JP Morgan - Indonesia Equity Strategy: How blue is the sky? Equity drivers at an all-time index peak

The JCI Composite closed at a new all-time high of 2,887 on 5 April. We use this vantage to review the major drivers of Indonesian equities – looking at their current positioning from the perspective of previous peaks.

· Growth: J. P. Morgan’s Economics team has raised Indonesian FY10 GDP growth forecasts to 6.2% (from 5.5%), which is higher than consensus of 5.7%. This compares to 2007 GDP growth of 6.3%.

· Earnings Revisions: Strong monthly volume data (cars, cement, etc.) and 4QFY09 net profits that were 14% above consensus lends confidence that consensus FY10E EPS growth of 14% carries upside potential.

· Valuations: At 14x 12M forward P/E, Indonesian market multiples are at a 15% discount to their 2007 peak levels of 16.4x.

· Interest Rates: We see the decline in 10-year bond yields (9.1% currently, down 75bps in the last month) as a key driver of equities via lower discount rates. The 10-year bond peaked at an 8.7% yield in FY07.

· Investor positions: Indonesia is a consensus overweight market, which could be a risk if fundamentals turn or investor appetite reverses. The extent of EM OW positioning (0.7% higher than benchmark) is in line with 2007 peak levels. Overall foreign holdings are less than Nov 09 peaks.
Overall, at this time, we do not view Indonesian equities as overextended. We are, however, wary of politics flaring up again. We highlight that evidence of better execution on infrastructure spending and resolving investment bottlenecks are critical if the re-rating is to prove sustainable and more than just cyclical. We rate Indonesia as a neutral weight within an ASEAN, Asian and EM context.

· Forty-five percent of the JCI move since the end of February can be traced to five stocks – Astra, BRI, BCA, PGAS and BMRI. We expect Astra to consolidate, but think medium-term drivers remain in place. Tariff hikes propelled PGAS recently, and it may cool off till gas volumes start to accelerate. The banks have outperformed uniformly despite divergent fundamental trends – asset quality at BMRI & BCA is improving while 4Q new NPL creation at BRI was 13% of disbursals. We recommend selling BRI and buying BMRI. We recommend buying property (mid-caps) or building materials stocks (laggards) to capitalize on property sales volumes, which have picked up recently on domestic demand strength and lower rates. We would look for earnings estimates stabilizing/recovering as an inflection point for telcos, which we think may be an opportunity down the line, given their substantial underperformance over one/three/12 months.