Sept 2011: [Citi] Indonesian Strategy

No Longer the Best Performing Market; Time to Accumulate?

The JCI has fallen 10.5% YTD and 11.7% in USD terms; no longer an outlier —After a significant correction in the past two weeks, Indonesia was no longer the best performing market in Asia Pac as of Sept 26. Indonesia is now down 11.0% in USD terms and similar to performance in China, Japan and The Philippines. After strengthening by close to 6% from the beginning of the year to August, Indonesia has now depreciated by 1.3% YTD after significant weaknesses in the past two week.

Valuations are now trading at 11x 1-year forward PER, around 0.5SD below the 6-year historical mean; what are the worst case scenarios? — The index is now trading on 1-year forward PER of 11x, around 0.5SD below its 6-year historical mean. During the global financial crisis the index fell to as low as 1.75SD below its 6-year historical mean. Although we believe that Indonesia’s fundamental economy is different now than in 2008, 1.75SD below the historical mean translates to a 1-year PER of 8.1x, which translates to 2,500.

Outflows from the bond (US$3.5b) and equity (US$1.7b) markets continue, but at a slower pace — Investors sold due to problems in the Euro zone, a possible recession in the US and concerns over rupiah volatility. Total outflows in the bond market reached US$3.5b+ this month while YTD equity net inflows were flat (USD1.7bn in the past two months) due to significant outflows over the past two months. In our last strategy report, Indonesia Equity Strategy - Outflow and Correction in the Government Bond Market; What Does It Mean for the Equity Market?, Sept 21, 2011, we indicated that about Rp72trn (US$8b) of government bonds are prone to unwinding.

Indonesian fundamental economy remains intact; business people remain confident — Indonesian economic growth remains solid and should be among the fastest in Asia Pacific over the next two years due to its less dependence on exports (25% gross exports to GDP), the second lowest after India. Our conversation with people in the real sector also indicates that things are still doing fine; they are still spending and expanding capacity despite volatility in the stock market and exchange rates. They seem to agree that this volatility will be short-lived so long as the Central Bank can manage the rupiah (The Central Bank has been accumulating US$30b of forex reserves in the past eight months to US$126b at the peak).

Bottom-fishing at this level? — We believe that clients could start to bottom fish slowly especially for stocks that have been bombed-out massively, but that have a defensive earnings outlook. We provide the list of the top 30 stocks and those that we cover. Amongst bombed-out stocks are mainly commodity resources stocks such as Indofood Agri, PGAS, Inco, and Adaro. Among our top picks, Indocement (down 25% YTD and 38% from the peak), Mandiri (-14% and -32%) and United Tractors (-14% and -34%) performed below the market’s YTD performance.