DBS Indonesia Strategy Optimism priced in mostly

• Earnings upgrade cycle has clearly slowed down. Market unlikely to re-rate beyond 14x PER.
• FY11 earnings growth would provide some upside though.
• We like banks for strong loan growth. Profit taking in the coal sector in 2QCY10 should be a buying opportunity.
• Top picks are Bank Mandiri, Bank Rakyat, PT Telkom, PT Adaro, Indofood Sukses, Perusahaan Gas Negara and Sampoerna Agro

Earnings upgrade cycle has slowed down. Consensus earnings have been revised up only by 0.6%, over the last one month compared to 1.9% and 6.5% over the last three and six months respectively. Consumer discretionary (Astra) has led the earnings upgrades, followed by basic material and banking sector. Regional comparisons do not favor Indonesia either.

Market offers 14-15% upside potential in 2010. MSCI Indonesia is up 6% year-to-date with 12-month forward PER of 14x on rolling basis. This translates to +1 standard deviation of historical average of 11x. We do not expect market to re-rate beyond +1
STD in view of absence of major earnings revisions and global risk aversion. We expect MSCI Indonesia to trade at 14x FY11 PER by end 2010, implying 14% potential upside.

Firm Rupiah reflects investors’ confidence though. After initial jitters due to the European debt crisis, Rupiah has regained lost ground. DBS forecasts the USD/Rupiah exchange rate to be range bound between 9000-9300 in 2010 before appreciating
to 8700 in 2011. Our economist does not foresee the contagion impact on Indonesia’s economy as most of the external debt is long-term in nature and debt coverage ratio is stable.

Two key themes to ride on: (i) Strong loan growth in an underleveraged economy; and (ii) Rising demand and production in the coal sector, although some of the coal stocks could pull back in 2QCY10 on profit taking.

Top picks. Bank Mandiri for recovery of written-off assets, Bank Rakyat for its micro credit franchise, Adaro for solid track record of coal production growth, PT Telkom for improved cellular performance from 2Q10 onwards, Indofood Seksus for higher sugar/rubber prices and potential expansion into other segments, PGas for domestic gas demand and over 4% yield, Sampoerna Agro as the least expensive upstream plantation player in our coverage.