Morgan Stanley - Indonesia banks: Another Leg Up ... Raising Target Prices

Investment conclusion:

We continue to recommend investors stay Overweight on Bank Mandiri and Bank Rakyat Indonesia (BRI) with higher target prices. We anticipate further expansion in multiples, driven by an improving macro, lower interest rates and upside earnings surprise. We see another leg up in valuations.

1Q09 insights:
Banks under our current coverage beat our expectations in core profit, and met or exceeded our estimates at the net profit level. Key drivers are volume growth, margin expansion and productivity gains. Asset quality deterioration is manageable – it is being more than offset by improvements in core operating profits.

Above consensus:
On our current forecasts, we are already materially above the Street’s estimates at
Mandiri (18% above) and BRI to a lesser extent. Yet we continue to see upside risks potentially from: higher volume growth, greater productivity, lower credit costs.

Higher target prices:
Given upside EPS risks and declining interest rates, we reduce our cost of equity (COE) assumptions across the banks by 100bp and apply probability-weights to our bull, base and bear case scenarios. We apply 18% COE for Mandiri and BRI, and 17% COE for BCA (for a widely-perceived higher quality franchise). Our new TPs imply 21% upside at Mandiri, 17% upside at BRI and 2% downside at BCA.

Maintain OW on Mandiri and BRI:
Higher upside, upwardly-biased earnings risk (on our and consensus forecasts) reinforce our preference for these two banks. We remain Equal-weight on BCA. Mandiri is our preferred choice for lower valuations and EPS upside.

Regional perspective:
Not only are these banks among the most profitable, best capitalized and possessing the most excess provision reserves, they also have the highest threshold for credit costs. On a P/Core Profit versus Core Profit/Loans matrix, these banks offer outstanding value regionally.