Investment theme for 2012
Overall corporate earnings still on the rise
Unlike during the 2008 financial crisis, the decline in PER multiples for the JCI in late-2011 does not suggest a decline in earnings. It was purely a broad adjustment of market valuation in line with those of its regional peers. We are still projecting for overall corporate earnings (represented by our coverage universe, accounting for 63% of total JCI market capitalization) to grow by 16% for 2012. However, it is worth noting that growth will not be uniform across all sectors, with those having wider exposure to domestic consumption expected to perform better.
Consumer sector leads the way
Key indicators from various sources point to yet another strong performance for the consumer sector in 2011, with no signs of slowing down in 2012. The consumer confidence index, published by an independent survey firm Roy Morgan, was at a record 147.3 for Oct 2011. The same survey also reveals that the income of the average Indonesian worker was 30% higher than a year ago, with unemployment staying at a record low. That said, the low interest rate environment arising from BI’s aggressive reference rate cuts is expected to have a positive impact on the sales of automotives, heavy equipment and properties.
Enticing prospects for automotive, cement and property
For 2012, we expect four-wheel (4W) vehicle sales unit to grow by 7.5% (2011f: 12.5%), with 2W vehicle figures slated to rise by 10% (2011f: 12.7%). These numbers are respectable considering the already high base resulting from the strong growth in the prior years. Meanwhile, despite registering a surprising 12% growth in 2011, we still see cement sales accelerate by 7% in 2012.
Based on BI data, residential unit sales in 14 major cities in Indonesia continued to register healthy growth in the past two years, spurred by low interest rates. In 2010, total sales unit jumped 14% y-o-y and increased by 16% y-o-y as of Sept 2011. We expect this trend to continue into 2012.
Politics not yet a risk
With the presidential and parliament elections due to be held only in 2014, we believe that political tensions will not intensify in 2012 as yet. Some minor conflicts or disagreements among the big political parties might emerge, but not quite on a large scale. However, the current lack of strong candidates within the Partai Demokrat (the ruling party) remains a crucial concern.
Recent polls by several independent polling agencies show that Partai Demokrat apparently still enjoys significant support, along with the two other big political parties – Partai Golkar and PDI-Perjuangan (Source: Reformasi Weekly Review – RWR).
Upside from land clearing bill; downside in fuel subsidy removal
According to the 2 Dec 11 edition of RWR, parliament is making progress on the Bill on Land Acquisition for public interest development, with an estimated timetable of 16 Dec 2010 to end-Jan 2012 for it to be passed. The contentious areas are: (i) the authority of the National Land Agency (BPN), (ii) the government’s proposed mechanism for arbitrating disputes over compensation levels in land acquisitions, and (iii) the definition of “public interest”, where parliament prefers the law to provide a detailed and explicit definition of the phrase to ensure that the regulation will only apply to projects that genuinely fulfil the interests of the broader public.
As with fuel subsidies, the government still lacks clarity on how to address this issue. There might be a possibility of the government ruling out fuel price hikes in 2012 and instead focus on rationing the sale of subsidized fuel, but the implementation details have yet to be disclosed. The risk of a fuel price hike will linger on in 2012, especially if global crude oil prices continue to move up.
More upside for JCI in 2012
Based on our bottom-up approach for our stock coverage universe, our year-end JCI target for 2012 is 4,450 pts, implying a 14.8x FY12f earnings and offering a 19% upside potential from the current level (based on the 18 Nov 2011 closing). We estimate that total earnings will grow by 16% y-o-y in 2012 compared to 21% y-o-y in 2011. At this juncture, sector preference and stock picking will be crucial for the upcoming year, as valuations are at a relative premium compared to Indonesia’s regional peers and the earnings growth acceleration will not be even across the board.
The possibility of a credit upgrade in Indonesia’s rating to investment grade by the rating agencies will be testament to the country’s sturdy fundamentals, which could help the country pull in more investments. Note that Indonesia is currently only a whisker away from investment grade status, according to the major rating agencies such as S&P, Fitch and Moody’s.
2011 review: A year of volatility
Starting the year with inflation fears
The JCI kicked off the year hammered by heavy selling pressure as inflation in January soared to 7% y-o-y. The main trigger of inflation during the month was the higher food prices caused by supply disruptions which arose due to the extreme weather conditions. However, inflation started to soften in the following months, which also helped boost market sentiment.
The JCI started to rally at the start of 2Q, fuelled by strong corporate earnings performance (FY2010 and 1Q11) and easing inflation. The benchmark index hit its highest level for the year at 4,195 pts in August 2011.
Global fears fed by eurozone debt crisis
In 3Q11, JCI started to enter a correction phase in line with the global trend as the eurozone financial crisis escalated. Although heavy selling in Indonesian equities and treasury bonds weighed down the rupiah, the joint intervention by BI and the government helped reduce the foreign exchange volatility somewhat.
While foreign ownership in Indonesia’s treasuries was declining, the percentage of foreign ownership remained above its historical average. Meanwhile, foreign investor ownership in a large number of stocks on the JCI also stood at high levels. Based on our sample of 29 listed companies representing 65% of the JCI market cap, foreign investors still held about 76% of the free float shares of these companies.
Our small-cap picks beat the overall market
One interesting point is that small-cap stocks still generated positive alpha despite the overall flat market performance. Our top 25 small-cap picks outperformed the JCI by 24% as at our cut-off date of 18 Nov 2011. Thus, we believe that there are still opportunities for small-cap stocks in 2012 as investors are keen to look for new stocks that offer huge growth potential that is still not fully priced in.
Market strategy: Key sector picks
Consumer and Infrastructure our top sector picks. In view of rising income, the huge exposure to domestic demand as well as being direct beneficiaries of higher government spending, we believe the following sectors will be the outperformers in 2012:
Rising consumer confidence is this sector’s key catalyst. The improving outlook for domestic demand consumption will be spurred by low interest rates as inflation softens. The sector covers a broad range of subsectors such as automotives, retail, poultry and media. In the media subsector, consumer-centric companies will have more incentive to promote their products through advertisements. This will, in turn, benefit the media companies.
Driven by strong demand from the mining and agricultural sectors, Indonesia’s heavy equipment sales continued to head north, with a 55% y-o-y growth for 9M11. Demand from the two markets will continue to stay strong in 2012 and adding to the mix is infrastructure development. Once infrastructure development picks up, it will translate into additional demand for the overall sector. The industry’s highly concentrated nature will keep selling prices buoyant, which then helps sustain profit margins.
Indonesia is in dire need for more infrastructure development to sustain the current economic growth momentum and to attract more foreign direct investments. We expect the pace of Indonesia’s infrastructure development to accelerate as capital spending for 2012 is targeted to increase by 19% to IDR168trn, mainly for infrastructure spending. The key catalyst for this sector would be the passage of the land clearing bill to address land clearing issues that have hampered infrastructure development in Indonesia.
Indonesia’s long-term cement outlook is promising, given its low consumption base, rising per capital income and relatively inadequate infrastructure. The low interest rate environment could also translate into rising demand for houses in the near term. We foresee domestic cement sales growing by 7% y-o-y in 2012. Again, the passage of the land clearing bill will also be a key catalyst.
Our overweight stance on the sector is based on our view that demand for property will remain strong, supported by Indonesia’s rising economic growth, all-time low interest reference rate and the current supply shortfall of new homes.
With the Newcastle Export Index (NEX) staying robust, the outlook for contract price deliveries in 2012 is again in the favour of coal sellers. With prices staying high, we expect this trend to also trickle down to the average selling prices (ASPs) for coal producers. As more coal-fired power plants come on stream, domestic demand for coal is expected to scale higher.
Our View on The Other Sectors
Rounding up our view
For the Banking, Telecommunication and Plantation sectors, we have a NEUTRAL call, with an UNDERWEIGHT call on the Metal sector.
Banking. We downgrade our stance on the banking sector to NEUTRAL from OVERWEIGHT, as we believe that heading into 2012, the sector faces strong headwinds in the form of slower credit growth, downward net interest margin (NIM) pressure and rising asset quality risk. Our earnings growth forecast is up to 9% below that of consensus in view of the lower NIMs and higher loans impairment rate.
We expect industry revenue growth to decelerate further to 4-5% in 2012 on the back of headline (SIM) penetration surpassing 100%. The key revenue driver – in tandem with the current global trend – will continue to be data, which we project to account for 49% of total mobile revenue by end-2012, from 43% in 2011. While Indonesian telcos are relatively inexpensive when stacked against their regional peers, the structural slowdown in the top-line as well as margin dilution will result in lacklustre earnings growth.
While we expect the supply growth of CPO to be strong next year, the price outlook remains not too promising. A combination of abundant supply with lacklustre demand will keep CPO prices flat.
The prolonged economic slowdown has resulted in a pullback in commodity prices, which are expected to remain relatively flat in 2012, except for the price of nickel, which is anticipated to fall even more in the face of increasing supply of the metal in 2012-2013. As lacklustre prices will compress margins, metal mining companies are likely to see another challenging year.
Our Stock Picks for 2012
We have sifted several names across sectors to come up with a list of stocks, which we believe offer attractive upside potential by virtue of their solid earnings growth profile and foothold in their respective industries. Most of these names are in sectors on which we have an overweight call, although we also have included two banks among our top picks as we believe the two names offer compelling investment propositions.
Astra International (TP: IDR82,500)
We like ASII’s healthy diversified earnings backed its strong position in domestic automotive, heavy equipment, and agribusiness industries. The Indonesia Auto Industry Association estimates the 4W vehicle sales volume for 2012 to grow 10% y-o-y, faster than our estimate of 7.5% y-o-y. This will be driven by rising consumer income and low interest rates. In addition, we believe that the strong earnings trend for heavy equipment makers should continue next year on the back of solid demand for coal mining and plantation contractors.
Surya Citra Media (TP: IDR9,150)
Our BUY recommendation hinges on the following factors: (i) SCMA is well-positioned in the Indonesian TV network, (ii) SCMA’s improving profitability, (iii) high dividend yields, and (iv) strong cash flow. It also has room to improve on cost efficiency, which comes from lower programme costs as SCMA aims to increase the proportion of in-house programmes to 45% in 2012, up from 40% currently. SCMA’s dividend is attractive, with an expected yield of 4.9%-5.8% in FY12-13f.
Selamat Sempurna (TP: IDR2,050)
We like Selamat Sempurna for its: (i) high dividend yield, (ii) high profitability, and (iii) stable revenue growth prospects. SMSM is adept at maintaining its profit margin amid raw material price fluctuations by employing sound inventory management and cost reduction programmes. SMSM’s current utilization rate stands at only 48% for radiators and 56% for filters. Hence, we believe that the company does not need to spend high capex in the short term to support growth.
Malindo Feedmill (TP: IDR1,490)
Indonesia’s population of some 240m people and the low consumption of poultry per capita of 5kg (the lowest in Asia) provide the industry with favourable growth prospects. The growth in poultry consumption should be robust on the back of a solid GDP growth, income per capita growth and burgeoning middle income class. Malindo is the most profitable feedmill producer in Indonesia with the highest ROE of 54%, a creditable operating margin of 11% and highest net profit expansion of 36% compared to its peers in 9M11.
Hexindo Adiperkasa (TP: IDR10,900)
We believe that expectations of firm commodity prices will spur the production of commodities (especially coal and CPO), and robust infrastructure development will further fuel demand for heavy equipment. We expect Indonesian heavy equipment sales to rise by 53% y-o-y to 18,136 units in 2011 and 18% y-o-y to 21,418 units in 2012. We believe this is achievable as the country posted a compounded annual growth rate (CAGR) of 19% in heavy equipment sales to 11,854 units from the period of 2005-2010. Additionally, given that some 65% of heavy equipment purchases are financed through leasing or credit companies, the current low interest rate should support demand.
Total Bangun Persada (TP: IDR390)
The company is expected to get IDR1.6trn worth of new contracts this year, which will boost its outstanding jobs to IDR4.3trn, of which IDR2.8trn will be carried forward to 2012. A historically low benchmark interest rate of 6% should have a positive impact on the construction industry as it will spur demand for the construction services. Total posted a strong CAGR of 19% for 2011-2013 earnings, spurred by its growing orderbook and the fact that it enjoys superior margins relative to its peers. Its clean balance sheet and cash pile give the company a strong advantage over its financially weaker competitors, when it comes to bagging yet more construction projects.
Semen Gresik (TP: IDR12,500)
Our BUY recommendation on SMGR is premised on: (i) additional capacity from new cement plant commencements, (ii) costs efficiency from new cement plants, and (iii) strong market positions both in Java and out-of-Java markets. The total capacity of the new cement plants is equivalent to more than 20% of the company’s existing capacity, which would allow SMGR to increase its production volume which was flat in the last two years. SMGR will benefit most from higher cement demand outside the Java area, which is estimated to grow faster compared to that of Java.
Alam Sutera (TP: IDR600)
ASRI continues to be our top pick based on the following factors: (i) strong future growth and profitability, (ii) the successful launch of its second project, “Suvarna Padi” in Pasar Kemis, and (iii) its grand plan to acquire more land in Bali and Jakarta.
Resource Alam Indonesia (TP: IDR7,500). KKGI offers one of highest growth in terms of volume and earnings for 2012 in our coal universe. Announcement of coal reserves and resources based on the JORC standard would be a catalyst for the counter, as it will improve the company’s mine-life certainty and operational going concern.
Bank Mandiri (TP: IDR9,000)
Its liquid balance sheet (78% loan-to-deposit ratio – LDR) allows it to chalk up strong credit growth entering 2012, during which we see the risks to loans growth fade. The bank is rapidly growing its non-corporate segments where yields are higher. Its aggressive investment in the deposit franchise will also likely give it more flexibility in lowering its cost of funds. Collectively, this should translate into NIM expansion next year. BMRI is well-capitalised and its valuation is not demanding with, a 2012F PER of 10.6x and P/BV of 2.1x, given its ROAE of approximately 21%. As an anchor banking stock, it faces risks associated with NPLs in the non-corporate segment and its high foreign ownership of around 30%.
Bank Bukopin (TP: IDR850)
NIM has room to grow next year as the bank is pushing its non-Bulog loans (about 79% of its loan book). Its deposit profile is decent with its current account savings account (CASA) composition hovering above 40% and it has multiple opportunities arising from its partnerships with various bodies, with Jamsostek potentially being the most promising. Risks to the bank include the weakening of asset quality outside its comfort zone of lending to Bulog. It has an inexpensive valuation considering its 2012F PER of 6.3x, P/BV of 1.0x and ROAE of around 17%.
Increased income levels
The Jakarta Governor has approved a monthly minimum wage increase in FY12 to IDR1.53m (+18.5% y-o-y). Following this hike, Jakarta will in 2012 have a minimum wage that is higher than the city’s standard cost of living for the first time in six years. The wage hike in Jakarta is a benchmark for any increase in the take-home pay in other areas. Notably, the average Indonesian worker brought home IDR1.45m a month in June, 30% higher than the IDR1.12m a year ago. The pace of income growth was faster than the average household expenditure growth, which stood at IDR1.20m per month in June, and was up by a mere 7.7%.
Confidence at record level
The Roy Morgan Consumer Confidence Index is now at a record high 147.3 in October, which shows that consumer confidence is now 10.6 pts higher than it was a year ago. Unemployment is at record lows as the number of people actively “looking for a job” is fallen to 3.5% of the workforce. Notably, the purchase of 230 new Boeing aircraft by Lion Air reflects the business community’s confidence on the consumer outlook for Indonesia.
Low interest rates rev up auto sales
We see promising auto sales growth for FY12, given the fact that the benchmark interest rate is now at the lowest level. The central bank lowered its benchmark interest rate to 6.0% in November from 6.5% in the previous month, which is likely to maintain the auto sector’s high-growth rate. Spare parts companies are also beneficiaries of a robust auto industry as international auto companies such as Toyota, Daihatsu, and Nissan are aggressively expanding their manufacturing facilities in Indonesia.
Massive growth of poultry feed seen
Indonesia still lags in terms of per capita protein consumption, which provides tremendous opportunities for the poultry industry, given that chicken meat is one of the cheapest sources of animal protein. Indonesia’s broiler consumption per capita is 5.0kg in 2010, still considerably low compared to the Philippines’ 8.1kg, or Malaysia’s 37.3kg, thus providing room for higher future chicken consumption. We see the oligopolistic nature of the industry giving the players pricing power and thereby, enabling companies to pass on any cost increases.
Media a noble proxy to the consumer
We believe consumer companies tend to spend more on advertising when economic conditions are improving. Indonesia’s advertising spending as a proportion of GDP is among the lowest in Asia. The country’s advertising spending as a proportion of GDP is at a mere 0.3%, compared with Thailand’s 0.4%, Singapore’s 0.5% and the Philippines’ 0.6%. Indonesia’s advertising rate is rising by 15-20%, with corporate advertising expenditure remaining strong. The media companies’ operating leverage is huge as programming costs are fixed. Hence, their higher revenue would allow them to leverage on robust profit margins to great effect.
Our top picks for the consumer sector are Astra International (ASII), Selamat Sempurna (SMSM), Malindo Feedmill (MAIN), and Surya Citra (SCMA).
Industry sales surge 55% amid bright outlook
Indonesia’s heavy equipment sales surged 55% y-o-y to 14,233 units for 9M11, largely driven by strong demand from the mining sector. During the 9-month period, excavators were the best selling equipment by type, accounting for 64% of total sales at 9,104 units. The second largest are bulldozers/crawler dozers (15% or 2,075 units), followed by rigid dump trucks (9% or 1,271 units), motor graders (4.9% or 695 units), wheel loaders (3.8% or 547 units) and articulated dump trucks (3.8% or 541 units).
Strong demand to continue
We believe that expectations of firm commodity prices will spur the production of commodities (especially coal and CPO), and robust infrastructure developments will fuel demand for equipment. Indonesia is the world’s largest exporter of thermal coal, controlling around 31% of the world coal market in 2010, with a total production of 335m tonnes.
Indonesia’s major coal producers are gearing up for higher production capacity to take advantage of the growing global coal market and solid coal prices. From 2010-2015, the country’s coal production is predicted to enjoy a CAGR of 8% to 480m tonnes. These factors could serve as long-term catalysts for heavy equipment demand by the mining sector, which currently make up 54% of total heavy equipment industry volume.
We expect Indonesian heavy equipment sales to rise by 53% y-o-y to 18,136 units in 2011 and 18% y-o-y to 21,418 units in 2012. We believe this is achievable as the country has posted a CAGR of 19% in heavy equipment sales to 11,854 units from 2005-2010.
Record-low interest rate, stable rupiah to prop up demand
Historical data shows that Indonesian heavy equipment demand is relatively sensitive to interest and exchange rates, given that some 65% of their purchase are financed through leasing or credit companies, as well as the selling prices are quoted in USD. Indonesia’s inflation has been declining, which is expected to compel the central bank to the keep the benchmark interest rate low in the near term. Bank Indonesia (BI) recently made a surprise 50bpts cut in the benchmark lending rate, taking it to a historical low of 6.0%.
Our economist forecasts that the BI reference rate will rise by 75bpts to 6.75% and the rupiah will remain stable at IDR8,800/USD at end-2012. Fundamentally, even at 6.75%, this rate is considered low for the Indonesian economy and IDR8,800/USD is still stronger than the average rate of IDR9,500/USD from 2005-2010.
Oligopolistic industry to support pricing power
Indonesia’s heavy equipment industry is extremely concentrated, with around 86% of the market controlled by United Tractors (Komatsu brand), Hexindo Adiperkasa (Hitachi), Trakindo Utama (Caterpillar) and Daya Kobelco Indonesia (Kobelco). We believe the oligopolistic nature of the market should allow distributors to raise selling prices, especially in times of strong demand, which could enhance earnings and profitability.
HEXA is our top pick; we also like UNTR
We maintain our overweight rating for Indonesia’s heavy equipment sector and BUY rating for both UNTR and HEXA. The heavy equipment sector has advanced by 9.5% YTD and outperformed the JCI by 10.4%. We see the sector recording a strong aggregate earnings growth of 31% for 2010-2012. HEXA is our top pick in the heavy equipment sector given its attractive valuation, stronger earnings growth and higher upside potential than UNTR. We also like UNTR’s dominance in the heavy equipment industry and it is in a good position to grow further, owing to its high exposure to mining contracting and coal-mining operations.
Keeping up the growth momentum
Indonesia has the world’s fourth largest population (240m people) and ranks 18th in terms of size of economy with a GDP of USD707bn in 2010, according to the International Monetary Fund (IMF). Like many developing and emerging Asian economies, Indonesia has weathered the latest global economic crisis remarkably well. GDP growth exceeded 6% in 2008 and 2010, and in 2009, it kept going at a robust 4.6 % during the height of the crisis. The Economist Intelligent Unit (EIU) predicts that growth will accelerate to 6.2%-6.4% from the period 2011-2015, approaching the forecast growth for China of 7.9% and India (6.7%).
In urgent need of better infrastructure
One of the country’s most glaring shortcomings is the state of its infrastructure. Its roads and railroads are generally in poor condition, and the capacity of its seaports is extremely limited. The inadequate supply of electricity is also a major concern, while the uptake of information and communication technologies also remains limited for businesses and the population at large.
According to the Global Competitiveness Report in June 2011, Indonesia’s infrastructure, ranked 82nd globally, is in need of far-reaching improvements and has been identified as one of most prohibitive factors for doing business in Indonesia in 2010. We expect the pace of Indonesia’s infrastructure development to accelerate, as the Indonesian government plans to increase its capital spending by 19% to IDR168trn from IDR141trn, mainly for infrastructure spending.
Growing signs of investment pick-up
To support growth, we believe Indonesia needs to attract more investments, avoid over-capacity and keep inflation in check. Investments in Indonesia may be facing several challenges, but we believe that any signs of a pick-up in investment will likely improve the overall sentiment for the country, at least in the short to medium term. After experiencing years of sluggish foreign direct investment (FDI), Indonesia saw a huge jump in FDI flows in 2009.
However, much of the FDI in 2009 was from portfolio rather than direct investment. In 2010, we saw a turnaround in growth composition with healthy growth recorded for direct investment. Although Indonesia’s FDI is well below that of China and India, the country’s FDI is now among the top four countries in the region.
Benign land acquisition draft bill draft the availability of infra-related funds
Among the key features of the draft land acquisition bill is that the national land agency (BPN) sets the compensation value for the land that would be acquired for public use. Land owners have 14 days to file a legal case, and the national court has 30 days to reach a final and binding verdict.
Meanwhile, infra-related funds such as IDR1.4trn for land-revolving and IDR4.9trn for land-capping funds are still available for toll road projects. The Indonesia Infrastructure Fund (IIF) plans to fund some 14 power plant projects in the pipeline. Moreover, the Indonesia Infrastructure Guarantee Fund (IIGF) also recently guaranteed a USD4bn power project (with 2 x 1,000MW capacity) that involves a consortium of Adaro Energy and Japanese power companies.
We like infrastructure sector: TOTL is our top pick
Across our entire universe, the stocks that we believe will directly benefit from infrastructure improvements are toll-road operators such as JSMR, and construction companies (WIKA, ADHI, TOTL, and SSIA). Our top pick for infrastructure is Indonesia’s leading private contractor Total Bangun Persada (TOTL). Total posted a strong earnings CAGR of 25% from 2010-2012 boosted by its growing orderbook and its superior margins relative to its peers. We have a BUY rating and Target Price of IDR390 (+47% potential upside), implying a 2012 earnings multiple of only 8.5x.
Low interest rate stimulates appetite for cement
We see promising housing sales growth for FY12 given the fact that the benchmark interest rate is now at its lowest. The central bank lowered its benchmark interest rate to 6.0% in November from 6.5% in October. This is likely to buoy property sales and support the housing sector’s high growth rate. Notably, property companies under our coverage have reported that sales surged by at least 20% in 2011.
More infrastructure jobs to spur consumption further
We expect the government to put in more efforts to accelerate infrastructure development projects before its current mandate ends in 2014. Construction of the Sukarno-Hatta Terminal 4 airport, as well as the Kalibaru and Jambi seaports are slated to begin in 2012-2013. Furthermore, at least nine toll-road projects covering a total of 215km are in the pipeline for 2013-2014.
FY12 volume growth to remain strong
We see the domestic cement sales volume reaching 48.9m tonnes (+7% y-o-y) next year. FY12 sales volume growth is expected to be strong, but it is anticipated to be slower than that in FY11. Notably, FY11 sales were exceptional, reaching 39m tonnes from Jan-Oct this year (+16.9% y-o-y), driven by recovering property sales in Java.
New capacity may damp selling prices
We reckon that the cement selling price hike may not match the cost increase, as SMGR – Indonesia’s largest cement producer – seems intent on increasing its market share to absorb its new capacity. The company’s new cement plants, expected to commence operations in early-2012, will have a total annual capacity of 5m tonnes, accounting for around 9% of the existing national capacity.
Overweight on cement sector
The long-term outlook for this sector appears promising, driven by the construction of more houses. The new policy on land acquisition for public use is positive for accelerating the roll-out of infrastructure projects. Indonesian cement companies look attractive as they provide a higher return on equity (ROE of 25.7%-24.8% in FY12-13f), and are also trading at lower earnings multiple (PER of 12.4x-10.9x in FY12-13f) vs their regional peers (ROE 15.6%-16.3% and PER of 15.3x-13.7x).We recommend BUY on SMGR and INTP. Our top pick is SMGR, whose growth potential is driven by higher sales volume arising from new capacity.
Domestic cement sales volume remained strong with a y-o-y growth of 16.9%, reaching 39m tonnes in the Jan-Oct period. This boosted the national production capacity to 82% in 2011 from 77% in 2010. We expect cement sales growth for next year to rise to 48.9m tonnes (up 7% y-o-y), fuelled by rising house construction activities. However, the additional capacity from SMGR’s new cement plants has led to a decline in national production capacity utilization to 80%. To absorb its new capacity, SMGR seems intent on increasing its market share, which may slow the price hike for cement.
Accelerating infrastructure construction projects will fire up cement sales growth
The government is targeting to build USD34bn worth of public infrastructure from 2010-2014, mainly on toll-roads and to construct railways. However, the implementation of these infrastructure projects has been slow due to land clearance constraints. The new policy on land acquisition for public use is a positive catalyst in accelerating the roll-out of infrastructure projects, which are estimated to create new demand for 4m tonnes of cement (merely for toll-road projects alone).
Sector outlook bright
We maintain our OVERWEIGHT stance on the property sector as we expect demand for property to remain strong, supported by: (i) Indonesia’s strong economic growth, (ii) an all-time low benchmark interest rate of 6% should be closely followed by lower mortgage rates (note over 70% of consumers buy property via mortgages), and (iii) the current supply shortfall of 13.6m new homes (up from 8m units in 2009).
Nonetheless, property stocks are priced at a discount of 49% to NAV, with an average weighted 2012f PER of 18.4x and 2012f PBV of 1.9x. ASRI remains our top pick in the sector, as the company is expected to maintain its strong future growth and profitability, in view of the successful launch of its second project, “Suvarna Padi” in Pasar Kemis, and its grand plan to acquire more land in Bali and Jakarta.
2011 was an incredible year
Sales of residential developments (landed and strata) have been rather robust, with 9M11 sales by companies under our coverage reaching IDR8.9trn (up by 47% y-o-y) surpassing the FY10 pre-sales totalling IDR7.7trn. CTRA posted the strongest pre-sales growth of 83% y-o-y, backed by the launch of seven new projects during the period under review, followed by ASRI, which grew 69% y-o-y, driven by a price increase of more than 50% YTD.
Sales of industrial land are also at a historic high, as the total land sold within the three consecutive quarters reaching 897.04ha, compared with 543ha in FY10. LPKR, through its subsidiary LPCK, also posted industrial land sales of IDR606bn (+79% YTD) by selling some 150ha during 9M11. As such, we expect a robust revenue growth of 31%–22% for FY12–13f in tandem with the strong pre-sales.
2012: In positive territory but only modestly
We expect FY12f marketing sales from our property stock universe to grow modestly at 10% to IDR12.6trn, with the depletion of prime landbank and a high base effect. Escalating cost of land will continue to drive demand as people seek more affordable housing in the fringes of Jakarta. Despite the traffic congestion and high population (with about 10m people living within a 660 sq km area), many house buyers are still attracted to Jakarta.
As such, we expect higher demand for condominiums or apartments. Condominium prices outside the CBD are more reasonable, but those located not too far from the CBD will be more appealing, especially to middle-income buyers. The likes of SMRA and ASRI will expect some contribution from apartment sales as their landbank in certain areas is depleting.
Factors that can derail the sector
Potential risks to the property sector include: (i) rising inflation, which will lead to hikes in the benchmark interest rate, (ii) regulatory changes, such as the recent law on the prevention and eradication of money laundering (8/2010) which might temporarily curb the demand for residential properties. The law states that property companies must disclose property buyers’ sources of funds for any transaction exceeding IDR500m, (iii) any large acquisition that requires large capex or additional funding via bank loans might temporarily have an adverse impact on the company’s revenue growth and margin, (iv) a potential economic slowdown that may dampen consumer purchasing power, and (v) a spike in raw material cost.
Glowing outlook for 2012 contract prices. With the Newcastle Export Index (NEX) staying robust, the outlook of contract price deliveries for 2012 is in favour of sellers yet again. With prices staying high, we expect this to also trickle down to the average selling prices (ASPs) for coal producers. Note that in 2011, coal companies under our coverage registered increases of 18%-29% in their ASPs for the 9M11 period, with McCloskey Newcastle (Coal Index) price climbing 24% YTD during the same period.
For 2012, we are forecasting a coal index price of USD130/tonne, which represents a 7% increase from the 2011 level and thus, we expect coal producers’ ASPs to remain at a high level, although the growth would not be as high as that experienced in 2011.
Two sides of the coin
As more coal-fired power plants come on stream, this will translate into higher domestic demand for coal. While most of Indonesia’s coal was destined for the export market in recent years, this trend may change drastically going forward. One of the steps taken by the Indonesian government to implement changes was to introduce an annual Domestic Market Obligation (DMO) for all Indonesian coal producers.
Scrutinising the 2012 DMO list (see Figure 2) and its impact on the coal companies under our coverage, there appears to be greater uncertainty over ITMG and HRUM’s ability to fulfil their required domestic tonnage since historically most of their production is exported. Currently, the government, coal producers and the Mining Association are discussing ways to make up the required tonnage required.
Production cost a key variable
Despite the huge ASP increases, coal companies also experienced surprisingly significant production cost increases in 2011, largely due to escalating oil prices. As such, only high-volume coal producers would be able to enjoy meaningful profit increases going forward. However, recent global events have triggered a slight correction in oil prices, which could help bring down production cost.
However, this positive could be offset by the fact that historically coal prices have a high correlation with oil prices and hence, the net impact to the bottom-line should be somewhat limited.
Growth orientation favoured
For the coal sector, we prefer companies that offer sizeable production volume growth in the upcoming years. For 2012, our top pick is Resource Alam (KKGI IJ), with another BUY recommendation on Harum Energy (HRUM IJ) and Bukit Asam (PTBA IJ). PTBA’s huge exposure to the domestic market will be an advantage given the current global economic uncertainties.
Risks to the Indonesian coal industry include: (i) a significant correction in energy prices, (ii) extreme weather conditions, (iii) regulatory changes, and (iv) slower-than-expected global economic growth.
Downgrade sector to NEUTRAL from OVERWEIGHT
We downgrade Indonesian banks’ rating from OVERWEIGHT to NEUTRAL as we believe the sector faces headwinds going into 2012 in the form of slower credit growth, downward NIM pressure and rising asset quality risk. Our earnings growth forecast is up to 9% below that of consensus in view of lower NIMs and a higher loan impairment rate.
Strong, but slower credit growth
The current pace of credit growth (25% y-o-y) could slow down next year as: (i) economic growth is expected to soften (our economists expect 6.1% growth in 2012) and (ii) LDR has now risen to a post-Asian Financial Crisis high of 84%. Removing the most liquid three largest banks (BBCA, BMRI and BBNI), the LDR stands at 91%, while removing the largest five banks by asset size (the above plus BBRI and BNGA, making up about 45% of total credit in the system) the LDR will be as high as 93%.
We believe this ratio helps to screen the capacity of banks to lend and only selected banks with lower LDRs may have the room to maintain robust credit growth. These are BBCA, BMRI, BBKP and BJBR, which are under our coverage.
Downward pressure on NIM
BI rate cuts will likely keep the cost of funds low but we think NIM expansion will be hard to come by as we expect credit growth to slow, lending rates to fall on the back of competition, and increasing regulatory pressure on banks to narrow interest spreads. Banks with strong credit growth, which can deftly manage their cost of funds and which possess a favourable asset mix will be better positioned to keep NIM expansion expectations alive. BBCA, BMRI and BBKP fall within this category.
Risk of asset quality disappointment is now higher
The industry-wide gross NPL ratio has been hovering at a healthy 2.8% for the good part of 2011 but nominal NPL (IDR56trn) has now surpassed post-global financial crisis levels. We are of the view that the inflation is likely to resume its upward trajectory rather than recede next year, which does not bode well for credit quality outlook. We think that risks to credit quality are higher for the smaller banks operating in the SME segment and in banks which face steep learning curves in new lending areas.
Preference tilts towards banks with liquid balance sheet and earnings resilience, backed by reasonable valuation. The valuation factor filters out BBCA. Our top picks are BMRI in the large cap space and BBKP in the small cap space. The upside risks to earnings would be stronger credit growth, a lag in falling lending rates vs lower cost of funds (both of which will naturally lead to upside surprises for NIMs) and manageable NPL stress. BDMN and BBTN are our least preferred stocks.
Competition in steady state; focus distinctly on data
2011 has mostly panned out as we anticipated, with voice competition staying rational and the telcos aggressively beefing up their share of the data wallet through promotions and acquisition campaigns. Through unique partnerships with handset vendors, Indonesian telcos are able to drive stronger smartphone take-up by making the devices more accessible (Indonesian telcos do not bundle handsets outright). We estimate smartphone penetration at under 5%, which significantly lags that of the more advanced economies at 60-70%.
The proliferation of Chinese/white label handsets should drive prices of smartphones to under USD50 by 1H12, and shorten the replacement cycle of current 2G models, now the preferred mode of access for data. We believe voice competition should remain rational in 2012 as telcos recognize the low elasticity with pricing campaigns that are inherently tactical in nature, as with 2011. Note the slew of copycat campaigns during the Lebaran period involving Telkomsel and XL which were nothing more than short-term attempts to stimulate voice during the Idul-Fitri celebrations.
Our checks also revealed that revenue per minute (RPM) continued to move up in 4Q11 with telcos re-pricing their packages accordingly. With the telcos posting mobile revenue growth of 5-7% y-o-y in 9MFY11, it would appear that the industry revenue is on track to grow by 5-6% for 2011, down from 8-12% in 2010.
Premium SMS ruling will have knock-on effect from 4Q11
The blanket ruling by the telecoms regulator to unregister premium short messaging service (SMS) effective from 18 Oct caught the operators off-guard and will have a negative impact on industry revenue from 4Q11. That said, we find it difficult to ascertain the eventual impact on individual telcos as it would ultimately depend on the success of initiatives to win back customers.
XL stated that 6-7% of its gross mobile revenue could be impacted by the move, while Telkosmel had guided a revenue impact of IDR450bn for 2012. We believe the overall impact may be modest given that telcos share a percentage of their premium content with content providers.
The sale of towers should remain high on the agenda although the level of progress may differ from one telco to another. Despite media reports indicating that XL may re-visit its previous plan to dispose of some of its towers, management said it is in no hurry and is not in need of cash, and will continue to pursue the strategy of sharing its towers. Indosat is reported to be finalizing plans to hive off up to 4,000 towers to independent tower company, Tower Bersama, which could rake in some USD500m.
We expect industry revenue growth to decelerate further to 4-5% in 2012 on the back of headline SIM penetration surpassing 100%. The key revenue driver – as with the current global trend – will continue to be data, which we project would account for 49% of total mobile revenue by end-2012, from 43% in 2011, as smartphones take-up accelerate from a low base. As with 2011, we expect the telcos to keep their opex and capex in check, with the focus on minimizing the impact on margins from the migration to data.
While Indonesian telcos are relatively inexpensive when stacked against their regional peers, the structural slowdown in top-line and margin dilution will contribute to lacklustre earnings growth. Hence, we continue to advocate stock picking with a preference for telcos with good operational standing, strong cashflow and balance sheets.
Our favourite is TELKOM (TRADING BUY, FV: IDR8,500) as: (i) its valuations remain undemanding for a large cap, and (ii) it has the strongest balance sheet among its peers. A site visit to Sulawesi in mid-2011 reinforced our positive view on the strong growth potential accorded outside of Java, where its mobile arm Telkomsel has the biggest market share. While we acknowledge the improved sentiment on INDOSAT (NEUTRAL, FV: IDR6,000), we remain concerned over execution risks.
A year of abundant supply
We believe that supply growth will continue to be strong next year, rising by 2.7m tonnes vs the 2.9m-tonne increase in 2010. This will be boosted by favourable weather conditions, increasing the yield from young trees and newly mature areas in Indonesia. New planting for most big players in Indonesia peaked in 2007 and reached maturity this year, which helped fuel production growth.
Production growth in these newly mature areas will continue to accelerate in the next 4-5 years. Hence, we believe that supply will continue to be strong going into next year. The Southern Oscillation Index is now pointing to a mild La Nina, which is also favourable for palm oil production.
Limited post-bumper crop stress
Despite 2011’s bumper crop, we believe the drop in production from thereon will be limited. This is because most parts of Kalimantan experienced a decline in 2H11 production due to the tail-end effects of the 2009 drought. The lower production means the trees in the area have had their rest and the opportunity to rebuild their reserves.
Meanwhile, the demand from China and India has been relatively weak this year. China’s edible oil purchases fell by 7.9% in the first nine months of 2011 to the lowest level since 2005, while India’s edible oils purchase dropped 7.0%, but that of CPO was up 3.1% due to its wide discount to soybean oil. We doubt that the demand scene will improve much in 2012.
Dull CPO prices ahead
Given the weak price outlook, palm oil prices should rightfully have fallen to even lower levels. However, we observe that any price dips below the RM3,000 per tonne level had not been accompanied by follow-through selling. Furthermore, the volatility in palm oil prices has eased, and the price of the commodity has fallen to levels where it tends to bottom out. On another front, speculative positions in soybean oil are now net short, which suggests a similar situation for palm oil as it is a near-perfect substitute of the former.
Still, the price of palm oil has continued to hold up. Given the diminished downside volatility amid the limited upside due to lacklustre demand and abundant supply expected for next year, we believe that the price of palm oil will enter a period of very dull price action as it continues to bottom. This should follow the current episode of CPO price strength, which we think is seasonal and believe will be sustained into early 1Q12.
Average CPO price forecast
We maintain our view that the 2012 average CPO price will be lower than in 2011, when prices were boosted by poor production in 1Q. Nevertheless, given the price action in the past few months, we are now of the view that prices will average higher than what we had expected earlier. Hence, we are raising our average CPO price assumption from RM2,700 per tonne previously to RM3,000 for 2012.
Positioning for the next upcycle
We suspect that Indonesia’s palm oil production will peak around 2015, given the historical planting and the fact that most companies had not been able to meet their planting targets since 2008. This was made worse by the moratorium imposed on new planting this year. Since palm oil is the only major oil – among global edible oils – that has seen growth, the output growth would come mainly from Indonesia.
Hence, it stands to reason that if Indonesia’s palm oil production peaks, global edible oils supply will also hit a crest, and this would have very bullish price implications. While it is too early to position for the next upcycle, we believe that investors should accumulate good growth plantation stocks, which will provide the alpha as they tend to be rather illiquid. We like names like BW Plantation, Lonsum and JA Wattie, which have tree age profiles that will fuel long-term production growth.
Unfavourable 2012 outlook
The prolonged economic slowdown has resulted in a pullback in commodity prices, which are expected to remain relatively flat in 2012, except for the price of nickel, which is anticipated to fall even more in the face of increasing supply of the metal in 2012-2013. We predict a gradual downturn in average nickel prices to USD23,500/tonne (-2% y-o-y) in 2012, before retracing further to USD23,000/tonne (-2% y-o-y) in 2013.
Meanwhile, we see tin prices trending flat given our view that supply scarcity (refer to Figure 1, which illustrates the steep downtrend in tin inventory in the short term) combined with weak demand going forward will dampen the commodity’s long-term price sustainability. We believe that domestic tin producers’ collective efforts to halt tin exports to push up prices to at least USD23,000-USD25,000/tonne level is apparent in Indonesia, which is the world’s largest tin exporter.
Thus, we see 2012 average tin price at around USD25,000, which is 15% higher than the current level. Providing relief to the plunge in commodity prices is gold, which is considered a safe haven (see Figure 3). We expect the average gold price to go up by 7% y-o-y to USD16,000/oz. in 2012 and remain steady in 2013. From another perspective, despite its safe haven status in the short term amid falling commodity prices, over a period of 15 years from 1995 to 2011, gold prices were highly correlated with the movement of oil prices, with a correlation of 0.82.
Snapshot on the companies
The declines in commodity prices have also led to compression in metal mining companies’ 3Q11 margins. However, in view of the differences in their industry structures and operation profiles, investors may find it worthwhile to take note of the recent developments related to the three companies under our coverage:
ANTM: Hefty capex in 2012-2013 to replace old equipment as well as expand its ferronickel plant will lead to diminished ore exports and higher financing expenses. We see execution risk in meeting project deadlines.
TINS: We believe the bucket wheel dredge purchased in 4Q11 will be delayed, given the more severe short-term problem the company faces when spot exports were halted on 1 Oct, a development which we believe will severely hit 4Q11 earnings.
INCO: The recent explosion at one of its furnaces will affect nickel production in 4Q11 and 1Q12.
Among the metal mining companies, INCO is our top pick, with a BUY recommendation and target price of IDR3,800 for: (i) its higher earnings CAGR for 2011-2013 on the back higher volume growth and improved cost efficiencies, (ii) higher margins compared to its peers, and (iii) low execution risk given the completion of its Karebbe project, which met its deadline.