Credit Suisse Asia Equity Strategy - Indonesia Overweight

Over the last three months, we have been Overweighting Indonesia as the home of cheap cyclicals. The key question now is whether Indonesia is still undervalued as it is up 72% YTD in USD terms (similar to Shanghai’s 71% YTD performance).

On our P/BV versus ROE valuation model, Indonesia has moved from being the most undervalued (a position it got to at end- February) to now the second most undervalued market in the region. Thailand’s discount at 32% is now slightly larger than Indonesia’s at 28% (see Figure 1). Also, Indonesia’s discount narrowed from 74% at end-February to 28% now.

While the discount has narrowed, we note four positives for Indonesia. Firstly, it is a domestic growth story similar to China (H shares discount is 17%) and India (14% discount). Second, it has been associated with strong upgrades to consensus EPS (see Figure 2). Third, there is potential room for one more rate cut and if not stable rates. Finally, if the exit polls are accurate, there is a potential for a stronger government after Wednesday’s Presidential elections.

Indonesia moves from being the most undervalued to second most undervalued Over the last three months, we have been Overweighting Indonesia as the home of cheap cyclicals. The key question now for investors is whether Indonesia is still undervalued as it is up 72% YTD in USD terms (versus 34% for MSCI Asia ex-Japan in USD terms).

On our P/BV versus ROE valuation model, Indonesia has moved from being the most undervalued (a position it got to at end-February) to now the second most undervalued market in the region. Thailand’s discount at 32% is now slightly larger than Indonesia’s at 28%. Also, the discount narrowed from 74% at end-February to 28% now.

While Indonesia’s P/B at 2.8x is much higher than Asia’s 1.73x, we note that we get the 28% discount as Indonesia’s ROE of 20.7% is close to double Asia’s ROE of 10.8%.

Figure 2 highlights that 2009E consensus EPS revisions have been accelerating in Indonesia from +0.1% in April to +3.5% in May to +3.2% in June and +2.8% in just the first week of July. Indonesia’s consensus EPS upgrades appear to be broad-based with only telcos (-0.8%) and industrials (-0.3%) associated with downgrades so far in
July.

The strongest upgrades so far in July have been in Indonesian energy (+12%), utilities (+4%), materials (+3.4%), consumer cyclicals (+2%) and financials (+1.4%). Significantly, all these sectors are trading at a discount to the region.

The biggest discounts are in energy (142%), consumer cyclicals (47%), consumer staples (44%), materials (25%) and financials (20%). Within energy, we estimate a 159% discount for coal (versus just 20% for Chinese coal) and 59% for palm oil (versus a 14% premium for Singapore/Malaysian palm oil).

While the Indonesian energy discount is probably overstated as the current ROE is unsustainably high at 29.3%, we estimate that the sector is priced for ROE to fall to 14%. In other words with a 14% ROE, the discount goes to zero.

So for investors like us who are keen on cheap cyclicals, Indonesia is still the place to be.