Consumer Price Index rose by 0.76% mom or increased 6.44% yoy in Aug10 lower than our and consensus estimates. Year-to-date, the CPI has increased 4.82%. Aug10 inflation was mainly driven by electricity tariff hike (0.35ppt) and processed food (0.11ppt). Meanwhile, raw food prices only increased slightly (0.09ppt), as some of the prices have started to decline from their peaks in Jul10 inflation.
Given the current inflation rate, we still believe this year inflation figure likely will exceed the central bank target of 4%-6% in 2010. Besides rising demand, unfavorable climate that may trigger a spike in food prices, and increase in administered prices would drive the inflation higher. Thus, we revised our inflation forecast to 6.3% yoy in 2010 from previously 5.9% yoy and maintain 6.6% yoy inflation next year.
We expect to see a more hawkish stance in BI policy statement, as there some indication that demand started to stoke inflation and inflation expectation is building up, indicating by a steady increase in core inflation However, we believe, the central bank may refrain from raising the rate at the next board meeting on Friday (3/9) and opt to increase reserve requirement instead. We maintain our first rate hike on Nov10 by a total 50 bps this year and another 50 bps next year that will bring BI rate to 7.5% by YE11.
Trade balance turned deficit in Jul10 of US$0.13bn, as export stabilized (29.0% yoy) and imports surged (45.3% yoy). Despite the persistent trend, the deterioration in trade balance may not have directly put pressure on the currency as we believe it will be compensated by capital inflows.
Rabu, 08 September 2010
JP Morgan - PGAS 2Q10 strong but in-line with consensus. Flat revenue and profit in FY11E
• 1H10 net income in-line with consensus: PGAS reported 1H10 net income of Rp3,206B; up 0.6% Y/Y. 1H10 core net income came in at Rp3,230B up 23.4% Y/Y. Operating profit: which is free to forex swing and other distortions, grew by 16.2% Y/Y in 1H10. PGAS 1H10 operating profit is inline with consensus’ (52.2%) full year operating profit expectation of Rp8,750B but ahead of JPM’s (60.3%) full year operating profit expectation of Rp7,566B. With the results in-line with consensus’ expectation, we view that the stock is likely to trade sideways (with a positive bias); while there is an upside risk to our FY10E earnings forecast by about 5%.
• 2Q10 is strong: Subtracting 1Q10 result, 2Q10 core net income came in at Rp1,746B; up 24.6% Y/Y and 17.7% Q/Q. The reason is that 15% price hike in 2Q10 offset the 13.5% appreciation in Rp at the revenue level; while Rp appreciation led to lower COGS and expanded margin. Gross profit expanded by 633bp Y/Y and 520bp Q/Q. Below the operating profit line; forex and swap gain (loss) cause reported 2Q10 reported net income to actually decline by 27.0% Y/Y and 19.0% Q/Q.
• Flat profit growth in FY11E: PGAS CEO: Mr. Hendi Santoso, recently was quoted by Bloomberg that FY11E revenue and profit in FY11E are likely to be flat Y/Y due to constraints in the supply of gas. Our inquiry confirmed that this is the current view that PGAS is communicating to the market and it is currently working on signing some new contracts. Considering that consensus FY11E earnings forecast implies a 14.8% Y/Y growth, we view that downside revision to FY11E could lead to share price
underperformance. Currently, our FY11E EPS is about 12.9% below that of consensus, and is a key reason behind our UW stand.
• Maintain UW and Dec-10 PT of Rp3,400: At this point, we are in the process of reviewing our model. Meanwhile, on the back of flat and lower than expected profit in FY11E, we maintain UW and our Dec-10 PT of Rp3,400 on PGAS. Our PT is derived from a combination of DCF and PE methods.
• 2Q10 is strong: Subtracting 1Q10 result, 2Q10 core net income came in at Rp1,746B; up 24.6% Y/Y and 17.7% Q/Q. The reason is that 15% price hike in 2Q10 offset the 13.5% appreciation in Rp at the revenue level; while Rp appreciation led to lower COGS and expanded margin. Gross profit expanded by 633bp Y/Y and 520bp Q/Q. Below the operating profit line; forex and swap gain (loss) cause reported 2Q10 reported net income to actually decline by 27.0% Y/Y and 19.0% Q/Q.
• Flat profit growth in FY11E: PGAS CEO: Mr. Hendi Santoso, recently was quoted by Bloomberg that FY11E revenue and profit in FY11E are likely to be flat Y/Y due to constraints in the supply of gas. Our inquiry confirmed that this is the current view that PGAS is communicating to the market and it is currently working on signing some new contracts. Considering that consensus FY11E earnings forecast implies a 14.8% Y/Y growth, we view that downside revision to FY11E could lead to share price
underperformance. Currently, our FY11E EPS is about 12.9% below that of consensus, and is a key reason behind our UW stand.
• Maintain UW and Dec-10 PT of Rp3,400: At this point, we are in the process of reviewing our model. Meanwhile, on the back of flat and lower than expected profit in FY11E, we maintain UW and our Dec-10 PT of Rp3,400 on PGAS. Our PT is derived from a combination of DCF and PE methods.
JP Morgan - Riz note: How could bank shortly keep its funding cost flat
* By looking at the industry’s data, I believe Indonesian banks could raise up to Rp39 trillion (US$4.3 billion) long dated IDR funding by a) taking the cross currency swap and b) bringing up its non-IDR LDR from currently 68% to 80%. The strategy should temporarily ease concerns IDR funding competition.
* In addition to Bank Danamon (BDMN IJ, Market cap: USD5.0B, Liquidity: USD3.0M/day, and 12.8x FY11 consensus EPS), which has undertaken the strategy, I believe Bank Central Asia (BBCA IJ, USD16.3B, USD5.3M/day, and 15.5x FY11 EPS) and Bank Mandiri (BMRI IJ, USD14.0B, USD11.9M/day, and 12.3x FY11 EPS) could take this strategy.
IDR LDR HAS GONE UOP, BUT USD LDR HAS GONE DOWN,...
With the IDR Loans-to-Deposits Ratio (LDR) in the Indonesian banking industry rose from 64% in Dec-07 to 80% in Jun-10, thanks to the strong economy growth, concerns over the ability of Indonesian bankers to fund the growth of their loans book are rising. The text book mentions that, in an attempt to keep up with their loans growth rates, bankers will have to enter into funding competition, resulting in an increase in funding cost and lower net interest margin. Accordingly, the Indonesian banking sector has underperformed the broad market by 65bp QTD.
However, at the same time, the non-IDR (mostly USD) LDR in the Indonesian banking industry has decreased from 94% to 68%. Huge IDR/USD volatility post the Lehman crisis (during the 4Q08 to 1Q09 period) has discouraged Indonesian companies to borrow in USD. As recently demonstrated by Bank Danamon, this excess offshore USD liquidity could actually be used by the industry to partly cover its IDR liquidity requirement.
...CREATING A CROSS CURRENCY SWAP OPPORTUNITY
How did Bank Danamon do it? The bank entered into a plain vanilla three years currency swap with a number of foreign banks. Under the deal, the bank gives its excess USD to foreign banks and receives IDR from foreign banks. On the other side of the trade, Bank Danamon gives an annual fixed IDR interest rate of 7.75% to these foreign banks and receives 6-month floating USD LIBOR from these foreign banks over the next three years. On the maturity date, the bank will give the IDR back to foreign banks and vice versa at the spot exchange rate. In addition of securing its IDR requirement, Bank Danamon is also able to lock relatively low long-term funding. If the bank issues a 3-year bond at 100-150bp above the sovereign rate today, the bank will have to pay 8.1-8.6% (versus the currency cross swap rate of 7.75%). Kindly go to IHUSW03 and C1323Y in your Bloomberg, to find out the historical time series of the three-year IDR/USD cross currency swap rates and three year IDR sovereign yield, respectively.
Why would foreign banks do it? At the glance, the trade doesn’t make sense as foreign banks normally long USD and short IDR. However, between the Dec-07 to date, the Riz note reader would note that non- residents have also increased their holdings on IDR papers (both SBI and T-bonds) from US$11.3 billion to US$24.0 billion. While these
non-residents are still bullish on the IDR outlook, the need to partially hedge their IDR bond books (by partially swapping their IDR positions with USD) from their risk management perspective has also risen.
As an Indonesian bank is no longer required to provide the breakdown of its loans and deposits by type of currency, it has been becoming difficult for me to accurately identify which other Indonesian banks, which could follow Bank Danamon’s strategy in recycling its excess USD (low USD LDR) for long dated IDR funding. However, based on
channel checking, I believe both Bank Central Asia and Bank Mandiri have opportunities to copy cat Bank Danamon’s move as these banks a) are sometimes USD lenders in onshore money market and b) have aspirations to strengthen their consumer lending, requiring long dated IDR funding.
By looking at the industry’s data, I believe Indonesian banks could raise up to Rp39 trillion (US$4.3 billion) long dated IDR funding by taking the cross currency swap and bringing up its non-IDR LDR from currently 68% to 80%. The strategy should temporarily provide a relief for bankers in funding their rising IDR loans books.
* In addition to Bank Danamon (BDMN IJ, Market cap: USD5.0B, Liquidity: USD3.0M/day, and 12.8x FY11 consensus EPS), which has undertaken the strategy, I believe Bank Central Asia (BBCA IJ, USD16.3B, USD5.3M/day, and 15.5x FY11 EPS) and Bank Mandiri (BMRI IJ, USD14.0B, USD11.9M/day, and 12.3x FY11 EPS) could take this strategy.
IDR LDR HAS GONE UOP, BUT USD LDR HAS GONE DOWN,...
With the IDR Loans-to-Deposits Ratio (LDR) in the Indonesian banking industry rose from 64% in Dec-07 to 80% in Jun-10, thanks to the strong economy growth, concerns over the ability of Indonesian bankers to fund the growth of their loans book are rising. The text book mentions that, in an attempt to keep up with their loans growth rates, bankers will have to enter into funding competition, resulting in an increase in funding cost and lower net interest margin. Accordingly, the Indonesian banking sector has underperformed the broad market by 65bp QTD.
However, at the same time, the non-IDR (mostly USD) LDR in the Indonesian banking industry has decreased from 94% to 68%. Huge IDR/USD volatility post the Lehman crisis (during the 4Q08 to 1Q09 period) has discouraged Indonesian companies to borrow in USD. As recently demonstrated by Bank Danamon, this excess offshore USD liquidity could actually be used by the industry to partly cover its IDR liquidity requirement.
...CREATING A CROSS CURRENCY SWAP OPPORTUNITY
How did Bank Danamon do it? The bank entered into a plain vanilla three years currency swap with a number of foreign banks. Under the deal, the bank gives its excess USD to foreign banks and receives IDR from foreign banks. On the other side of the trade, Bank Danamon gives an annual fixed IDR interest rate of 7.75% to these foreign banks and receives 6-month floating USD LIBOR from these foreign banks over the next three years. On the maturity date, the bank will give the IDR back to foreign banks and vice versa at the spot exchange rate. In addition of securing its IDR requirement, Bank Danamon is also able to lock relatively low long-term funding. If the bank issues a 3-year bond at 100-150bp above the sovereign rate today, the bank will have to pay 8.1-8.6% (versus the currency cross swap rate of 7.75%). Kindly go to IHUSW03
Why would foreign banks do it? At the glance, the trade doesn’t make sense as foreign banks normally long USD and short IDR. However, between the Dec-07 to date, the Riz note reader would note that non- residents have also increased their holdings on IDR papers (both SBI and T-bonds) from US$11.3 billion to US$24.0 billion. While these
non-residents are still bullish on the IDR outlook, the need to partially hedge their IDR bond books (by partially swapping their IDR positions with USD) from their risk management perspective has also risen.
As an Indonesian bank is no longer required to provide the breakdown of its loans and deposits by type of currency, it has been becoming difficult for me to accurately identify which other Indonesian banks, which could follow Bank Danamon’s strategy in recycling its excess USD (low USD LDR) for long dated IDR funding. However, based on
channel checking, I believe both Bank Central Asia and Bank Mandiri have opportunities to copy cat Bank Danamon’s move as these banks a) are sometimes USD lenders in onshore money market and b) have aspirations to strengthen their consumer lending, requiring long dated IDR funding.
By looking at the industry’s data, I believe Indonesian banks could raise up to Rp39 trillion (US$4.3 billion) long dated IDR funding by taking the cross currency swap and bringing up its non-IDR LDR from currently 68% to 80%. The strategy should temporarily provide a relief for bankers in funding their rising IDR loans books.
JP Morgan - Indonesia: August CPI lower than expected despite tariff hike (Sin Beng Ong)
August inflation in Indonesia rose a lower than expected 0.8%m/m, sa and was up 6.4%oya (J.P. Morgan and consensus 6.7%oya).
CPI up on tariff hikes not food - In terms of the overall 0.79%m/m, nsa increase in inflation, 0.4%pts came from higher housing and electricity related costs, which reflects the one-off increase in electricity tariffs in August and encouragingly, 0.2%pts came from food prices, against increases of well over 0.7%m/m, nsa in the previous two months (first chart).
The increase in electricity tariffs is not expected to be persistent and should roll off in the coming months, as has been the case in recent history. The moderation in food prices in August likely reflects the impact of beginning of Ramadan and also from the impact of BULOG’s efforts to ease food prices. Thus, while food prices were lower in August, the real test will be in September and October.
Watching food prices in September/October - Lebaran, which falls on September 10, tends to lead to one-off increases in food prices which fades in the subsequent month. The real test will be whether food prices indeed moderate in October after Lebaran. The J.P. Morgan forecast assumes it will, since by that time adverse weather effects are expected to have eased and also that the rice harvest in 3Q10 should provide some offset.
Underlying inflation modest so far - Importantly, despite the increase in headline inflation, core inflation has remained modest and this should keep the central bank on hold through 2010. Moreover, non-food inflation remains modest despite the increase in food prices which suggests that food inflation has not widened into broader prices. At a broader level, WPI inflation in Indonesia tends to be a leading indicator for underlying inflationary pressures and while WPI has recently risen, it still remains low and should not feed into broader CPI (fourth chart). Also importantly, the recent stability of the IDR has also likely helped anchor inflation transmission and the forecast for a slow but steady appreciation of the IDR should keep the inflation pass through modest.
BI expected to remain on hold through 2010 – Given the expectations above for modest core inflation, there would be little need for the central bank to raise rates in 2010.
CPI up on tariff hikes not food - In terms of the overall 0.79%m/m, nsa increase in inflation, 0.4%pts came from higher housing and electricity related costs, which reflects the one-off increase in electricity tariffs in August and encouragingly, 0.2%pts came from food prices, against increases of well over 0.7%m/m, nsa in the previous two months (first chart).
The increase in electricity tariffs is not expected to be persistent and should roll off in the coming months, as has been the case in recent history. The moderation in food prices in August likely reflects the impact of beginning of Ramadan and also from the impact of BULOG’s efforts to ease food prices. Thus, while food prices were lower in August, the real test will be in September and October.
Watching food prices in September/October - Lebaran, which falls on September 10, tends to lead to one-off increases in food prices which fades in the subsequent month. The real test will be whether food prices indeed moderate in October after Lebaran. The J.P. Morgan forecast assumes it will, since by that time adverse weather effects are expected to have eased and also that the rice harvest in 3Q10 should provide some offset.
Underlying inflation modest so far - Importantly, despite the increase in headline inflation, core inflation has remained modest and this should keep the central bank on hold through 2010. Moreover, non-food inflation remains modest despite the increase in food prices which suggests that food inflation has not widened into broader prices. At a broader level, WPI inflation in Indonesia tends to be a leading indicator for underlying inflationary pressures and while WPI has recently risen, it still remains low and should not feed into broader CPI (fourth chart). Also importantly, the recent stability of the IDR has also likely helped anchor inflation transmission and the forecast for a slow but steady appreciation of the IDR should keep the inflation pass through modest.
BI expected to remain on hold through 2010 – Given the expectations above for modest core inflation, there would be little need for the central bank to raise rates in 2010.
JP Morgan - Indonesia: BoP stepping (a little) into the unknown (Sin Beng Ong)
Indonesia’s July trade balance printed a rare deficit, coming in at negative US$0.13 billion. A large bulk of the narrowing in the trade balance owed to imports, which rose a solid 2.5%m/m, sa even as exports moderated to contract 0.9%m/m, sa.
Current account deficit looks likely in next couple quarters - In the case of Indonesia, the trade balance tends to be a large driver of the current account and the recent narrowing in the trade balance reflects slowing exports and strong imports (first chart). This suggests that the current account is on track to print a deficit in 4Q10/1Q11 with the forecast for the deficit to persist into 2011 (second chart, see also “Indonesia’s BoP to lean more on capital account,” GDW, June 11 2010).
A good part of this narrowing in the trade balance reflects the natural ebb and flow of domestic demand, reflected via car sales, which tends to lead to oscillations in the external balances as was the case in 2005 and 2008 and forecast also in 2010 (third chart).
Watching high-powered money and credit growth - Looking ahead, the recent strength of inflows has also led to some leakage into high-powered money (fourth chart). In the case of Indonesia, the expansion in base money growth has historically been a catalyst for credit growth and this cycle is expected to be no different (fifth chart). Thus, credit growth is expected to be buoyant into 2H10 and should reinforce the domestic demand cycle and, in turn, further narrow the current account (sixth chart).
Capital account flows expected to offset current account narrowing – Since the Asian crisis in 1998, the quality of capital account inflows in Indonesia has been poor and thus any narrowing in the current account has not usually been offset by steady capital account inflows. This thus implies that any current account narrowing tends to leave the BoP vulnerable to pullbacks in risk appetite which has been the case in the last decade or so.
However, one encouraging dynamic in 2009 and into 2010 has been the persistence and strength of inflows in the capital account, not only reflecting portfolio inflows in the local bond market but also renewed strength in FDI inflows (table below). Indeed, in 1H10, FDI inflows rose to US$2.9 billion and are expected to print at record levels in 2010. Part of this forecast reflects the expectation that manufacturing wages in Indonesia are becoming increasingly cost competitive which also reflects the recent increase in manufacturing sector wages in China. Indeed, the labor intensive manufacturing sector has seen renewed strength reflected in the recent rise in the textiles industry which could migrate also to low-end electronics manufacturing (see “ASEAN: relative export prices still matter for some,” GDW, April 9 2010).
Thus, the next few quarters will provide an important test for Indonesia and its ability to manage a smooth transition to a current account deficit from surplus.
In J.P. Morgan’s forecast, Indonesia should be able to make this transition relatively smoothly – assisted by unusually low global policy rates and the relocation of low-end manufacturing back to Indonesia.
The best indicator for this transition will be the BoP data. However, in the case of Indonesia, this tends to be very lagged, with the best proxy indicator for the BoP being the trend in FX reserves.
Current account deficit looks likely in next couple quarters - In the case of Indonesia, the trade balance tends to be a large driver of the current account and the recent narrowing in the trade balance reflects slowing exports and strong imports (first chart). This suggests that the current account is on track to print a deficit in 4Q10/1Q11 with the forecast for the deficit to persist into 2011 (second chart, see also “Indonesia’s BoP to lean more on capital account,” GDW, June 11 2010).
A good part of this narrowing in the trade balance reflects the natural ebb and flow of domestic demand, reflected via car sales, which tends to lead to oscillations in the external balances as was the case in 2005 and 2008 and forecast also in 2010 (third chart).
Watching high-powered money and credit growth - Looking ahead, the recent strength of inflows has also led to some leakage into high-powered money (fourth chart). In the case of Indonesia, the expansion in base money growth has historically been a catalyst for credit growth and this cycle is expected to be no different (fifth chart). Thus, credit growth is expected to be buoyant into 2H10 and should reinforce the domestic demand cycle and, in turn, further narrow the current account (sixth chart).
Capital account flows expected to offset current account narrowing – Since the Asian crisis in 1998, the quality of capital account inflows in Indonesia has been poor and thus any narrowing in the current account has not usually been offset by steady capital account inflows. This thus implies that any current account narrowing tends to leave the BoP vulnerable to pullbacks in risk appetite which has been the case in the last decade or so.
However, one encouraging dynamic in 2009 and into 2010 has been the persistence and strength of inflows in the capital account, not only reflecting portfolio inflows in the local bond market but also renewed strength in FDI inflows (table below). Indeed, in 1H10, FDI inflows rose to US$2.9 billion and are expected to print at record levels in 2010. Part of this forecast reflects the expectation that manufacturing wages in Indonesia are becoming increasingly cost competitive which also reflects the recent increase in manufacturing sector wages in China. Indeed, the labor intensive manufacturing sector has seen renewed strength reflected in the recent rise in the textiles industry which could migrate also to low-end electronics manufacturing (see “ASEAN: relative export prices still matter for some,” GDW, April 9 2010).
Thus, the next few quarters will provide an important test for Indonesia and its ability to manage a smooth transition to a current account deficit from surplus.
In J.P. Morgan’s forecast, Indonesia should be able to make this transition relatively smoothly – assisted by unusually low global policy rates and the relocation of low-end manufacturing back to Indonesia.
The best indicator for this transition will be the BoP data. However, in the case of Indonesia, this tends to be very lagged, with the best proxy indicator for the BoP being the trend in FX reserves.
JP Morgan - Adaro Energy: Risk to consensus FY11 earnings forecast; downgrade to UW (Stevanus Juanda)
We downgrade ADRO to UW and reduce PT to Rp1,700: On the back of slower volume and profit growth than peers, downside risk to consensus’ FY11E earnings forecast and high valuation, we downgrade ADRO from OW to UW and reduce our PT from Rp2,600 to Rp1,700. We think downward revision to consensus earnings is likely, and that this could result in ADRO underperforming.
Reduce our FY10E/FY11E net income by 13.7%/21.4%: With the lower-than-expected results recorded in 2Q10, we lower our FY10E and FY11E net income by 13.7% and 21.4%, respectively. In the past six months, the stock has underperformed the JCI index by 19.7%; despite the relatively small downside in absolute terms, we see further underperformance from here on the back of consensus downgrades and because we estimate ADRO’s FY11 volume and profit growth will be among the lowest of industry peers.
Downside risk to consensus FY11E earnings: Our FY10E and FY11E net income forecasts are 16.9% and 32.2% below the Street’s estimates. We therefore see downside risk to consensus earnings, as the current consensus FY11E operating profit forecast of Rp11,798 billion implies an operating profit of US$27.3/ton, a level which has not been seen even when the coal price averaged US$125/ton.
Reduce our FY10E/FY11E net income by 13.7%/21.4%: With the lower-than-expected results recorded in 2Q10, we lower our FY10E and FY11E net income by 13.7% and 21.4%, respectively. In the past six months, the stock has underperformed the JCI index by 19.7%; despite the relatively small downside in absolute terms, we see further underperformance from here on the back of consensus downgrades and because we estimate ADRO’s FY11 volume and profit growth will be among the lowest of industry peers.
Downside risk to consensus FY11E earnings: Our FY10E and FY11E net income forecasts are 16.9% and 32.2% below the Street’s estimates. We therefore see downside risk to consensus earnings, as the current consensus FY11E operating profit forecast of Rp11,798 billion implies an operating profit of US$27.3/ton, a level which has not been seen even when the coal price averaged US$125/ton.
JP Morgan - Buy Perusahaan Gas Negara (PGAS)
Buy Perusahaan Gas Negara (PGAS): 2Q10 results addressed earlier concerns about gas volume drop-off, that was caused by government intervention on gas allocation. Distribution volume is returning to normal but more importantly, average selling price jumped 5.4% QoQ, driving a 16% QoQ growth in EBIT. If we assume the 2Q10 EBIT of Rp2,456bn is sustained in Q3 and Q4, full year EBIT can reach around Rp9.5trn – this is 8% higher than consensus of Rp8.8trn and 25% higher than Stevanus Juanda’s number. If we assume the 2Q10 core net income of Rp1,746bn is sustained in Q3 and Q4, full year core net income can reach around Rp6.7trn – this is 5% higher than consensus of Rp6.4trn and 22% higher than Stevanus Juanda’s number. Bottom-line: concerns on 2011 outlook appear unfounded as forecast for the base year (2010) is being revised upward; the stock trades on attractive P/E multiple of 14.5x FY10 with a 3-4% dividend yield. The stock may re-rate on the back of a continuing decline in Indonesia 10YR government bond yield.
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