DBS Regional Market Focus Indonesia Strategy

Bulls won’t be disappointed

• We expect a firm JCI as suggested by the low 10-year bond yield, a leading indicator in the past.
• 2010 GDP forecast revised up to 6% on solid domestic demand. 2011 budget proposals and IPO pipeline to boost sentiment.
• Based on 14x PER (+1 STD), JCI to reach 3400 by end-2010 and 3840 by end-2011. Recommend banks and utility companies.

10-year bond yields have declined 190 basis points YTD. Mathematically, we found a high correlation of -0.51x between changes in PER and 10-year bond yield since 2005.
A lower bond yield lowers the risk-free rate, reducing the cost of capital, and benefits DCF valuations.

GDP growth revised up, fiscal deficits to narrow further. DBS Group Research revised its GDP growth forecast to 6% (from 5.5%) for 2010 and 5.8% (from 5.5%) for 2011 on the back of strong 2Q10 numbers. Domestic demand accounting for 90% of real GDP, continues to be healthy. Government projects that fiscal deficit will narrow to 1.7% of GDP in 2011 from 2.1% in 2010. The actual deficit could be less than 1% of GDP, as revenue forecast is underestimated. On a positive note, the government intends to raise infrastructure spending while reducing subsidies.

Impressive IPO pipeline. Big companies such as Indonesia’s largest steel producer Krakatau Steel, national flag carrier Garuda Indonesia and Bumi Resources’ non-coal unit, Bumi Resources Mineral, are in the pipeline to float their shares on the stock exchange in 4Q10-1Q11.

Is JCI overstretched? JCI is at a record high of 3200, raising concerns whether the rally still has legs. Investors should take comfort in the fact that JCI trades at 12.7x 2011F PER (consensus) slightly higher than regional average of 11.5x due
to higher growth prospects than regional peers. By the end of 2010, we expect JCI to reach 3400 based on 14x 2011 PER (+1 STD of historical average of 11x). Further re-rating depends upon inflation outlook in 2011. Even without rerating, JCI could reach 3840 by the end of 2011, based on 13% earnings growth in 2012.

Recommend Banks and utility companies. Bank Mandiri, cellular company XL Axiata and utility company Pgas are our top picks. Consumer companies are also big beneficiaries but positives are priced in. Coal sector should benefit from the
seasonally strong 4Q, but valuations are not very attractive.