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Aug 29, 2016 22:08:56
Indonesia Equities: Pricing In Near Term Positives
- +9% gains in MSCI Indonesia since our country upgrade in July - Since our upgrade of Indonesian equities to overweight two months ago in the MIG publication after clarity on its tax amnesty programme emerged, sentiment has further improved following the appointment of well respected Finance Minister Sri Mulyani Indrawati. The Indonesian equity market has seen strong equity inflows in 3Q16 lifting the index up ~9% (local currency terms, +8.2% in USD), which has outpaced world equities’ gains (+5.2%) for the same period and supported our call.
- Year to date’s gains of +18.6% has also more than recouped 2015’s losses of -12%, which has supported the turnaround highlighted in our January 2016’s South East Asia Equity Strategy report. The equity market rally year to date has been supported by a benign environment of lower interest rates, stable IDR currency vs the USD, under-owned positions in global portfolios and improving confidence in Indonesia’s recovery story. Estimated equity inflows into Indonesia so far for 3Q has exceeded the total inflows for 1H16, driving the market to new highs. Since mid May this year, it is estimated that net equity inflows reached $1.7bln, vs $1.6bln net outflows over the whole of 2015 (source: JPM estimates).
- Near term positives post amnesty and cabinet reshuffle look priced in, valuations are now close to 10 year high – At 16x PER, Indonesian equities is now trading close to +2 standard deviations to its 10 year historical average multiple and at its highest valuation level since 2007, which we believe has priced in much of the near term positives. Although near term liquidity is likely to remain supportive given benign expectations on interest rates, we caution that valuations have caught up and believe it is prudent to start taking some money off the table. On domestic updates, while the recently released 2017 budget is credible, it is unlikely to lead to further corporate earnings upgrades given a moderate government spending target of 6% (planned fiscal deficit for 2017 is 2.4% of GDP, flat/lower than 2016E). Towards the end of September and December which marks the first and second phases of the tax amnesty programme’s staggered tax rates for declared wealth, investor sentiment may also be influenced by expectations over the tax collections.
- Muted start to the 9-month tax amnesty programme, although still early days - As of 23rd August 2016, the asset declaration in the Tax Amnesty Program has reached Rp51.7tn, consisting of 85% onshore/15% offshore assets (12% overseas assets declared, 3% overseas net assets repatriated), while asset repatriation has reached Rp1.6 tn. Momentum of onshore assets declared in first half of August has picked up, with the tax office reporting about Rp11.5tn worth of onshore assets declared (>4x July’s). About three-quarters of the assets declared were from private individuals, and the balance private entities, which we view as supportive of property sector’s recovery given interest rates are expected to remain low while the Ministry of Finance has allowed repatriated funds to be invested in real assets (such as property and gold).
- Looking ahead, earnings upgrades need to pick up momentum for the rally to have more legs - Earnings wise, the recent 2Q results season was mixed with single digit corporate top line growth from a year ago. Concerns on banks remain dragged by asset quality issues while commodity related earnings have been moderate. Following the latest 2Q earnings season (where consensus earnings were trimmed -2% lower for FY16E and FY17E), FY16E and FY17E earnings are now forecast to grow +7% and +14% respectively (higher than Asia ex Japan equities’ 2.2% FY16E and 11% for FY17E respectively) which we believe is priced in current valuations.
Time to lock in some profits – Switch out of names which have rallied and offer no upside to target prices
- Sectors we are cautious on are: Commodity related plays which have rallied and priced in recovery expectations (coal – Bukit Asam, ITMG, palm oil – Astra Agro, London Sumatra), Banks (loans growth will be moderate while we expect asset quality concerns to remain a near term overhang) and Utilities (in particular, Perusahaan Gas – where we think profitability will remain pressured by regulatory efforts to lower gas prices).
Preferred Picks/Switch Ideas
- Preferred Sectors we would accumulate new positions are: Property (Bumi Serpong – Western Jakarta play, large landbank catering to middle income buyers), Telecommunications (Telekomunikasi Indonesia – improving smartphone penetration and data usage supported by a young population), Consumer (Indofood and Media Nusantara, which benefit from an improving domestic economy in 2H16) and Infrastructure (Jasa Marga – No. 1 toll road operator, long term beneficiary of infrastructure development in Indonesia).
- Risks to the current rally include weaker than expected global economy, faster than expected Federal Reserve interest rate hikes which may result in global liquidity volatility and disappointments in the domestic recovery and infrastructure spending pace (continues to be a focus in the 2017 budget, with 9% yoy expected growth).