Citigroup Bank Rakyat Indonesia ( Persero ) (BBRI.JK) The Shopping List (Rate: Sell/Medium Risk)

 What's New — BBRI plans a 2-1 or 4-1 stock split and has expressed a desire to acquire Bank Bukopin (BBKP IJ). The proposed stock split is premised on share price remaining above Rp10,000, to attract retail investors. BBKP is a Rp4Trn bank (market cap) with a 41% stake owned by BULOG, a state owned entity for commodity trading. The acquisition will expand BBRI's loan book by 13%, adding farmers that sell to BULOG, but will not address the concerns about increasing dependence on Time Deposits. Based on 51% purchase, the standalone Tier 1 ratio will decline by 50bps to 11.7% and CAR by 100bps to 13.1%.
 Returns — The business model of BBKP generates low ROA of 1.1%, but ROE is boosted by high leverage to 17%, according to Bloomberg data as of June 10. It is trading at P/B of 1.4x (June 10) and PER of 8.1x (1H 2010A annualized). Credit Cost in 1H 2010 was only 0.5%.
 Other Shareholders — Besides BULOG (40.5%), the shareholders include Government (16.9%) and two Employee Trusts with 11.9% and 6.6% respectively.
 Bank Agroniaga (AGRO IJ) — BBRI is finalizing an acquisition of a small agriculture bank with an asset base of Rp3Trn (1% of BBRI). This is unlikely to have any material impact on its performance.

Investment strategy
We rate BBRI Sell/Medium Risk due to its strong stock performance, deteriorating loan quality and vulnerability to rising interest rates. Risks are increasing for banks due to high LDR (close to 90%) and deteriorating asset quality. Rising interest rates are likely to have a bigger impact on cost of funds than asset yields. BBRI's focus on asset growth has altered its balance sheet mix and dependence on time deposits.

Valuation
We use DDM to value Indonesian bank stocks due to declining bond yields. Our target price of Rp9,300 is based on DDM, using a 2011E DPS of Rp242. We assume BBRI will maintain a 30% payout ratio and 13.6% sustainable growth. BBRI has been growing loans at more than 20% but its earnings growth would likely be constrained by high LDR. Our cost of equity assumption is 16.2%, based on a 9.3% risk-free rate (6.0% inflation + 3.3% real rate, in line with the historical average) and a beta of 1.15x (1-year historical). Our target price implies a 2011E P/E of 11.5x (historical average) and P/B of 2.7x.

Risks
We assign a Medium Risk rating to BBRI due to operational risks - high LDR and a rising gross NPL ratio. Our quantitative risk-rating system, which tracks 260-day historical share price volatility, assigns it Low Risk. Upside risks that could prevent the stock from reaching our target price include sustained liquidity inflow, strong loan demand due to benign inflation (consumer/microfinance), and sharp export recovery (corporate).