Flavour (Indo): Focus on Risks, more infrastructure next year, BNI result ahead, and PTBA result in line - Nomura

Investors start to focus more on risks: Our view on step up GDP growth and robust macro economics in Indonesia are well received in our recent marketing trip to UK and US. Growing middle class, young population, robust GDP growth outlook of 7% as early as in 2012, and strong government fiscal and monetary discipline are hard to be ignored.

However, given the strong market performance, clients are focusing on what could possibly go wrong and what are the risks in investing in Indonesia. We point out three main risks: global/external factor, potential infrastructure bottleneck, and political risk (more details in the attached file).

President SBY said that government plans to reduce subsidies in 2012 budget and increase infrastructure spending. This will reduce the misallocation of resources/funding as fuel subsidy (Rp129.7tn) accounts for 1.8% of GDP and 9.8% of budget, while electricity subsidy (Rp65.6tn) accounts for 0.9% of GDP and 5.0% of budget. This compared to Rp58tn budget for Ministry of Public Works (proxy to infrastructure spending) and Rp136tn total government capital spending.

Bank Negara Indonesia (BBNI IJ – Buy) declared 1H earnings of IDR2.7tn (+41% y-y). On an annualized basis, it was at around IDR5.8tn, which is significantly ahead of Nomura and consensus at around IDR4.8-IDR5.3tn. This was due to sharp jump in loan growth (+10.3% q-q), expanding NIM (+40bp q-q), loan recoveries that lead to 49% in non-interest income, as well as modest compression on credit and overhead cost, although we expect some catch up on the cost over 2H11. While BNI’s 12% ytd loan growth looks on track with management’s 17-20% target, it is unlikely to be a major driver for our upside. We see, however, upside in NIM trend, from our estimates of 5.4% to align with management’s 5.5-6% target. The increase is as well for fee income, in response to improving franchise perception. Maintain BUY on BNI.

Bukit Asam (PTBA IJ – Buy) announced 1H11 earnings of Rp1,611bn (+77% y-y) on higher ASP (+33% y-y). The result was in-line with our estimates due to our conservative volume and ASP assumptions, but below consensus. The company operational performance was flattish with coal sales volume was up by merely 2% y-y. Railway volume was up 11% y-y, but growth was not visible from quarterly point of view. By the half on 2011, railway volume only reached ~41% internal target and with delay of equipment, we are pessimistic that the company will be able to achieve 13.6mn tones railways target. In spite of flattish growth in present volume, we reiterate BUY rating for Bukit Asam on our medium-term view (5 years), as we remain positive on the outlook of railways performance in the coming years and we believe company efficient production cash cost (excluding royalties) structure enables it to face cost challenges.

Krakatau Steel (KRAS IJ, Neutral), the state-owned and largest steel manufacturing company, announced 1H11 results that was below expectation. Revenue declined by 6.5% yoy and operating profit declined by more than 70% yoy. Problems related to commencement of expanded hot strip mill operation seem to have persisted into early 2Q11 affecting company’s operating financials. However, Krakatau was still able to record 9.5% y-y net income growth as the company booked Rp1.1trilion (US$125mn) of profit from sale of fixed assets (land) to the JV company that Krakatau has with Posco.

We expect problems related to new expanded HSM capacity to be a short term issue, and the new expanded capacity should aid the company to grow. Krakatau’s prospect lies on its future capacity expansion that will increase by 55% in 3 years time and its ability to capture growing domestic steel demand opportunity as the country develops infrastructure. However, execution will remain a key risk, hence our Neutral recommendation on the stock.