Indonesia Market Strategy - Credit Suisse

Inflation winners and losers
2011 inflation outlook: Manageable Current level of inflation remains low compared to the historical trend and we believe that 2011 inflation outlook remains manageable and is unlikely to induce demand destruction. Given improving weather conditions, we believe pressure of food prices on headline inflation will ease in the remainder of 2011. The main risk to this view is if the government raises the subsidised fuel price significantly, which we think is unlikely. However, given the
money supply uptrend, we see the risk of upward pressure on core inflation, leading to our expectation for 75 bp increase in policy rate in 2011. However, the 75 bp increase will bring Indonesia’s policy rate to 7.5%, well below the historical average. We do see longterm risk to Indonesia’s core inflation, given Indonesia’s lack of investment in the past ten years, which may induce capacity constraints. In the event that infrastructure development fails to kick off in 2012 and the country struggles to add capacity into the economy, we see the risk of demand-pull inflation.

Inflation winners and losers
We run a bottom-up analysis to examine inflation winners and losers. We set assumptions on cost increase and estimate the impact on operating expenses (COGS + SG&A) and in turn on FY11E earnings. We separately calculate the impact of higher interest rates resulting from the central bank’s efforts to stem inflation. Our key input assumptions are: 1) 10% rise in energy, soft commodities, transport and metal prices, 2) 5% rise in wages and 3) 1 pp rise in interest rates. On the revenue side, each analyst assumes a percentage pass-through of cost increases based on industry structure, demand elasticity and historical precedents. Based on our bottom-up analysis, metal (ANTM, INCO) and coal (INDY) producers as well as banks with strong CASA (BBCA, BBNI and BMRI) are net beneficiaries. Banks with low CASA (BDMN, BBTN), heavy equipment companies (UNTR) and companies with high debt position (ISAT) are net losers to higher inflation and policy rates, in our view.

Our recommendations
Indonesia is trading at the highest premium relative to regional peers of 25%, based on our ‘P/B less ROE’ method, and consensus earnings momentum is subsiding. However, we believe that Indonesia’s equity market is not over-bought and the central bank is not as behind the curve as the market perceives it to be. Net net, we maintain our Index target of 4,150, implying 12% potential upside from the current level. Our top buys are stocks that are currently trading at a discount both to the Indonesian market and regional peers, while at the same time exhibiting relatively robust consensus earnings momentum and have been relative underperformers. Our top buys comprise: 1) two banks (BMRI and BBNI) to capture Indonesia’s domestic consumption story as well as increasing credit penetration, 2) one integrated consumer play (INDF) with strong consumer brand products and control over the upstream feedstock and 3) a cement producer (SMGR) to benefit from Indonesia’s infrastructure development ahead. We recognise that the current valuation of Indonesian market is no longer at a discount and could be demanding, if the country fails to add capacity in the coming years, inducing a risk for Indonesia to enter into a demand-pull inflationary period. However, under the
scenario that Indonesia successfully jumpstarts its infrastructure development in 2012, the country could move into a multi-year capex addition phase. Under such a circumstance, while valuations may not be at discount, we believe they will be largely reasonable and may be at least sustainable.