of the historical range. However, given current valuations of the Indonesia equity market, implying high expectation and thus limited room for error, we believe that the absence for further improvement in inflation may further cause the Indonesia equity market to lag its relative peers going forward. For more details on inflation, please refer to Asian Daily, Indonesian inflation concerns: Lest we forget, by Robert Prior-Wandersforde, 19 September 2011.
Our channel checks also indicate that Indonesian central bank remains dovish when it comes to policy rate which may not go down well with the market.s expectations. However, we see room for Indonesian central bank to hike reserve requirement ahead. Currently, the LDR of Indonesian banking system stands at 82%. However, excluding BBCA, BMRI and BBNI, the country.s LDR is at 88%. Thus, with an 8% cash reserve requirement, the effective LDR of Indonesian banking system (excluding BBCA, BMRI and BBNI) is at around 96%. We thus believe that the room for further reserve requirement increase may be limited up to only 400 bp.


Valuation red flags
Given the potential for the Indonesia equity market to lag its regional peers ahead, we have highlighted companies that currently have high valuations. Based on our P/B less ROE measure, we have found the four companies that are trading at highest premiums relative to the Indonesia market to be UNVR, GGRM, KLBF and TOWR. In addition, we also highlight the stocks that are currently trading at 2x standard deviation higher than its historical average P/B less ROE measure, such as GGRM. We also see the potential downside pressure from the blue-chips stocks, such as ASII, that have been utilised as the country.s proxy. If Indonesia lags its regional peers, the stocks such as ASII that have so far been used as proxy for Indonesia are likely to underperform its regional peers.


Companies Mentioned (Price as of 16 Sep 11)

Aneka Tambang Tbk (ANTM.JK, Rp1,820.00, NEUTRAL, TP Rp2,600.00)
Astra International (ASII.JK, Rp65,900.00, NEUTRAL, TP Rp79,200.00)
Bakrie Telecom PT (BTEL.JK, Rp350.00, UNDERPERFORM [V], TP Rp185.00)
Bank Central Asia (BBCA.JK, Rp7,900.00, NEUTRAL, TP Rp8,600.00)
Bank Danamon (BDMN.JK, Rp4,950.00, NEUTRAL, TP Rp5,100.00)
Bank Jabar Banten (BJBR.JK, Rp1,050.00, NEUTRAL, TP Rp1,320.00)
Bank Mandiri (Persero) (BMRI.JK, Rp6,650.00, OUTPERFORM, TP Rp9,400.00)
Bank Negara Indonesia (BBNI.JK, Rp4,100.00, OUTPERFORM, TP Rp5,250.00)
Bank Pan Indonesia Tbk (PNBN.JK, Rp800.00, NEUTRAL, TP Rp1,000.00)
Bank Rakyat Indonesia (BBRI.JK, Rp6,450.00, OUTPERFORM, TP Rp8,330.00)
Bank Tabungan Negara (BBTN.JK, Rp1,450.00, NEUTRAL, TP Rp1,725.00)
Bank Tabungan Pensiunan Nasional (BTPN.JK, Rp3,750.00, OUTPERFORM, TP Rp4,400.00)
Ciputra Development Tbk PT (CTRA.JK, Rp570.00, NEUTRAL [V], TP Rp390.00)
Excelcomindo Pratama PT (EXCL.JK, Rp5,250.00, OUTPERFORM, TP Rp7,200.00)
Gudang Garam (GGRM.JK, Rp56,150.00, OUTPERFORM, TP Rp55,500.00)
Holcim Indonesia TBK PT (SMCB.JK, Rp1,990.00, NEUTRAL, TP Rp2,400.00)
Indocement (INTP.JK, Rp14,050.00, NEUTRAL, TP Rp18,400.00)
Indofood CBP (ICBP.JK, Rp5,350.00, OUTPERFORM [V], TP Rp7,300.00)
Indofood Sukses Makmur (INDF.JK, Rp5,650.00, NEUTRAL, TP Rp6,850.00)
Jasa Marga (Persero) TBK PT (JSMR.JK, Rp4,000.00, OUTPERFORM, TP Rp2,800.00)
Kalbe Farma (KLBF.JK, Rp3,550.00, NEUTRAL, TP Rp3,400.00)
Perusahaan Gas Negara (PGAS.JK, Rp2,675.00, OUTPERFORM, TP Rp4,500.00)
PT Adaro Energy Tbk (ADRO.JK, Rp1,980.00, UNDERPERFORM, TP Rp2,050.00)
PT Astra Agro Lestari Tbk (AALI.JK, Rp22,400.00, NEUTRAL, TP Rp26,000.00)
PT Borneo Lumbung Energi & Metal Tbk (BORN.JK, Rp1,180.00, NEUTRAL [V], TP Rp1,600.00)
PT Harum Energy Tbk (HRUM.JK, Rp8,250.00, NEUTRAL [V], TP Rp9,600.00)
PT Indika Energy Tbk (INDY.JK, Rp3,000.00, OUTPERFORM, TP Rp3,900.00)
PT Indo Tambangraya Megah (ITMG.JK, Rp44,550.00, OUTPERFORM, TP Rp57,000.00)
PT Indosat Tbk (ISAT.JK, Rp5,800.00, OUTPERFORM, TP Rp7,900.00)
PT International Nickel Indonesia Tbk (INCO.JK, Rp3,750.00, NEUTRAL, TP Rp4,400.00)
PT London Sumatra Indonesia (LSIP.JK, Rp2,225.00, OUTPERFORM, TP Rp3,300.00)
PT Sarana Menara Nusantara (TOWR.JK, Rp11,000.00, OUTPERFORM, TP Rp14,500.00)
PT Tambang Batubara Bukit Asam Tbk (PTBA.JK, Rp17,950.00, OUTPERFORM, TP Rp26,500.00)
PT Telkom (Telekomunikasi Indo.) (TLKM.JK, Rp7,350.00, OUTPERFORM, TP Rp9,750.00)
Salim Ivomas Pratama (SIMP.JK, Rp1,270.00, OUTPERFORM [V], TP Rp1,856.00)
Sampoerna Agro Tbk (SGRO.JK, Rp3,400.00, NEUTRAL, TP Rp4,000.00)
Semen Gresik (Persero) (SMGR.JK, Rp8,700.00, OUTPERFORM, TP Rp11,500.00)
Tower Bersama (TBIG.JK, Rp2,225.00, NEUTRAL [V], TP Rp2,725.00)
Unilever Indonesia (UNVR.JK, Rp16,850.00, UNDERPERFORM, TP Rp14,000.00)
United Tractors (UNTR.JK, Rp23,500.00, OUTPERFORM, TP Rp37,500.00)


source: CreditSuisse dated 19 September 2011