market strategy-16-dec-2016 mf...be enough to counter the sentiment ... adaro energy 1,680 4,026...

ed: CK / sa: YM, PY

JCI : 5,308.10

Analyst Indonesian Research Team [email protected]

Key Indices

Current Chg JCI 5,308.1 0.08% LQ45 890.3 0.1% Industry 548.1 0.31% Consumer 2,411.8 -0.2% Rp/US$ 13,337 -0.2% Daily Vol (m shrs) 10,415.3 Daily Turnover (Rpbn) 7,895.2 Daily Turnover (US$m) 592.0

Source: Bloomberg, DBS Vickers Market Key Data

(%) EPS Gth Div Yield 2015 -4.2 1.9 2016F 6.5 2.2 2017F 16.9 2.5 (x) PER EV/EBITDA 2015 19.5 11.3

2016F 18.4 10.8

2017F 15.7 9.7

Source: DBS Bank, DBS Vickers STOCKS

Source: DBS Bank, , DBS Vickers, Bloomberg Finance L.P. Closing price as of 9 Dec 2016

DBS Group Research . Equity 16 Dec 2016

Regional Market Focus

Indonesia Strategy

Refer to important disclosures at the end of this report

Subject to external pressures Turning cautious on JCI due to US outlook and

rising yields

Indonesia’s fundamentals are still fine but may not

be enough to counter the sentiment

Downside risk on JCI to 4,700-4,800 if USD/IDR

behaves in a similar way to 2015

Strategy: avoid expensive big caps, USD exposures

and focus on valuation.

Stock Picks: BDMN, MIKA, PTPP, INDF and ADRO.

Turning cautious on JCI. Going into 2017, we are turning cautious on the Indonesian market due to the positive economic outlook for US and rising yields. Our chief economist expects four rate hikes and US yields to rise to 3.2% for 2017 on the back of stronger US growth (2.7% in 2017 vs. 1.7% in 2016). Rising yield historically does not bode well for Indonesia’s equity market performance in the past few years.

Downside risk on JCI to 4,750 if 2015 USD/IDR performance

repeats again. Indonesia’s fundamentals may be fine but may not be enough to counter the sentiment in the near term. We believe there is downside risk on JCI to 4,750 if USD/IDR behaves in a similar way to 2015 whereby USD/IDR depreciated by more than 10%. The key risks to our call are slower Fed hike, stable currency and strong earnings growth as expected.

Avoid USD exposures and expensive big caps. Given our cautiousness on JCI in the near term, we recommend investors to avoid stocks with USD exposures and expensive big caps that could be under pressure from foreign sell-off. Keep in mind that JCI's 2H16 rally was driven by foreign flows and big caps tend to be prone to market volatility.

Stock picks. We recommend investors to focus on valuation and growth stocks with the ability to deliver. Several themes to consider are domestic consumption, investment growth and commodity rally. Our stock picks for 2017 are: Adaro Energy (ADRO), Indofood Sukses Makmur (INDF), Mitra Keluarga (MIKA), PT Pembangunan Perumahan (PTPP) and Bank Danamon (BDMN).

Price Mkt Cap 12-mth Target

Performance (%)

Rp US$m Price Rp 3 mth 12 mth Rating

Bank Danamon Indonesia bk

3,370 2,420 4,300 (8.4) 17.4 BUY Mitra Keluarga Karyasehat 2,540 2,769 3,150 (7.6) 10.2 BUY Pembangunan Perumahan 3,970 1,440 5,700 (4.6) 11.4 BUY Indofood Sukses Makmur 8,050 5,296 9,900 (1.8) 58.6 BUY Adaro Energy 1,680 4,026 1,900 32.3 242.9 BUY

Market Focus

2017 Outlook

Highlights

2017: Subject to external pressures

Going into 2017, we feel like it is a resemblance of what we saw a year ago when we were writing our 2016 outlook report. On the external front, Fed rate hike and currency risk resurfaced again which generally are unfavourable for Indonesia. The surprise victory of Donald Trump as the next US President is another concern for the emerging markets including Indonesia.

Stronger US outlook. Our chief economist expects four rate hikes in 2017 and our FX strategist sees the potential for USD to appreciate further from the current level. From a currency standpoint, DBS’ view is that a stronger USD will be the theme in 2017 that will put pressure on emerging currencies including rupiah. Meanwhile, our macro research team believes that US yield can increase further to 3.25% in 2017 vs. c.2.4% currently and c.1.8% prior to the US election in early November 2016.

Turning cautious on JCI. When we upgraded Indonesia to Overweight in August 2016, one of the key assumptions was an accommodative US Fed. Unfortunately, things have changed especially post US election in November 2016. The US economy is stronger and US interest rates, yields and currency are expected to rise in 2017. If history repeats itself, we could see a correction in the near term as US yields are expected to increase further and a stronger dollar will dampen foreign investor sentiment.

Downside risks to 4,700-4,800 if rupiah repeats its 2015 performance. Given the uncertainties, we are turning cautious on JCI with downside risk to the 4,700-4,800 level. This scenario is based on 13x PE multiple or the low valuation level in 2015 when the rupiah depreciated by ≥10+% against USD and foreign outflow accelerated. In addition, we assume earnings growth of 16% in 2017, coming off a low base in 2016.

The story on Indonesia has not changed. We are still positive on Indonesia in the long run and we expect the economy to continue on the recovery path in 2017. Our economists expect 5.3% GDP growth in 2017 vs. 5.1% in 2016 and 4.8% in 2015. The reform story also continues with the success of the 1st phase of the tax amnesty programme while the progress on infra projects is more visible than a year ago. In addition, commodity prices could provide a solid boost for Indonesia next year if the trend can continue.

Robust earnings growth expected. We are still expecting JCI earnings to grow 16% in 2017, which is among the best in the region. All sectors under our coverage universe, except for cement, are expected to show double-digit earnings growth. Two key drivers on the robust 2017 earnings outlook are optimism on Indonesia's economic growth and the low base effect in 2015 and 2016. Sector-wise, banks will be the main driver for earnings recovery among the big caps.

Investment growth will be crucial. Investment growth contributed 1.5ppts to overall GDP growth in 2016. However, this is one full percentage point lower than the average contribution in 2010-2012, during which GDP growth has averaged c.6% or more. Our economist believes that stronger investment growth is needed if we were to see stronger GDP growth ahead. On a positive note, net FDI has increased in 3Q16 to 2% of GDP while FDI into manufacturing is expected to reach US$17bn in 2016, the highest since 2011.

Not everything will be smooth sailing though. While 2017 is expected to be better, there are still some uncertainties that could lead to disappointments. On the external front, aside from a stronger USD, the impact from higher rate means that the low interest rate era is over. In addition, higher commodity prices could lead to moderation in margin and profitability for corporates. Domestically, fiscal constraints could curb government spending and political issues could distract the economy too.

Strategy and stock picks. Given our cautious view on JCI in the near term, we prefer investors to avoid stocks with USD exposures and expensive big caps that could be under pressure from foreign sell-off. The big cap stocks could suffer from rupiah volatility although their fundamentals may not be affected by it.

Several themes to consider for 2017 are domestic consumption, investment growth, commodity rally and USD exposures. In term of stock picks, we recommend investors to focus on valuation and growth stocks with the ability to deliver. Our stock picks for 2017 are: Adaro Energy (ADRO), Indofood Sukses Makmur (INDF), Mitra Keluarga (MIKA), PT Pembangunan Perumahan (PTPP) and Bank Danamon (BDMN).

Key risks to our call

Our view on US may not pan out. The Trump era has not started yet and it is perhaps too early to tell the impact of Trump’s policies while our house view on Fed rate hikes could be seen as overly aggressive too

Stronger domestic growth. In the absence of liquidity flows, we believe JCI re-rating must be supported by strong earnings growth, which is expected in 2017 (+16%).

Market Focus

2017 Outlook

JCI outlook: Turning cautious on stronger USD outlook and rising yields

We are turning cautious on Indonesia market entering 2017 as we believe that JCI remains vulnerable to a stronger US economic outlook and rising US yields. Our regional strategist has downgraded Indonesia from Overweight to reflect the external pressures.

We think that 2017 could be different than 2016 as the rise in 10-year US Treasury yield is driven by inflation expectations under Trump. Hence, investors may take a more serious look at the US economy, with some help from Trump’s policies.

Downside risk to JCI if USD/IDR behaves like what it did in 2015.

While JCI has corrected by c.3% from the recent peak in November 2016, we believe that JCI still have downside risks at least in the short term from rising US yields and a weaker rupiah. In our view, JCI may trade down to the 4,700-4,800 level or c.9% downside from the current level. This scenario is based on 13x PE multiple or the low valuation in 2015 when the rupiah depreciated by ≥10+% against USD and foreign outflow accelerated. In addition, we assume no deterioration in our FY17 earnings growth assumption of 16%.

JCI PE Band

Source: Bloomberg Finance L.P, DBS Vickers

External factors led us to turn cautious on JCI. We believe Indonesia’s fundamentals are still intact and our macro research team pretty much kept its forecasts unchanged for 2017. However, the external risk factors may outweigh the fundamentals in the near term. Why are we cautious?

JCI Performance vs USD Performance

Source: Bloomberg Finance L.P

Stronger US and Fed rate hike

US economy seems to be stronger and US interest rates, inflation and currency are expected to strengthen in 2017. Meanwhile Trump's victory has made the market think that the chance of more hikes is real. DBS' chief economist expects one hike in December and four in 2017. The stronger US outlook has left investors with more challenges in evaluating the attractiveness of the emerging markets including Indonesia vs. the risks.

Rising US yields do not bode well for JCI

JCI has historically underperformed when the US yield trend is on the rise and vice versa. This negative correlation has been repeated over the past few years. DBS' fixed income strategist expects US 10-year bond yields at 3.25% by end-2017 which is almost 100bps increase from the current level.

JCI vs US 10-year Bond


Average

+1 stdev

+2 stdev

-1 stdev

-2 stdev

10.0

12.0

14.0

16.0

18.0

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

(x)

‐51%

87%

46%

3%13%

‐1%

22%

‐12%

16%

‐16%

18%

5%

‐1%‐7%

‐20%

‐2%‐10%

4%

‐60%

‐40%

‐20%

0%

20%

40%

60%

80%

100%

2008 2009 2010 2011 2012 2013 2014 2015 2016

JCI IDR/USD

1.0

1.5

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3,600.0

4,100.0

4,600.0

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5,600.0

Jan‐12 Jan‐13 Jan‐14 Jan‐15 Jan‐16

JCI US 10yr treasury

US GovtJCI

Market Focus

2017 Outlook

Currency-USD appreciation

JCI tends to be vulnerable to USD/IDR given that foreign investors still accounted for up to 60% of JCI transactions. Our FX strategist also has a stronger USD view in 2017 against EM currencies including the rupiah. Investors tend to get nervous when the rupiah starts to lose ground against USD since currency will affect their overall investment performance.

USD/IDR Forecast USD/IDR 1Q17 2Q17 3Q17 4Q17 DBS 13,339 13,518 13,697 13,876 Consensus 13,650 13,700 13,800 13697

Source: Bloomberg Finance L.P, DBS Bank

JCI vs IDR/USD


Recent JCI rally performance driven by liquidity flow The JCI rally in 2H16 was prompted by foreign liquidity flow post BREXIT and delayed Fed hike. Foreign inflows to Indonesia rose to US$1.8bn in July and August 2016 vs. net inflow of under US$1bn in 1H16. YTD, foreign inflows are still above US$1bn despite the selloff since September. We believe investors may shift back to US markets at least in the near term as the USD starts to turn and interest rates normalize, coupled with a strong US economic outlook.

Foreign Flow


Risks to our view and the potential scenarios

Our view on US may not pan out. The Trump era has not started yet and it is perhaps too early to tell the impact of Trump policies while our house view on Fed rate hike could be seen as overly aggressive too. Consensus expects two rate hikes in 2017 according to Bloomberg. Unfortunately, the uncertainties that we will be facing in 2017 are not less than what we saw in early 2016. Therefore, JCI may see support if our views do not pan out.

Indonesia's economy stands still and earnings growth disappoint. GDP growth is expected to improve in 2017 to 5.3% but the risks to the economy are also growing against the potential of higher interest rate and some question marks over global growth outside US. Moreover, we expect FY17 earnings growth to accelerate to 16% vs. just under 5% in 2016. If growth disappoints, we believe JCI will de-rate as the appeal of Indonesia diminishes.

JCI Scenarios. Against the backdrop mentioned above, we expect some downside risk to JCI in the near term to 4,700-4,800 while under a more optimistic case, we expect JCI to trade between +0.5 and 1SD above the 5-year mean PE or the 5,100-5,400 level for 2017. Base case scenario (Downside risk to 4,700-4,800). We believe that JCI still have downside risks from the current level of 5,308 due to rising US yields and a weaker rupiah at least in the short term. Key assumptions for deriving to our JCI forecast:

1. Rising US yield to above 3% and four Fed hikes in 2017. 2. Earnings growth at 16% 3. Valuation is based on the 2015 low when the market

was nervous about the Fed's policies or 13.3x FY17PE which is -1SD below the 5-year mean PE.

More optimistic case (5,100-5,400). This scenario must be supported by relatively stable USD/IDR and robust earnings growth to support the valuation. Key assumptions:

1. Slower-than-expected Fed rate hikes (consensus at two times in 2017)

2. Relatively stable currency with USD/IDR staying below the 14,000 level

3. Earnings growth can be maintained at teen-level 4. Valuation at +0.5 to 1 SD above the 5-year mean PE or

between 14 and 16x FY17 PE. In this case, we expect JCI to trade at the 5,100-5,400 level or 14-15x FY17 PE multiple.

3,500

4,000

4,500

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8000

10000

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14000

16000

2011 2012 2013 2014 2015 2016

IDR/USD JCI

(2,320)

4,111

2,315

291

(185)

8,809

11,856 12,866

(3,289)(2,285)

(12,361)(15,000)

(5,000)

5,000

15,000

Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16

Rpbn

Market Focus

2017 Outlook

JCI Index Target

Earnings growth

PE 10% 12% 14% 16% 18% 12x 4,157 4,232 4,308 4,384 4,459 13x 4,503 4,585 4,667 4,749 4,831 14x 4,850 4,938 5,026 5,114 5,202 15x 5,196 5,290 5,385 5,479 5,574 16x 5,542 5,643 5,744 5,845 5,946 17x 5,889 5,996 6,103 6,210 6,317

Source: DBS Vickers

Market Focus

2017 Outlook

Reform Continues

We are still positive on the long-term outlook for Indonesia despite the slower growth trajectory in the last two years. We can't deny that the economic growth of Indonesia has not lived up to expectations and there are still many areas to improve since Jokowi became President in 2014. However, we should not be fixated with growth alone, considering that global growth remains muted and commodity prices have not really recovered until 2H16.

Instead, we should focus on the progress of the structural changes and the reforms that Jokowi and his cabinets have made so far. Some progress can be seen and we believe there will be more to come because we do not think it is realistic to expect everything to change overnight. We believe that the sustainability of the reforms will be more important in the long run while the economy picks up its pace.

Tax amnesty. The first phase of the tax amnesty programme that ended in 30 September 2016 was better than anticipated. The declaration of unreported assets reached Rp3,770tr of which almost 75% came from within Indonesia. In addition, the penalty revenue collected from the 1st phase was Rp89.2tr or more than 50% of the government's target.

Tax Amnesty-Asset Declaration

Source: Tax Authority

Tax Amnesty-Penalty

Source: Tax Authority

The important part about the tax amnesty programme is on expanding the tax base to improve tax revenue in the future. Indonesia has c.20m tax payers with a population of c.250m and yet, only 2.1% of tax payers participated in 1st phase of the tax amnesty programme. In addition, only less than 20,000 new tax ID were created during the tax amnesty period.

One aspect that is lagging is the repatriation of overseas assets which only reached Rp141tr vs. Rp1,000tr expected by the government. The tax authority intends to intensify the repatriation efforts before the programme ends in March 2017.

Infrastructure. Infrastructure development remains one of the main focuses of Jokowi's cabinet. Since taking over in 2014, a number of projects have started, including MRT in Jakarta, light rail in Palembang, Kalibaru port, Trans Sumatera and Trans Java toll roads, dam in East Nusa Tenggara and several ports and airports including Soekarno-Hatta T3.

Progress on priority infra projects

Projects Size (Rupiah) Progress

Batang Power (PLTU) 40tr Financial closures Palapa Ring (Broadband) 8.1tr Contract awarded Serang Panimbang Toll Road 10.7tr Land acquisition started Umbulan Water 4.5tr Financial agreement Balikpapan-Samarinda Toll Road 9.9tr Financial agreement Manado-Bitung Toll Road 8.7tr Financial agreement Bontang Refinery 75-150tr Scheme completed

Source: Economy Ministry

Rp2,872

Rp144

Rp988

Declaration - Domestic Repatriation Declaration - Overseas

Asset DeclarationRp4,003tr

Rp81

Rp11

Rp4Rp0.26

Personal Non SME Non SME Personal SME SME

Tax penaltyRp95.8tr

Market Focus

2017 Outlook

In 2016, a number of infra projects have been announced too such as Jakarta-Cikampek elevated toll road (38.3km), light rails in Jakarta, toll roads (outside of 30 priority projects), public housing and several power plants.

However, fewer than 100 projects out of 225 strategic projects that the government has targeted have moved into construction phase. According to Coordinating Minister of Economy, the government will continue to push on the infrastructure projects with more participation from private sectors.

Bureaucratic reforms. Investors have placed a high hope on Jokowi to improve bureaucracy by cutting the red tape and reduce corruption. A number of things have been introduced by the government since 2015, including 14 economic packages to improve investment and business climate through reforms. The result starts to show as Indonesia moved up by 15 places in Ease of Doing Business index to #91. This puts Indonesia as one of the top improvers among many countries

around the globe. On the other hand, Indonesia still has a lot of work to do to catch up with its neighbours such as Thailand (#46), Vietnam (#82), Singapore (#2) and Malaysia (#23).

Ease of Doing Business Ranking

Ranking 2015 2016

Singapore 1 2

Malaysia 22 23

Thailand 46 46

Vietnam 91 82

Indonesia 106 91

Philippines 99 99

Source: World Bank

Market Focus

2017 Outlook

Economic Outlook: Time for Investments to Pick Up

Global growth picture could be slightly better but mainly on the US. The global growth outlook in 2017 may be a bit brighter, driven by the improving US economy. The surprise victory of Trump is going to add a new element to the global growth picture although the US economy itself has been improving lately based on the recent data. However, it does not mean that faster growth will be seen in other developed countries as well. Euro zone and Japan’s economic outlook most likely will not change much while China’s economy is not expected to rebound too in 2017. Therefore, global growth in 2017 will remain muted in our view, barring any unexpected shocks.

Domestic economy still on recovery mode. We believe Indonesia’s economy will continue on its recovery mode in 2017. After bottoming out in 2015, our economist expects 2017 GDP growth to be 5.3% up from 5.1% (F) in 2016 and 4.8% in 2015. While we expect consumption to remain steady, it is also crucial to see a pick-up in investments to drive GDP growth in 2017. In addition, the positive trend in commodity prices, if it continues, may be able to improve exports and domestic consumption.

DBS’ Economic Indicator Forecast - Indonesia

2015 2016F 2017F

GDP Growth 4.8% 5.1% 5.3% Inflation 6.4% 3.4% 4.5% Current account -2.0% -2.0% -2.1% Fiscal deficit -2.5% -2.7% -2.5% USD/IDR (eoy) 13,794 13,333 13,876 7DRRR NA 4.75% 5.0%

Source: DBS Bank

Meanwhile the Indonesian government has turned conservative with only 5.1% growth expected for next year or flat from 2016. Under the new Finance Minister, Sri Mulyani, the government has turned more realistic in its assumptions for 2017 to manage expectations after being overly optimistic in the prior year on the back of a tight budget. This could work both ways in our view – on a positive note, the more realistic assumption provides more room for upside surprises than disappointments. On the flip side, it could be seen as a more cautious view on Indonesia's growth prospects too, perhaps stemming from global uncertainties and tax revenue.

Government Assumption

2016F 2017F

GDP Growth 5.2% 5.1% Inflation 4.0% 4.0% Fiscal deficit -2.3% -2.4% USD/IDR (eoy) 13,500 13,300

Source: Ministry of Finance

Investment growth will be crucial. Investment growth contributed 1.5ppts to overall GDP growth in 2016. However, this is one full percentage point lower than the average contribution in 2010-2012, during which GDP growth has averaged c.6% or more. Our economist believes that stronger investment growth is needed if we were to see stronger GDP growth ahead.

Investment by Type

Source: DBS Bank

Investment in equipment and machinery has been on downward trend this year (-6%), leading to poor overall investment growth. The government has taken several steps to boost investments from both domestic and foreign sources such as the roll-out of 14 economic packages, de-regulation, improving infrastructure and cutting rates. A few encouraging signs to be optimistic on this front: Net FDI has increased in 3Q16 to 2% of GDP while FDI into manufacturing is expected to reach US$17bn in 2016, the highest since 2011.

Steady consumption. Consumption and government spending have been the main growth drivers in the past two years. Our economist expects household consumption growth to remain stable at c.5%, supported by favourable demographics and low interest rates. Discretionary spending, however, has been moderating since 2013 to below 5% but higher commodity prices may help to reverse the trend.

Investment by Type

Source: DBS Bank

1.2 1.2 1.4 1.8 2.1 2.0 2.0 2.2 1.9 2.0 1.6 0.5 0.4 0.5 0.5 0.5 0.6

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Public Investment Private Investment Investment (Y/Y)

Market Focus

2017 Outlook

Surprise from commodity? Indonesia's total exports have declined by more than 25% since 2011 as commodity prices have been in a slump for several years. To date, CPO and coal prices have increased by c.45% and c.80%, respectively. Higher exports should boost CAD and the rupiah while it will also help boost the economy outside of Java especially Sumatra and Kalimantan. We expect several commodity prices to improve conservatively in 2017 and hence, any upside should provide positive impact on consumption as well.

Commodities


40.0

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Commodities Index Coal

Market Focus

2017 Outlook

Not Without Challenges Too

While GDP growth is expected to pick up domestically, we believe the external headwinds cannot be ignored and may be more real this time.

External factors. Stronger US outlook and rising US yields could bring the low interest era to an end and Indonesia will be affected too. Recent economic data from the US has been positive and the outcome of the US election could boost domestic growth in the US. Our economist expects US GDP growth to accelerate to 2.7% in 2017 vs. just under 2% in 2016. The Fed is expected to hike rates in December 2016 and our chief economist has maintained his view of four rate hikes in 2017. Hence, the pressures on currency may not be over yet since Indonesia remains vulnerable due to its low FX reserves to debt ratio and current account deficit.

Low interest rate may be over. The US 10-year Treasury yield has spiked to 2.4% from just 1.8% before the US election and DBS' Group Research view is that it could go to 3.25%. From a monetary policy standpoint, we think that Bank Indonesia (BI) will have limited room to manoeuvre and will be more cautious in 2017. Our economist predicts that BI will raise rates in 2H17 since inflation is most likely to go up too on higher commodity prices and a weaker currency.

Indonesia Govt 10yr vs US 10yr Treasury Yields

Source: Bloomberg Finance L.P 2017 Budget: Will fiscal constraints be an issue? The spending budget for 2107 is flat vs. 2016 at around Rp2,081tr. but it is also going to depend on tax revenue collection. Tax revenue collection is just at 65% by October 2016 and unlikely to meet the budget’s target in 2016. There is a similar risk in 2017, especially as tax amnesty will end in March 2017.

Tax collection progress


Reforms must continue. We expect the reforms under Jokowi to continue, which will be important as Indonesia needs to make changes. Looking at the 14 economic packages that have been introduced so far, the focus is pretty much on deregulation, ease of doing business and cutting red tape. Recently, Jokowi announced a crackdown on extortion called Saber Pungli. It may not seem much but it is a sign that the reforms continue to create more confidence for investors to invest more in Indonesia.

Foundation has been laid, so will the results appear soon? The infra projects that started in 2015 and 2016 mostly will be ready in 2018 and beyond. Hence, we need to be patient to see the impact of these infra projects. Meanwhile, the government has continued its commitment to spend on infra in 2017 with a similar budget to 2016 despite the limited funding source. Another important thing to note is that infrastructure is a prerequisite for Indonesia to move beyond commodities. For example, Indonesia has a lot of potential in tourism but it only contributes less than 10% of GDP vs. 20% for Thailand. One of the issues is related to infrastructure such as port, airports and electricity to be able to compete with other destinations.

Must keep an eye on the potential political issues. Jokowi got the support from some of the opposition parties in 2016 with Golkar being the last to join the coalition. This has made Jokowi's position stronger in bargaining with the parliament or even his own party, PDI-P.

In early 2017, Indonesia will conduct simultaneous elections in February involving over 100 provinces, cities and regional heads. The most interesting contest is of course the Jakarta governor position. The candidates include the incumbent, Ahok, SBY's son Agus and Anies Baswedan who was the Education Minister in Jokowi's cabinet for two years. The incumbent governor was accused of blasphemy and is set to stand trial after the police had determined that there is a case against him. The recent development involving the governor of Jakarta who is also Jokowi's man, is a reminder that the political scene in Indonesia is still fluid and could be a distraction to the economy too.

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ID Govt 10yr US Govt 10yr

US GovtIndo Gov

97%99%

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2010 2011 2012 2013 2014 2015 9M16

Market Focus

2017 Outlook

Robust Earnings Growth Expected

Despite the concerns over the external factors, Bloomberg consensus expects c.15% earnings growth in 2017, which is among the best in the region. From our coverage universe, we are expecting earnings to grow 16.9% in 2017. Pretty much all sectors under our coverage are expected to show double-digit earnings growth, except for cement. Two key drivers for the robust 2017 earnings outlook are optimism on Indonesia's economic growth and the low base effect from 2015 and 2016. Keep in mind that earnings growth in 2015 and 2016(F) are coming from a low base and below the historical CAGR of 15% between 2009 and 2014.

Regional Comparison

Source: Bloomberg Finance L.P Banks expected to recover the most among big caps. Within our universe, earnings growth next year is driven by the financial sector considering the weighting in JCI index (c.25%). Banks' earnings are forecast to grow 18.5% after two years of almost no growth. Oil and gas as well as mining activities are also expected to rebound strongly with more than 30% earnings growth in 2017 with higher commodity prices and this is also after two consecutive years of negative earnings. On the other hand, the consumer sector including animal protein is expected to experience slower growth although still above 10%.

Earnings Growth

15 16F 17F Conglomerate/Automotive (24.6) 13.7 18.5 Property & Industrial Estate (43.5) 13.8 9.4 Infrastructure (9.2) 3.7 3.5 Transportation na na na Consumer 0.2 14.6 12.0 Banks & Multifinance 1.0 (0.7) 17.1 Plantation (63.8) 62.8 10.0 Animal Protein 12.1 129.4 10.6 Oil, Gas & Energy (21.5) (6.6) 30.5 Telecomm. 40.2 25.3 18.4 Market (4.2) 6.5 16.9

Source: DBS Vickers

Higher growth means higher downside risks too. Earnings growth in 2016 turned positive but not as robust as expected. We revised down our forecast from 11% at the beginning of the year and now, at 6.5% for our universe. Two sectors that disappointed so far are the banks and property sectors. For 2017, there is downside risk to high earnings growth expectations on the back of moderate economic growth. This could come from banks and consumer sectors.

MSCI Indonesia Earnings Growth

Source: IBES, Datastream, DBS Bank

Valuation has retreated but big caps are still not cheap. JCI is trading at 14.6x forward PE or around its 5-year mean PE but slightly above the 10-year mean PE multiple of 13.8x. This year JCI traded as high as 16.5x PE multiple post BREXIT when foreign flows returned to emerging markets. Keep in mind that JCI rallied by as much as 9% in 2H16 driven by the surprise BREXIT vote and the delay in Fed rate hikes which spurred foreign flow into Indonesia. Hence, the risk for foreign outflow is also imminent on the back of a stronger US economy.

Despite the correction, most of the big cap stocks have re-rated vs. last year and are trading at c.15% premium to JCI's valuation. In addition, several sectors are still expensive relative to the 5-year mean PE valuation.

JCI vs LQ45


Price Earnings (x)

16F 17F 16F 17FUS S&P 17.9 16.5 10.5% 8.4%

Europe 15.4 14.0 17.5% 10.0%

Asia ex-Japan 13.6 12.3 -1.0% 10.3%

China A 9.9 9.2 -2.3% 7.5%

MSCI China 12.6 11.6 -2.2% 8.5%

MSCI Hong Kong 16.6 15.6 -11.0% 6.6%

Hang Seng 12.3 11.6 1.7% 6.4%

Singapore 13.7 13.1 -12.3% 4.9%

Malaysia 16.3 15.2 -0.3% 7.8%

Thailand 15.0 13.7 -1.2% 9.7%

Indonesia 16.5 14.3 6.3% 15.3%Taiwan 14.2 13.0 2.7% 8.9%

Korea 10.8 9.8 -0.3% 9.7%

India 17.8 14.3 4.8% 24.4%

Philippine 17.5 16.1 6.0% 8.6%

EPS Growth

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LQ45 JCI

Market Focus

2017 Outlook

Several Themes for 2017 We have several themes to consider for 2017:

USD exposures. The strong USD potential is generally unfavourable for Indonesian companies. As a country, Indonesia is a net importer such as fuel and raw materials. More companies under our coverage will suffer if the rupiah depreciates against USD because their costs are linked to USD.

Within our coverage, the main beneficiaries of stronger USD will be the commodity-related stocks such as Adaro, United Tractors, Astra Agro, London Sumatera and Tower Bersama.

Impact of Weaker Rupiah

Winners Mining, O&G, Plantation

Neutral Banks, Telco, Construction

Losers Consumer, Pharma, Airlines, Property

Source: DBS Vickers

On the other hand, the losers include Garuda Indonesia, Mitra Adiperkasa, Kalbe Farma, Lippo Karawaci and Pakuwon. Keep in mind that some companies have hedged their USD exposures, so the impact of a weaker rupiah could be limited for Indonesian companies. In addition, we believe that if USD/IDR stays within the 13,500-14,000 level, the impact on corporate earnings may not be significant.

Higher commodity prices. It appears that commodity prices may trend higher in 2017 vs. 2016. If this is the case, commodity stocks may have another leg to go higher after a strong 2016 that was driven by better-than-expected earnings.

Consensus Commodity Prices Forecast

2016F 2017F

Oil (Brent US$/bbl) 44.75 55$

Coal (US$/ton) 55-60 65-70

Nickel (US$/ton) 9,385 11,023

Source: Bloomberg Finance LP, DBS Vickers

Our picks for the commodity theme are Adaro (coal), Astra Agro (CPO) and United Tractors (coal mining). In the oil & gas sector, we have Medco Energi with a BUY call as the main beneficiary of a higher oil price outlook in 2017.

Domestic Consumption

Public and private consumption has been the growth engine for Indonesia against falling exports and commodity prices. We expect the consumption story to remain and the key drivers in 2017 will be a pick-up in spending post tax amnesty, mild inflation and improving commodity prices.

Consumer confidence may be jolted by USD/IDR volatility and disappointing growth but private consumption has been quite resilient. In addition, the seasonality in consumption could shift into 1H as Hari Raya in 2017 will move forward to the end of June.

Consumer Confidence Index

Source: Bank Indonesia

Our pick in this sector is Indofood given its attractive valuation. Other stocks to consider are Mitra Keluarga (healthcare) for defensive play and Mitra Adiperkasa (retail) for its earnings recovery story. In addition, the auto sector should benefit as well from higher commodity prices.

Investment growth. Our economist expects investment to pick up as it has been lacklustre in the past several years. There are a few encouraging signs to be optimistic on this front: Net FDI has increased in 3Q16 to 2% of GDP while FDI into manufacturing is expected to reach US$17bn in 2016, the highest since 2011.

FDI-Manufacturing

Source: DBS Bank

Market Focus

2017 Outlook

The government has taken several steps to boost investments from both domestic and foreign sources, such as the rollout of 14 economic packages, de-regulation, improving infrastructure and cutting rates.

We believe the beneficiaries include the industrial estate stocks such as Surya Semesta and Lippo Cikarang. However, the pre-sales data has not reflected the recent uptick in manufacturing FDI. Hence, we could see an improvement in 2017.

Market Focus

2017 Outlook

Sector Review

To date, the coal, auto and plantation sectors have outperformed the broader market. The coal sector is up by 41% while auto and plantation were up by 33% and 44% respectively. The commodity price rally in 2H16 has been the main driver despite the weak earnings, especially for the coal sector.

The consumer sector is up only 11%, slightly underperforming JCI. However, the main drag came from the retail stocks which suffered from weaker performance. Consumer staples tended to fare better in 2H16 mainly due to better margins. In the auto sector, we have seen a recovery in 4W sales volume, which is expected to rise by c.5% in 2016.

The underperformers were banks (+4%), construction (-16%) and property (-3%). The construction sector corrected mainly due to rights issues and its strong performance in the past two years. For banks and property, disappointing growth was the main reason for their underperformance this year.

YTD Sector Performance

Source: DBS Bank

2017 sector view. Looking into 2017, we are overweight on the consumer, construction and commodity sectors. Consumer and construction stocks should continue to benefit from the domestic growth story and perhaps stronger in 1H17 on the back of an earlier Hari Raya. However, valuation especially for consumer stocks remains high and there could be risks emanating from higher raw material costs and a stronger USD in 2017.

Meanwhile, we are Neutral on telco, plantation and banks. For telco, it is largely due to valuation while on banks, there are still some risks for asset quality and growth outlook. Earnings recovery for banks is driven mainly be less provisions in 2017.

We are underweight on cement and property as we believe there could be some pressures on earnings growth in 2017. Meanwhile, demand may improve just slightly in these two sectors. However, valuation may be attractive and such stocks have underperformed.

Please see our sector summary review on the following page.

Valuation largely still above 5yr average. From a valuation perspective, most of the sectors are still trading above the 5-year average. In fact, the telco sector is still trading near 2SD above the 5-year mean EV/EBITDA mainly due to Telkom’s strong performance.

Sector 5yr Average Multiple

Source: DBS Vickers

Consumer and commodity stocks are trading above the 5-year mean as they have performed pretty well this year. Hence, we recommend buying on weakness as these sectors will experience seasonal factors in 1Q17.

Telecom and property sector valuations are also currently above the 5-year mean. For the telecom sector, it is mainly due to PT Telkom that is trading at a premium – with other telco companies trading more in line with the industry average. XL Axiata has attractive valuations but the company is still trying to turn around.

The property sector has corrected in 2H16 but its valuation remains above its 5-year average PE and at a discount to RNAV. The outlook may be improving in 2017 but revenue and earnings growth is still going to be slower. Hence, we need to see further correction before becoming more excited on the sector.

Banks and infra (construction) sector valuations have underperfomed but these two sectors offer 19% and 28% earnings growth respectively, thus delivering one of the highest earnings growth in 2017. Hence, these sectors are quite attractive from a valuation perspective.

‐40.0%

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40.0% 2H

YTD

28.7 26.2 21.4 17.7 16.7 16.2 16.0 14.9 11.8 11.1 9.3 ‐

6.0

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18.0

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36.0

Avg

Current

Market Focus

2017 Outlook

Strategy and Stock Picks

JCI has done well in 2016 despite the recent correction after the US election. To date, JCI is up 14+% and with a stronger rupiah, foreign investors have an additional 2+% gain coming from currency since the beginning of the year.

Given our cautious view on JCI in the near term, we advise investors to avoid stocks with USD exposures and expensive big caps that could be under pressure from foreign sell-off. The big cap stocks could suffer from rupiah volatility although their fundamentals may not be affected by it.

Among the top index weightings, the following stocks have direct negative exposures to a stronger USD: Unilever, Kalbe Farma, Indofood Consumer Branded (ICBP) and Astra (through auto parts but can be offset by its commodity business). We would wait for a correction for these big cap stocks to minimise the potential downside risks arising from market volatility.

In term of stock picks, we recommend investors to focus on valuation and growth stocks with the ability to deliver. Our stock picks for 2017 are: Adaro Energy (ADRO), Indofood Sukses Makmur (INDF), Mitra Keluarga (MIKA), PT Pembangunan Perumahan (PTPP) and Bank Danamon (BDMN).

Adaro Energy (ADRO IJ, Buy, Rp1,680, TP:Rp1,900)

Manage to stay profitable amid low coal prices with good cost control.

Adaro maintains a conservative view despite recent surge in coal prices. Hence, there is upside if coal prices stay above US$70/ton in 2017.

Entry into power business will be positive for the long term. Be wary of near-term correction arising from seasonal

factors; thus we recommend accumulating on price weakness.

Bank Danamom (BDMN IJ, Buy, Rp3,370, TP:Rp4,300)

The successes of its transformation process are starting to bear fruit. Visible deliveries this year include lower funding costs and lower expenses.

With the lower-cost base and a cleaner balance sheet, we expect ROEs to improve closer to the 10% mark by end-

FY16F as loan growth starts to pick up and funding costs head lower.

Currently, the stock is traded at undemanding 0.8x BV 2017, lower than -1SD of the 4-year mean PBV. We have a BUY call with a TP of 4,300, which implies 1x FY17 BV.

Indofood Sukses Makmur (INDF IJ, Buy, Rp8,050, TP:Rp9,900)

Attractive valuation, trading at 15.6x PE 17F and 31% discount to its SOP valuation vs. historical mean of 15%.

The company is in the process of divesting its majority stake in China Minzhong Food Corporation, which should help to narrow its valuation discount as its balance sheet and earnings profile improve.

Potential recovery in domestic consumption and sales volume recovery in its agribusiness segment would serve as key positive catalysts in 2017.

Mitra Keluarga (MIKA IJ, Buy, Rp2,540, TP: Rp3,150)

Beneficiary of growing healthcare spending in Indonesia (12% CAGR projected until 2018).

Stable margin supported by mature hospitals with healthy balance (net cash of more than Rp2tr).

Potential expansion to join Universal Healthcare plan via COB and new hospital.

PT Pembangunan Perumahan (PTPP IJ, Buy, Rp3,970, TP: Rp5,400)

Order book momentum will continue to build up, fuelled by its enlarged equity base post rights issue. Among our coverage, we expect PTPP to be the only contractor to still maintain positive new contract growth in 2017.

The company plans to bid for more EPC and port projects, which could support margin expansion.

Undemanding valuation, trading at 16x PE 17F – a 10% discount to peers.

Market Focus

2017 Outlook

Sector (view) 2017 Outlook Picks

Auto (Neutral)

For 4W, recovery is on the way albeit slow. 2017 sales volume is expected to be up by c.5% driven by new models and LCGC.

Astra has re-gained its market shares in 4W in 2016 (54% vs. 50% in 2015) and we expect this momentum to continue with Calya and Sigra.

2W volume is still weak in 2016 but we expect to stabilize if not improving in 2017.

Commodity prices recovery in 2017 could spur demand including for 2W especially outside Java.

Valuation on auto companies have re-rated this year and may already priced in the positives. We will turn more positive if sales volume growth accelerate.

NA

Banks (Neutral)

Earnings growth is expected to recover in 2017, mainly from lower credit costs as provisions were largely accelerated in 2016.

We however caution that regulatory pressures may resume to push lending rates lower, exerting stress on NIM. The possible removal of the deposit rate cap may spark another deposit war in the current tighter liquidity environment, posing risks to NIM trends.

It would appear that end-2016 should mark the peak of asset-quality issues, but we expect some to still spill over into 2017.

We expect loan growth to recover slightly in 2017 to 11%, on par with macro indicators.

Indonesian banks’ valuations have retreated recently following capital outflows from the Indonesian market. The banks are trading below -1SD of their 10-year P/BV mean. The re-rating we saw in 3Q16 was driven by sentiment rather than fundamentals.

We maintain neutral view, with clearer signs that the banks are moving out of the NPL cycle would be a catalyst for re-rating.

Key Risk: Prolonged asset-quality woes; loan growth fails to pick up; aggressive push to lower lending rates and regulatory pressures.

Bank Danamon and Bank BCA

Consumer (Overweight)

Consumer staples’ margins to moderate going forward as key soft commodity prices reversed their downward trend.

We expect retailers’ net profit growth to outpace consumer staples due to the low base effect in 2016. Demand could see some support from rising soft commodity prices given that 33% of workforce works in the agriculture sector.

Valuation discount between retailers and staples have widened and with soft commodity prices creeping up, consumer staples stocks that trade at lofty valuations may be at risk. We prefer cheaper names that have dominant market share such as INDF.

Key risks: Weakening rupiah as around half of consumer staples’ raw materials are denominated in USD. Among retailers, MAPI would be the most negatively affected by significant rupiah depreciation since more than 60% of its merchandise is imported.

Indofood Sukses Makmur

Construction (Overweight)

FY17F net profit growth to decelerate slightly to 28% y-o-y (we forecast 34% net profit growth for FY16F) but still outpace the broader market.

New contracts will likely peak out this year except for our top pick, PTPP, which is still guiding for positive new contract growth of 26% y-o-y in FY17.

Precast suppliers are in the sweet spot to benefit from faster execution of infrastructure projects, in our view.

Key risks: Contractors’ working capital needs will likely rise along with increasing portion of semi-turnkey and turkey projects, which may compromise profitability.

PTPP, Wika Beton

Market Focus

2017 Outlook


Cement (Underweight)

Domestic sales growth has remained uninspiring with only 1.5% growth in 10M16.

Oversupply conditions continue to impact incumbent cement producers. We expect excess capacity to reach uncharted territory of c.33m tons.

Recent rally in coal price could erode margins given 16%-18% of cash cost is for coal/fuel. Meanwhile, we expect ASP to remain weak due to the oversupply situation.

Key upside risks could arise if the government steps in to address the current oversupply condition in the domestic cement sector by limiting investment.

NA

Coal (Overweight)

Coal prices in 2017 should normalise but will still be better than the average in 2016. We expect coal prices to be US$65-75 per ton in 2017.

Supply cut from China may not last but at the same time supply growth seems to be relatively mild despite the recent surge of coal price to above US$100 per ton.

Coal miners also cautious on their outlook for 2017, preferring to have moderate production growth to sustain higher coal price and profitability.

The market has priced in the recent rally in coal prices but further improvement in earnings driven by higher coal prices could drive coal stocks higher, as their valuation is under 14x PE.

Adaro Energy

Oil and Gas (Overweight on upstream)

We are cautiously optimistic on upstream E&P for 2017 as we expect oil prices to improve next year. Our forecast for 2017 is US$55-65 per barrel.

Domestic contractors could benefit from consolidation in the oil and gas sector in Indonesia. Foreign operators may not renew their PSC contract under the current environment.

Mid-stream oil and gas outlook is still unclear due to regulation and relatively low oil prices.

The risk to our view still lies with the crude oil price outlook and regulations. The progress on the regulatory side has been slow and affecting the industry outlook domestically.

Medco

Plantations (Neutral)

Neutral view. Three key issues will shape the sector over the next 12 months: (1) tight inventory; (2) higher biodiesel blending; and (3) strong USD. We have recently upgraded our view to Neutral; premised on reduced downside risk to prices.

Tight inventory continues. A significant 8% y-o-y recovery in global palm oil supply next year (low-base effect) to 64.3m MT is no relief; as we expect biodiesel blending in Indonesia to pick up – together with export levy collection. Demand is forecast to expand towards 64.5m MT

Watch out for strong USD. We expect palm oil prices to average US$618/MT next year – 2% y-o-y lower – on record US soybean harvests. Yet, in rupiah, we expect prices to increase. Together with a yield recovery, we believe quarterly earnings have bottomed in 2Q16.

Risks. There could be supply disruptions in soybean production in South America in 1Q17 due to la Nina (this may have higher price implications for palm oil). Stronger-than-anticipated palm oil yield recovery would be bearish for prices. Should the Indian government raise import tariffs, there may be lower demand for palm oil. Headwinds from demonetisation reform are expected to temporary curb demand through 1Q17. Volatility in crude oil prices/USD could also affect the biodiesel blending target

Astra Agro Lestari

Market Focus

2017 Outlook


Property (Underweight)

Subtle improvement in underlying demand could be seen next year due to slight improvement in affordability, as price-to-income ratio has shown some downtick in mid-2016.

Measures introduced in 2016 were meant to boost property demand: six policy rate cuts in 2016; relaxation for 2nd home purchasers and tax cuts – final sales tax for developers (to 2.5% from 5%) and on title transfer on the acquisition of rights to property (BPHTB). However, presales figures to date have not improved.

Margins to continue to be under pressure due to a shift in product mix to high-rise products in the past three years. Higher costs are also expected from aggressive promotions and new project launches.

The sector currently trade at 41% discount to RNAV which is still above 4-year mean, hence we believe the valuation is not attractive considering weak presales todate.

Bumi Serpong Damai

Telco (Neutral)

Telco remains a defensive growth sector in Indonesia, mainly driven by data growth. Revenue and EBITDA growth expected to show positive y-o-y growth in 2017.

ARPU trend is positive and operators are still focusing on profitability at least in the near term.

Big three operators are still dominating but Telkom's performance has been the most consistent among the three.

However, valuations (especially Telkom’s) are quite rich at +2SD above the 5-year mean EV/EBITDA. We prefer XL Axiata on valuation grounds (30% discount to Telkom).

XL Axiata

Market Focus

2017 Outlook

Banks (Sue Lin LIM, [email protected]; Benedictus Agung SWANDONO, [email protected])

Indonesian Banks: Loan Growth and NPL

Source: Companies, DBS Bank, DBS Vickers Earnings Outlook

Earnings recovery but largely from lower provisions; core earnings growth hinges on loan growth. Earnings growth is expected to recover in 2017 mainly from lower credit costs as provisions were largely accelerated in 2016. Higher provisions were set aside for existing NPL issues as well as potential ones; banks also took the opportunity where possible to build provision reserves, in anticipation of further deterioration. Loan loss reserve coverage ratios declined as NPLs mounted. However, we opine that NPL issues are not over yet and may drag till 2Q17 at the latest unless economic growth remains sluggish. Topline growth should show a slight growth as loan growth picks up albeit at a moderate pace, but NIM may slip as funding costs may increase.

1. Lower credit costs - the key earnings growth driver. Credit costs are expected to decelerate in 2017 after significant increases in 2015 and 2016. The culprit for the high credit cost in 2016 was Bank Mandiri (BMRI) while in 2015, it was Bank Negara Indonesia (BBNI). These two banks kept credit costs high, close to 2% for both years. We expect the bulk of provisions to be done by 2016 as banks will take the opportunity to build up loan loss coverage ratios to higher levels. We expect banks to gradually lower provisions throughout 2017, making it the key driver to bottomline growth for the year. Our credit cost assumption for 2017 is at 1.3% (2016F: 1.9%).

2. Marginal improvement in sector loan growth. Sector loan growth up to Sep-16 has been the slowest in the past decade, below 7%. Although we are expecting a positive surprise in 4Q16, we believe sector loan growth would at best hit the 9% level by the year end. Stripping out state-owned enterprise (SOE) loans, there would be hardly any loan growth seen in the industry. Strong loan growth was recorded by the SOE banks, except BMRI as it is

struggling to manage its asset quality issues. Moving into 2017, we expect the year to start slowly with loan growth still slightly above mid-single digits before momentum picks up in 2H17. Positive flows from infra projects could spur growth and the trickle-down effect would then be felt by the non-SOE banks after. At this juncture, we remain cautious and expect loans to grow by 11% in 2017.

3. NIM may slip. Banks have enjoyed a good year with NIM expansion as funding costs were driven down throughout 2016 thanks to policy rate cuts. Regulators were also not harsh on imposing the single digit lending rate regime although it appeared that banks were encouraged to do so. We believe banks with micro loans in their loan portfolio may still stay exempted. In 2017, banks are unlikely to see funding costs improve further unless it is structural (such as Bank Danamon (BDMN)). Liquidity has tightened as a result of the tax amnesty, but this may be seen as a temporary phenomenon. That said, banks are already seeking alternative funding sources i.e. bond issuances and negotiated certificate of deposits (NCD). These may pose a slight crunch to NIM.

4. Fee income and expenses may be the swing factor. Fee income has been slow in 2016 as the Indonesian banks derive most of their fee income from loans. And since loan growth was slow in 2016, banks saw a large decline in fee income. This was partially offset by treasury gains for some banks. With loan growth expected to pick up in 2017, albeit marginally, fee income should also improve. Contrary to previous years where banks had extensively been expanding branches and outlets, this does not seem to be the case for 2016-17. We expect branch expansion to moderate as banks relook at the productivity of its branches. Some banks may even move towards branch rationalisation as their digital banking agenda steps up. We expect to see cost-to-income ratio remaining relatively flat in 2017.

Asset quality issues still brewing. NPL issues may be over for some banks by the end of 2016 but from our checks, we believe asset quality issues may linger on till at least 2Q17 before it clears up. NPL formation has yet to stabilise. Even then, we would put a caveat that asset quality would hit a peak only if macro indicators start to accelerate and infra projects are turned on smoothly by 2Q17. In the meantime, we continue to expect loans to continue to be restructured and special mention loans (SML) to stay relatively high.

No risks for capital raising. Indonesian banks remain one of the highest capitalised banks among the ASEAN-5, even in the past before the Basel III requirements. This is because Indonesian banks have always been in high-growth mode, which consumes a lot of capital. Indonesian banks are the last

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Loan Growth NPL

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Market Focus

2017 Outlook

of the ASEAN-5 banks to adopt Basel III. In 2016, only Bank Permata (BNLI) raised a rights issue. Coupled with asset revaluations (all banks under our coverage have done this, except BDMN), the banks have seen capital ratios improve by at least 2ppts y-o-y. However, this was at the expense of lower ROE. Indonesian banks are expected to see CET-1/Tier-1 and Total CAR at high teens and low 20%, respectively.

Key Risks

Asset quality woes prolong. Although we are expecting NPLs to stabilise by 2Q17, should macro indicators not pick up in the first two quarters of the year, NPL formation may still stay high while slippages from SML to non-performing status would then still be at risk. When we add loans at risk (defined as NPL+SML+ restructured but not classified as NPLs), the adjusted NPL ratio would be as high as 8-9%.

Loan growth fails to pick up. Loan momentum is highly hinged on a demand pick-up in the real economy. Until corporates (ex-SOEs) garner sufficient confidence on macro momentum, we may continue to see loan demand and hence loan growth staying sluggish.

Aggressive push to lower lending rates; regulatory pressures. It appears that the regulators have cut the slack on banks, forcing them to lower lending yields to single digit lending rates in 2016. We believe this was because regulators and banks were preoccupied with managing NPLs. Should regulators resume its aggression to lower lending rates again in 2017, there would be further pressure on NIM.

What has been priced in?

Sector trades at -1 SD of the 10-year P/BV mean. The Indonesian banks have re-rated in the past 6 months but this was purely based on sentiment in our view. The rally was a result of positive sentiment from the tax amnesty and the reshuffling of the cabinet ministers, with the Finance Minister appointment being a key factor. Market appears to be pricing in too many positives in our view. Apart from the positive sentiments cited above, market may be overly optimistic on a recovery, in our view. Fundamentally, the Indonesian banks

are still in the downturn phase of a credit cycle and would only gradually emerge out of it by 2Q16 into “repair” mode, in our base case.

Indonesian Banks: Forward-rolling P/BV band

Source: Bloomberg Finance L.P, DBS Bank, DBS Vickers

Top Picks for the Sector

BBCA and BDMN remain our top picks. Our appetite for picks is still skewed to the cautious end, which justifies BBCA (BUY, TP Rp16,400) as our top pick. We remain positive on BDMN (BUY, TP Rp4,300) as it moves on to its next phase of its transformation. In addition, we believe the recovery in auto sales would also bode well for BDMN.

Other stock ratings. BTPN and PNBN remain BUYs. We continue to monitor BMRI (HOLD, TP Rp10,500) and would gradually turn positive as it emerges out of its asset-quality woes. BBRI (HOLD, TP Rp12,200) remains a HOLD on regulatory risks related to NIM pressure exerted by KUR. We remain cautious on BBNI’s (HOLD, TP Rp5,400) aggressive growth. BBTN is upgraded to HOLD (TP Rp1,660) on valuations

Mean, 2.52

+1SD, 2.93

+2SD, 3.34

-1SD, 2.11

-2SD, 1.69

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PBV (X)

Market Focus

2017 Outlook

Cement (Indonesia Research Team)

Nobody’s position is sacrosanct

Oversupply conditions continue to impact incumbent

cement producers

Recent rally in coal price could erode margins; ASP to

remain weak due to oversupply situation

Reiterate negative view on cement sector with FULLY

VALUED calls for both Indocement Tunggal Prakarsa

(INTP) and Semen Indonesia (SMGR)

2017 Outlook

Uninspiring domestic sales volume growth. Cement domestic volume sales only grew a modest 1.5% y-o-y to 50.8m tonnes in the ten months to Oct 2016. The growth was still driven by Sulawesi and Sumatra, where a number of transport-based infrastructure projects are in progress. During this period, demand from Sulawesi and Sumatra grew 5.9% and 17.1% y-o-y respectively and now account for 21.7% and 8.7% of nationwide cement demand. Meanwhile, the largest market, Java (contributing 54.5% of nationwide cement demand) saw demand fall by 1.1% y-o-y.

Historical and Expected Demand per Region

Source: DBS Vickers

Growth would be driven by bulk segment. Growth from an acceleration in infrastructure development, coupled with slower property pre-sales growth, will result in sales proportion of the bulk segment heading towards an uncharted level (currently at 23.8%). We expect bulk segment sales to grow at 10.2% CAGR between 2015 and 2018, while forecasting only 4% growth for the bag segment within the same period. The long-term multiplier effect from the much-heralded infrastructure development to property pre-sales will remain a key positive catalyst for bag cement demand, but not in the near term.

Bag and Bulk Cement Demand Growth

Source: Company, DBS Vickers

Oversupply conditions worsening. On our estimates, cement production capacity is expected to reach 96.3m tonnes by the end of 2016 (24% increase from last year). We forecast another 8.6m tonnes additional capacity in 2017-2018. Given the stream of new capacities coming in between now and 2018 and the modest expected growth in domestic cement consumption in the same timeframe, the excess capacity should reach uncharted territory of c.33m tonnes. The supply-demand imbalance and the aggressiveness of new entrants (especially the deep pocketed players) have resulted in incumbent cement producers losing market share. The market share for the outside “Big 3” producers reached an all-time high of 18.7%.

Oversupply Conditions in Indonesia’s Cement Industry

Source: Companies, DBS Vickers

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20

17

F

20

18

F

m tonnes

Market Focus

2017 Outlook

Demand, Supply and Utilisation Rate Dynamics


Surge in coal price – another cost item to deal with. The recent surge in coal price (i.e. Newcastle benchmark coal price index has risen 68% since early May 2016) would cause cost per tonne to increase further (given 16%-18% of cash cost is for coal/fuel) and erode cement producers’ margins further.

Energy Prices Trend


ASP to remain weak. The oversupply condition coupled with aggressiveness of new entrants (especially those with deep pockets and strong financial positions) to gain market share through disruptive pricing, has caused ASP to decline over time. The market share of cement producers outside the “Big 3” reached an all -time high of 18.7%.

All incumbent producers faced downward pressure in their ASPs, especially in the lucrative areas where competition is heating up. Indocement Tunggal Prakarsa experienced a more severe ASP decline (estimated at 6.4% below its ASP at the end of 2015) than Semen Indonesia (estimated at 2.7% below its ASP at the end of 2015). This is mainly due to more intense competition in INTP’s stronghold areas (i.e. West Java and East Kalimantan areas) and SMGR’s diversified presence in a few key areas.

Key Risks

Government may step in to address oversupply. The possibility of a government plan to limit investment in the cement sector 3-5 years down the road (through revision of its Investment Negative List) to address the oversupply situation should provide a reprieve and potential upside risk for cement stocks, if it materialises.

Valuation & Recommendation

Cement Sector EV/EBITDA Band


We prefer SMGR to INTP in light of the former’s market leader position, diversified presence in key market areas and more attractive EV/tonne valuation of c.US$190 (vs replacement cost of US$150).

67%

96%

66%

68%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

-

20,000

40,000

60,000

80,000

100,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F

Demand (000 tons) - LHS

Design capacity (000 tons) - LHS

Utilization rate - RHS

'000 tonnes

No additional capacity until 2009Demand growth in-line with GDP growth

70

80

90

100

110

120

130

140

Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16

ICP (RHS) Electricity tariff - I4 (LHS) Coal (LHS) USD/IDR (RHS)

Average

+1 stdev

+2 stdev

-1 stdev

-2 stdev

25.0

30.0

35.0

40.0

45.0

50.0

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

(x)

Market Focus

2017 Outlook

Construction (Chong Tjen San, [email protected], & Tiesha Putri, [email protected])

Moving into execution phase

FY17F net profit growth to decelerate slightly to 28% y-

o-y but still outpace the broader market

We forecast value of new contracts to drop by 17% in

2017; new contracts will likely peak out in 2016 for most

contractors except for PT PP

EPC and port projects could provide upside to margins

Stay selective; top picks: PT PP (PTPP) and Wijaya Karya

Beton (WTON)

2017 Outlook

FY17F earnings to decelerate slightly but still outpace the broader market. We expect construction sector’s earnings growth to still outpace the broader market with 28% y-o-y growth in FY17F, although this is a slight deceleration from our estimate of 34% in FY16F. Post rights issues (Waskita Karya in 2015, and PT PP and Wijaya Karya in Nov 2016), the contractors have stronger balance sheets to undertake more projects. Revenue visibility remains intact with a record high order backlog of Rp178tr (as at end-Sep 2016) which equals to 5x/3x FY15A/FY16F revenue.

New contracts will likely peak out this year except for PTPP. In the nine months to Sep 2016, new contract wins more than doubled over the achievement in the same period last year, surging 120% y-o-y. The big chunk of the contracts came from toll road projects with Waskita Karya (WSKT) grabbing the largest share. As most of the mega projects have already been awarded this year, we expect aggregate value of new contracts to drop by 17% y-o-y to Rp111tr in 2017. Our top pick, PTPP, is the only contractor in our coverage still guiding for a positive growth in new contracts, at 26% y-o-y in FY17.

Aggregate Value and Growth in New Contracts

Source: Companies, DBS Vickers

New Contracts Trend and Forecast

Source: DBS Vickers

What can surprise on the upside? In the past two years, contract awards have largely concentrated on toll road projects while other infrastructure categories such as power plants, electricity transmission and ports have lagged. Power plants and ports typically command higher margins compared to toll roads as high technical expertise is required to deliver the projects. If government and project owners can accelerate the execution of these margin-enhancing infrastructure projects in 2017, there could be upside to our earnings forecasts. Contractors that will benefit the most from port and EPC project roll-outs are PTPP and WIKA.

Key Risks

Higher working capital requirements may compromise profitability. A number of SOE-funded projects would adopt the semi-turnkey and turnkey scheme where pre-financing by contractors is required as project owners will only disburse payments to contractors annually or after the construction work is finished. In some cases, interest costs associated with the project’s construction is partially borne by project owners, hence translating to lower margins for contractors.

Valuation

The sector trades at 22x/18x FY16F/17F PE, only +0.3SD above its historical mean since 2012 (the start of the upcycle). Most contractors except WSKT have underperformed the JCI year-to-date which we believe was attributable to concerns over state budget cuts, while some stocks have de-rated ahead of the pricing of rights issues.

Looking at current valuations, there is room for share prices to re-rate as execution progresses. Nonetheless, we prefer to stick with contractors with strong balance sheets and ample capacity to take on more projects. PTPP remains our top pick among contractors. We also like WIKA’s precast concrete subsidiary WTON.

50,632 60,497

84,380

134,889

111,465

4%

19%

39%

60%

-17%-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

2013A 2014A 2015A 2016F 2017F

New contracts (Rp bn) Growth y-o-y (RHS)

32.1 27.1 25.2

60.0

29.9

45.0 40.0

33.9 37.6

-

10.0

20.0

30.0

40.0

50.0

60.0

70.0

WSKT PTPP WIKA

Rp tr

2015A 2016F 2017F

Market Focus

2017 Outlook

Construction Companies’ PE Valuation Range Since 2012


Construction Sector Forward PE Band

Source: DBS Vickers, Bloomberg Finance, L.P.

Construction Sector Forward PE Band

Source: DBS Vickers, Bloomberg Finance, L.P.


PT PP (PTPP IJ, Rp3,970, BUY, TP: Rp5,700)

We believe order book momentum would continue to build up fuelled by an enlarged equity base post rights issue. The company plans to bid for more EPC and port projects in 2017, which could support margin expansion. PTPP now trades at 16x FY17F PE, a 5% discount to peers. Among stocks under our coverage, we expect PTPP to be the only contractor to record an increase in new contracts awarded in 2017, unlike the other contractors, who are expected to see a decline in value of new contracts awarded.

Wijaya Karya Beton (WTON IJ, Rp860, BUY, TP: Rp1,150)

As one of the leading precast manufacturers with the most extensive presence across Indonesia, we believe WTON is in a sweet spot to benefit from faster execution of infrastructure projects. Stronger order book replenishment of WIKA, WTON’s parent company, should also translate to better earnings outlook for WTON.

5

15

25

35

45

55

65

75

WSKT PTPP WIKA WTON

5

10

15

20

25

30

Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16

+2sd

+1sd

‐1sd

‐2sd

Avg.

-60%

-40%

-20%

0%

20%

40%

60%

5

10

15

20

25

30

Jan-

12

Apr

-12

Jul-1

2

Oct

-12

Jan-

13

Apr

-13

Jul-1

3

Oct

-13

Jan-

14

Apr

-14

Jul-1

4

Oct

-14

Jan-

15

Apr

-15

Jul-1

5

Oct

-15

Jan-

16

Apr

-16

Jul-1

6

Construction PE premium to JCI (RHS) Construction PE

JCI PE Avg. construction PE premium to JCI (RHS)

Market Focus

2017 Outlook

Consumer (Tiesha Putri, [email protected] & Andy Sim, [email protected])

Loosening the purse strings

Input cost tailwind dissipates; expecting margins of

staple products to moderate

Retailers poised for strong earnings growth due to low

base effect

Demand environment is still soft but steadily improving

Prefer cheaper names with strong pricing power. Top

pick: Indofood Sukses Makmur

2017 Outlook

Staples’ margins to moderate on the back of higher input costs; retailers’ earnings to grow from a low base. We expect the sector to book 12% y-o-y net profit growth in FY17F on the back of improving consumer demand. Retailers’ earnings growth will likely outpace consumer staples partly due to low-base effect in 2016. Key commodity prices have reversed their downward trend in the past two months, hence we expect consumer staples’ margins to moderate going forward after enjoying the boost from lower input costs in the nine months to Sep 2016.

Commodity Price Trend (Quarterly avg. Price)


Demand environment is still soft but steadily improving. Looking at results reported by consumer companies in 3Q16, demand for staple categories have generally improved compared to the start of 2016. Nonetheless, consumers are still holding back on discretionary spending, especially for big-ticket items, as seen in weak retailers’ same-store-sales-growth (SSSG) and vehicle purchases.

Consumer Confidence Index (CCI) and CPI Trend


Retail Sales Index


Moderate increase in 2017 minimum wage. More regions will comply with the minimum wage formula stipulated by Government Regulation No. 78/2015 next year, which pegs minimum wage growth to inflation and GDP growth rate. The implication is a slower minimum wage increase in 2017 compared to that in the past years. On average, the minimum wage in 34 provinces will rise by only 9% in 2017 vs. 12% increase each in 2015 and 2016.

Given the moderate minimum wage increase next year, trend of commodity price and the execution of infrastructure projects are two things to keep an eye on. It is worth noting that 33% and 7% of the workforce are employed in the agriculture and construction sector respectively. Hence, rising soft commodity prices and infrastructure spending would help to spur household consumption and sustain consumption recovery momentum next year.

USDIDR Wheat CPOSkim Milk

PowderCoffee Cocoa Sugar Crude oil

yoy1Q16 6% -11% 9% -31% -22% 1% 2% -31%2Q16 1% -7% 19% -17% -5% 0% 37% -21%3Q16 -5% -21% 26% 21% 18% -8% 79% -1%QTD -5% -17% 25% 15% 31% -18% 52% 14%qoq

1Q16 -2% -5% 11% -11% -1% -10% -2% -20%2Q16 -1% 1% 5% -2% 6% 4% 18% 35%3Q16 -1% -14% 1% 17% 14% -2% 19% 1%QTD 0% 0% 5% 13% 9% -10% 10% 4%

Market Focus

2017 Outlook

Average Minimum Wage Trend


Employment by Sector


Key Risks

Rupiah depreciation. Weakening rupiah may pose downside risk to earnings as around half of consumer staples’ raw materials are denominated in US dollars. Among retailers, MAPI would be the most negatively affected by the rupiah’s depreciation since more than 60% of its merchandise is imported (18% of its COGS is in USD, while 24% is in EUR). Upside risk would be if demand recovers faster than our expectations, hence any cost pressures could be immediately passed on to consumers through price increases.

Less support from government. Fiscal stimulus appears to be lower with subsidy allocation being cut by 9% y–o-y. While we acknowledge that the budget has been re-allocated towards more productive areas such as infrastructure – which in the longer term would serve as a more sustainable consumption growth driver - lower subsidies may hurt consumers’ purchasing power in the shorter term although temporarily. Oil price is something to keep an eye on, since energy cost together with housing and utilities comprises 25% of the CPI basket.

Valuation

The sector trades at 1.1SD above its five-year mean PE, with sector’s PE premium over JCI at 172%, higher than its five-year average of 102%. The re-rating in the past one year has been driven by consumer staples, which recorded solid earnings growth as input costs declined. Meanwhile, retailer stocks have mostly de-rated as the soft demand environment raises concerns on potential operating deleverage and margin contraction.

Consumer Staples vs. Retailers’ forward PE Band


The valuation discount between retailers and staples has widened and with soft commodity prices creeping up, consumer staples stocks trading at lofty valuations may be at risk. We prefer cheaper names with dominant market shares. Indofood Sukses Makmur fits this criteria, trading at 16x PE 17F with market share dominance and strong pricing power on its key instant noodle segment. Given the attractive valuation gap to consumer staples, we would revisit our view on retailers once we see a firmer recovery on domestic demand. In the meantime, we advise investors to focus on company-specific positive drivers. We like MAPI among retailers due to the ongoing store rationalisation and reduction in discounting activity which should continue to drive profitability improvement in the coming quartes.


Indofood Sukses Makmur (INDF IJ, Rp8,050, BUY,

12-mth TP: Rp9,900)

We believe INDF offers better value for consumers looking for exposure on its 80.5%-owned subsidiary Indofood CBP (ICBP IJ). INDF now trades at a 31% discount to its SOTP valuation vs. historical average discount of 15%. The company is currently in the process of divesting its majority stake in China Minzhong Food Corporation (MINZ SP) which we believe should narrow its valuation discount as its balance sheet and earnings profile improves.

1.30 1.51

1.69 1.91

2.08 19%

16%

12% 12%

9%

0%

5%

10%

15%

20%

25%

-

0.50

1.00

1.50

2.00

2.50

2013 2014 2015 2016 2017

Avg. minimum wage, Rp mn (LHS) Growth y-o-y (RHS)

Agriculture33%

Mining1%

Industrial13%

Construction7%

Trade23%

Others23% -60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

5

15

25

35

45

55

65

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Retailers' PE premium to staples Retailers' PE

Consumer staples' PE Avg. retailers' PE premium to staples

Market Focus

2017 Outlook

Oil and Gas (William Simadiputra [email protected])

Positive but still cautious

Still cautiously optimistic on upstream E&P

Efficiencies positive for O&G service business

Slow regulatory reform and clarity are key risks

Medco Energi is our top pick

2017 Outlook

Upstream: Positive but still cautious

Our pick for the upstream E&P contactor sector is Medco Energi (MEDC). We are still cautious on the oil and gas sector next year given uncertainties on whether crude oil prices can trend higher than US$50 per barrel. Indonesia’s offshore oil and gas projects may not fully kick in if crude oil prices stay at current levels, as the offshore projects require higher crude oil prices of US$60-70 per barrel.

Capital (excluding M&A) and operational efficiencies will remain the key operational theme among upstream E&P players next year. We believe profitability maximisation will be upstream E&P players’ highest priority next year, via maintaining a low cost strategy, while raising production.

Indonesia’s upstream oil and gas sector operates on a low cash cost structure, as the main projects are mostly onshore blocks. Amid the downtrend in ASP, MEDC was still able to reduce its cash cost per barrel of oil equivalent (BOE) to US$7.9 per barrel in 3Q16. MEDC is only focusing on its most profitable block Rimau, besides its integrated upstream-downstream Donggi-Senoro integrated LNG project.

MEDC 's Revenue (US$m) and Profitability Trend


The focus on efficiencies also means the pressure on oil and gas service companies will still persist next year. Under our coverage, Elnusa (ELSA) posted weaker q-o-q performance trends in the past two quarters. Revenue growth has been

stagnant, and slow roll-out of new projects means that ELSA is only depending on its existing contracts. Margins are expected to contract in the short term, as we think that ELSA would not be able to extract higher efficiencies given slower revenue growth momentum trend.

ELSA Revenue (Rpbn) and Profitability Trend


Consolidation is happening; domestic contractors have benefited

E&P contractors with strong balance sheets are on the lookout for assets available for sale. Foreign contractors’ long-term business strategy has changed and they are unable to continue operating using the existing product sharing contract (PSC) terms in Indonesia. This will benefit domestic contractors.

British Petroleum (BP)’s PSC on Sanga Sanga Conventional Block (SSCB) in East Kalimantan expired this year. BP’s stake in SSCB was 26.25% alongside other investors (see chart) like Lasmu Sanga Sanga and OPICOIL Houston. The buyer of BP's stake in SSCB block is still unknown at this point.

SSCB Shareholding Structure

Source: Media, DBS Vickers

MEDC also recently completed the acquisition of ConocoPhilips’s 40% stake in a sharing block in South Natuna

0%

10%

20%

30%

40%

50%

60%

0

50

100

150

200

250

300

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16

Revenue GPM EBITDAM

0%

5%

10%

15%

20%

25%

30%

0

200

400

600

800

1,000

1,200

1,400


Revenue GP NPAT

BP East Kalimantan26.3%

Virgina International Co. LLC15.6%

Universe Gas and Oil Company4.4%

OPICOIL Houston20.0%

Lasmu Sanga Sanga26.3%

Virgina Indonesia Co. LLC7.5%

Market Focus

2017 Outlook

Sea Block (SNSB). This transaction is also another example that strong E&P contractors can seize M&A opportunities relating to ongoing, and well-run projects. As such, MEDC will not have to deal with the early stages of development which can take 5-10 years before reaching the current operational stage.

No incentives in sight

The government’s plan to boost incentives such as changes in the PSC scheme into a sliding scheme is positive on paper, but it will only apply to the newly signed PSCs. Under the new scheme, the share of revenue between the government and contractors will consider the crude oil price level, and hence, it will be fairer for contractors. However, this scheme is not addressing the earlier stages, like exploration projects, which can be very costly for contractors.

Midstream - fragile gas distributor outlook on regulation uncertainties

The challenges in the midstream segment for a company like Perusahaan Gas Negara (PGAS) is the uncertainty of regulations, mainly 1) natural gas pricing regulation, and 2) Pertagas-PGAS merger plan, where the status is currently unclear. Both factors are key concerns surrounding PGAS in the past two years. The natural gas pricing regulation will provide clarity on PGAS’s distribution spread and margin outlook while the Pertagas-PGAS merger will give more clarity on the natural gas distribution business’s competitive landscape.

Despite the presidential regulation (Pepres) No.40/2016 issued in June this year, the plan to lower natural gas prices has yet to be implemented, according to our checks with ceramic tile and power plant players. The Minister of Energy and Mineral Resources (ESDM) is also planning to make an announcement soon about the gas pricing formula, which is expected to be fully implemented in January 2017.

PGAS Distribution Volume and Spread


Key Risks

Crude oil price outlook. Indonesia’s oil and gas projects, mainly the new offshore deep water projects in Eastern part of Indonesia, require a long-term sustainable oil price of above US$50 per barrel.

Regulation issues. Slow regulation reform means Indonesia’s oil and gas products will continue to miss the government’s lifting target. The unappealing investment climate in this sector may continue going forward.

Valuation

The services and upstream contractors trade at different valuations. Upstream contractors are trading at undemanding valuations in our view, as MEDC’s performance has been decent amid the worst of the crude oil price cycle, thanks to its low-cost structure.

However, we believe valuations of PGAS and ELSA deserve to be de-rated relative to historical levels given the changes in their business outlook. PGAS’s earnings outlook is facing uncertainties on the natural gas pricing regulation plan. Meanwhile ELSA's upstream clients are putting pressure on the company to reduce contract fees.

FY17 P/E Multiple (X)


Top picks for the sector

Medco Energi (MEDC IJ, Rp1,350, BUY, TP: Rp2,000). We like MEDC for its low-cost structure. MEDC has been able to expand its profitability even amid the ASP downtrend cycle. Its low-cost structure is a definite plus when crude oil prices recover. The acquisitions of NNT (Newmont Nusa Tenggara) and SSNB are also earnings accretive, as MEDC acquired both assets at good prices at the bottom of the commodity cycle.

800807

824

865

780

741726 726

3.9 4.2

3.3 3.3

2.5 2.5

2.5 2.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

650

700

750

800

850

900

2011 2012 2013 2014 2015 2016F 2017F 2018F

Distribution volume (MMSCFD) ‐ LHS Spread (US$ per MMBTU) ‐ RHS

6.4

8.5

11.2

20.4

0

5

10

15

20

25

MEDC ELSA PGAS AKRA

P/E (X)

Market Focus

2017 Outlook

Property (Indonesian Research Team)

A ray of hope

Better affordability and looser policy should help

demand

Expecting full impact of tax amnesty and lower interest

rate next year

Margin pressure may stay

Neutral stance on the sector, BSDE as top pick

2017 Outlook

2017 maybe a better year

2016 has been bumpy as expected. Aggregate 9M16 marketing sales (for seven major developers) barely make up half of our full-year marketing sales forecast. Meanwhile, earnings in the 9M16 only achieved a mere 58%/56% of ours/consensus full-year estimates due to weak deliveries, lower-than-expected margins, higher opex, and higher interest expenses.

Property Developers Marketing Sales

Source: Companies, Bloomberg Finance L.P., DBS Bank, DBS Vickers

Notes: Aggregate marketing sales above include ASRI, APLN, BSDE, CTRA, LPKR, PWON, and SMRA as proxy; Marketing sales achievement in 9M16

Although a significant surge in property demand might still be far off, we believe that subtle improvement in underlying demand should be seen next year due to slight improvement in affordability, as price-to-income ratio has shown some tick-down in mid-2016. Although we believe that this is mainly due to unaggressive pricing from developers rather than significant purchasing power improvement, this should translate into better volume sales ahead.

Furthermore, the impact of tax amnesty has not translated into stronger marketing sales in 2016. In fact, tax amnesty has a temporary negative impact on sales as it drew not only effort, but also cash liquidity (due to the cash payment of the tax penalty). Meanwhile, the Rp143tn repatriation funds

from the first phase of tax amnesty need some time to trickle down into stronger property demand.

Price to Income Ratio

Source: Numbeo

Full impact of looser policy

Measures introduced in 2016 were meant to boost property demand. The central bank has made six policy rate cuts this year in an effort to kick-start the economic growth. This translates into lower lending rates, including those in the mortgage segment. The banks have been aggressively pricing down its promotional mortgage rate to help boost the subdued loan growth. As an example, BBCA offers a 3-year fixed rate of 7.99% plus another 3-year floating rate capped at 8.99%. BMRI also offers an attractive 5-year fixed rate of 8.5%.

Demand should also be helped by the full impact from a set of regulation relaxation introduced in 2016 including: relaxation for 2nd home indent purchase and tax cut for both final sales tax for developers (to 2.5% from 5%) and on title transfer for the acquisition of rights to property (BPHTB).

Interest Rate on Consumer Loans

Source: Bank Indonesia

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

2009 2010 2011 2012 2013 2014 2015 2016F 2017F

Marketing sales achieved

DBS forecasted marketing sales

Rpbnplateauing

-

5.00

10.00

15.00

20.00

25.00

2009 2010 2011 2012 2013 2014 Mid 2014

2015 Mid 2015

2016 Mid 2016

13.94 13.9313.91 13.90

13.8613.83 13.82

13.7413.72

13.60

13.65

13.70

13.75

13.80

13.85

13.90

13.95

14.00

Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16

Market Focus

2017 Outlook

Margin pressure may stay

Developers may continue to face margin pressure resulting from a shift in product mix to high-rise products in the past three years. Furthermore, we believe developers may continue to limit price increase in order to adapt with the restrained purchasing power.

We also expect some developers with new project launches such as SMRA to continue booking higher operating expenses from promotions and administrative expenses. Interest expenses should not see significant changes next year as most of the bond issuance in 2016 are intended for refinancing to take advantage of lower interest rates.

High-rise Marketing Sales Portion Kept Rising

Source: Companies, DBS Bank, DBS Vickers

Key Risks

Higher-than-expected interest hike. Our economist expects a one-time hike in 7-day reverse repo next year. Although we believe a one-time interest rate hike should not significantly affect demand, a higher-than-expected interest rate hike might keep the demand muted.

USD/IDR. Most of developers in our coverage (ASRI, BSDE, PWON, and LPKR) are exposed to USD debt. Therefore, currency depreciation should act as a negative catalyst for these property stocks.

Valuation

The sector is currently trading at a 38% discount to RNAV (higher than 4-year average of 37%). Despite the significant corrections following 3Q16 results disappointment and the Trump tantrum, we do not see the current valuations as good entry points for Indonesian property stocks. Bear in mind that

Indonesian property and industrial estate stocks have a smaller market capitalisation, higher beta, and high foreign ownership, which are prone to external disturbances.

We maintain our cautious stance on the property sector. We favour developers with strong balance sheets to ride out this challenging market.

Historical Discount to NAV

Source: Companies, DBS Bank, DBS Vickers

Top Pick for the Sector

Bumi Serpong Damai (BSDE IJ, Rp1,865, BUY, TP: Rp2,200)

We recently upgraded BSDE to BUY (from HOLD) after the stock price plunged by as much as 20% since the US election and currently trades at an 8-year average discount to RNAV of 53%. We believe the current valuation is attractive with 19% upside to our TP, and BSDE is still one of the best to ride out the current property cycle, supported by its abundant land bank and healthy balance sheet.

Property demand has been slow this year and the tax amnesty has not boosted demand yet thus far. However, BSDE is being proactive since the end of the first phase of the tax amnesty to fulfil its marketing sales target of Rp6.8tn this year through marketing campaigns such as the “price amnesty”, which added a respectable Rp1.1tn in sales during the first phase.

BSDE has just issued US$200m of 7-year global bonds with a coupon of 5.5%. The US$146m of funds raised from the global bond issuance has been allocated to refinance another outstanding bonds due in 2020 with 6.75% coupon. In addition, the company will benefit from a lower property sales tax (2.5% vs. 5% previously). Overall, this will help to offset slower revenue growth on its bottom line.

-

5,000.0

10,000.0

15,000.0

20,000.0

25,000.0

30,000.0

35,000.0

40,000.0

45,000.0

2009 2010 2011 2012 2013 2014 2015

Marketing sales (non-high-rise) Makreting sales (high rise)

0%

10%

20%

30%

40%

50%

60%

Jan

-11

Jun

-11

No

v-1

1

Ap

r-12

Sep

-12

Feb

-13

Jul-

13

Dec-

13

May-1

4

Oct

-14

Mar-

15

Au

g-1

5

Jan

-16

Jun

-16

No

v-1

6

Average 37%

Market Focus

2017 Outlook

Thermal coal (William Simadiputra [email protected])

Coming out of the dark

Coal prices will normalise but it should take time

Slow supply response from global miners

Market only priced in a modest recovery in coal prices

and miners’ earnings outlook

PTBA and ADRO are our picks

2017 Outlook

Coal prices will normalise but it should take some time

We believe coal prices will not stay above US$100 per tonne next year in the absence of seasonal coal winter restocking and relatively subdued crude oil price outlook. We believe coal prices will normalise to around US$65-75 per tonne next year. Our current coal price benchmark for FY17 is US$65 per tonne.

Seasonal global coal restocking, led by China, will reach its tail-end at the end of 4Q. Winter restocking has provided a strong short-term demand buffer, and has absorbed almost all of China’s coal inventories, thus triggering higher coal imports from the seaborne market in the past three months.

China’s Quarterly Coal Import Trend (Annualised)

Source: Company, SX Coal, DBS Vickers

Our checks with some coal traders also suggest that they are cautious about coal prices, largely revolving around how long the buyers (mainly coal-fired power plants) can cope with elevated coal prices in the absence of the winter season.

The winter season has led to higher operating hours for coal-fired power plants and fuel (coal) supply assurance is very crucial in averting costly temporary shutdowns. The absence of a low-temperature winter season means lower power consumption, and this can limit the downside risk for coal prices in the short term. However, the traders have recently

mentioned about supply scarcity in the market on the back of the heavy rainfall in Kalimantan.

This is also confirmed by our talks with ITMG last week that the heavy rainfall was the key short-term operational challenge. We also believe the short-term supply scarcity was also one of the key reasons behind the coal price spike immediately after China’s supply cut announcement.

Upcoming new volume to the market is unavoidable, but the pace seems pretty slow

Indonesia’s coal output trend will be relatively flattish in 2017 on the back of operation cessation by the smaller miners, according to the Director-General of Coal and Minerals at Indonesia Energy and Mineral Resources in May 2016. According to our checks, the trend will not change much going forward.

Indonesia’s Coal Output Trend (mn tonnes)

Source: Various media, ESDM as of May 2016, DBS Vickers

The miners’ cautious view is also impacting their production activity. In other words, a conservative production expansion means lower new coal volume coming onto the market. Thus, this will hinder a quick reversal of coal prices.

On paper, a higher coal price at US$100 per ton means almost 90% of global coal capacities are above water. Coupled with low crude oil prices, this will trigger a sizeable potential coal supply increase in the market. Low crude oil prices also will help miners to expand production, as this implies that miners can enjoy favourable cash margins.

However, we notice that operational flexibility is only enjoyed by medium- to large-scale coal miners, or miners that are still resuming their operational activity and have positive cash margins. Meanwhile, smaller coal miners, particularly the ones that are facing mining closure or temporary operation discontinuation, need some more time to revamp their production. Discontinued mine concessions require field reassessment and equipment purchase, which take some time.

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Market Focus

2017 Outlook

There is a more complicated relationship between the small miners with their creditors and suppliers. Regaining creditors or machinery suppliers’ trust is a bit challenging at this point, given that these stakeholders were hard hit during the coal price down-cycle in the past three years.

We estimate that Indonesia miners need 3-6 months before ramping up their coal production. Directly outsourcing mining activities to third-party miners will also not boost mining concession production spontaneously, as the mining contractors need a take-or-pay volume commitment of at least three years. Mining contractors need to lock up their minimum project IRR in order to allocate the right capital spending, mainly for machineries to run the project. Therefore, as long as we do not sense a more positive view from the miners, we would not witness a medium-term increase in coal supply.

Our check suggests that Indonesia’s local coal miners are still cautiously optimistic on the coal price outlook for next year, and a majority of them agree that the current high coal prices will not sustain beyond 1Q17. Most of the miners are stuck with their initial mining plan of flat to single-digit production expansion next year.

Structural demand decline is still unfolding, but its emergence will be slow. Our better coal price outlook arose mainly from the limited supply reaction rather than the increasing usage of coal globally. We understand that although coal is dirty, around half of the global energy mix still relies on coal. Replacing coal with new alternative renewable energy sources will not happen immediately, especially with China still constructing new coal-fired power plants.

Key Risks

China’s domestic policies. China’s domestic policies can present both upside and downside risks to coal prices. For example, China’s policy to reduce coal-fired power generation in the coastal areas has changed the global coal supply and demand dynamics in the past five years. However, China’s plan to cut domestic coal production has proven to be successful in reviving coal prices. China’s future policies – whether on supply or consumption control – will help define the coal supply and demand outlook.

Supply reaction to coal prices. A massive coal supply influx from major coal-producing countries like Indonesia and Australia can cause a sudden reversal of coal price uptrend.

Valuation

Even at the current coal price level at US$100 per tonne, coal stocks are still trading at 9.3x FY17 PE. We believe this reflects the market’s ongoing caution on coal miners’ earnings outlook amid widespread belief that coal prices will not remain at the current high levels. Note that the coal

stocks were trading at 15.0-25.0x PE during the coal price up-cycles in 2007-2008 and 2009-2012.

Our DCF-based target prices for ADRO, PTBA and ITMG still imply PE multiples of 11.5x, which we believe is undemanding relative to their historical levels. Even with a plain vanilla, earnings-based valuation methodology, we can also deduce that the Indonesian coal miners are still enjoying healthy profitability.

Coal Miners Current PE Multiple


Re-rating must be supported by improving demand. We have applied a conservative target price multiple as a further re-rating will only materialise if we see a structural recovery in the coal supply and demand outlook. In the meantime, we are sticking to our conservative valuation multiple, as our current ASP and operational scenarios still assume a coal price benchmark of US$65 per tonne for next year.


Adaro Energy (ADRO IJ, Rp1,680, BUY, TP: Rp1,900)

We like its low-cost structure, which enables ADRO to maintain its strong profitability in the face of the abysmally low coal prices. ADRO’s strong profitability will sustain on the back of 1) its stable third-party mining contracting fee, 2) more efficient fuel cost, and 3) improving ASP on a y-o-y basis. ADRO is also currently pursuing other promising ventures such as the Batang power plant project and Indomet Coal coking coal mining concession.

Bukit Asam (PTBA IJ, Rp11,800, BUY, TP: Rp13,600)

We like PTBA for its stable profitability outlook on the back of its visible domestic coal ASP outlook. PTBA could also clinch a better export ASP amid the uptrend in coal benchmark price index. Further upside surprises could emerge if and when PTBA sells the higher-calorie coal next year. Its volume expansion in 2017 will also be better than this year after the completion of the double track railway in 4Q16.

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P/E (X)

Market Focus

2017 Outlook

Telecommunication sector (Sachin Mittal [email protected], William Simadiputra [email protected])

A three-horse race

Growth prospects are still bright but who will win the

race?

Growing subscribers without bonus quota

We have a BUY rating on EXCL

2017 Outlook

Growth prospects are still positive

We believe the sector is poised for stable earnings growth in 2017. Industry average revenue per user (ARPU) is trending up y-o-y on the back of stabilising data pricing competition among operators. Operators are focusing on increasing service quality instead of offering irrational price discounts. ISAT will reduce the bonus quota in 4Q16. Moreover, subscriber uptrend will sustain next year on the back of Indonesia’s low smartphone penetration rate, which is still lower than a lot of other countries. This is a sign that data revenue could still trend up amid the rise in smartphone affordability and accessibility.

Smartphone Penetration Rate (%)


Indonesia’s telecommunication sector will post positive y-o-y revenue and EBITDA growth next year. The EBITDA margin and overall profitability outlook for the operators also seems pretty healthy, as we do not see significant changes in their main operating costs.

Operators’ EBITDA Trend (Rpbn)


Big three operators will remain dominant, but maintaining strong earnings growth momentum can be challenging

Despite the bright prospects in Indonesia’s telecommunication sector, picking the winners can be challenging, considering that every operator has its own challenges – mainly revolving around how to continuously gain market share without hurting their profitability.

For example, how they can increase data usage in the face of higher smartphone penetration and emerging data-based app services in Indonesia. Operators intend to revamp their data service quality as well as encourage subscribers to use data services for mobile apps, text messaging and voice calling.

Big Three Operators’ Data Usage Trend (TB)


Telkomsel. Its dominance in Indonesia’s cellular industry will continue, enabling it to have strong top-line growth and stable profitability – thanks mainly to its growth in all segments of data, and legacy voice & SMS. The main question is how long TLKM can sustain its competitiveness and superior profitability amid increasing

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Market Focus

2017 Outlook

mobile and data service penetration, coupled with its reliance on the highly-profitable voice and SMS services.

EXCL has gradually built up its high-value subscribers by revamping its traditional channel and in-house modern channel. Subscriber addition started to pick up in 3Q16 and we expect the trend to continue. Its EBITDA margin bottomed in 3Q16 and we should start to see improvements ahead on the back of normalising marketing cost after the traditional channel revamp.

Though ISAT’s subscriber addition has outpaced its competitors', its EBITDA growth stagnated – which is a sign that ISAT’s move to acquire EXCL’s churned non- profitable subscribers can lead to long-term challenges for monetising this type of subscribers (similar to what EXCL experienced in the past). ISAT’s move to reduce its quota bonus also raises the question of whether it managed to sustain its strong subscriber growth in the past one year.

Key Risks

TLKM's solid performance to sustain? TLKM has the most visible earnings outlook given its subsidiary Telkomsel's ability to grow its subscribers and ARPU – that make it the best-performing operator in Indonesia. TLKM’s valuation reached its five-year historical high, trouncing other ASEAN operators in becoming the most expensive operator.

EXCL’s slow turnaround progress. As it works on revamping itself, some of EXCL’s operational and financial metrics missed our and consensus expectations. This has resulted in the drop in its share price. The stock is currently trading at its five-year historical low EV/EBITDA of 5.0x.

Valuation

What is priced in?

The valuation of listed operators is pretty divergent. There exists a valuation gap between TLKM and the other two competitors, which we believe reflects market expectations of TLKM being able to maintain its strong performance. We believe the market has priced in TLKM’s superior earnings visibility outlook given its subsidiary Telkomsel's ability to grow its subscribers and ARPU – that make it the best-performing operator in Indonesia. TLKM’s valuation reached its five-year historical high, trouncing other ASEAN operators in becoming the most expensive operator. The market values TLKM as the most expensive telecommunication stock in ASEAN. TLKM's valuation is at an all-time high, +2SD of its five-year PE and EV/EBITDA.

Despite its strong performance outlook, we think that the key question is how long TLKM can rely on its legacy business to stay on top of the Indonesian telecommunication industry going forward. We also believe the market has not priced the potential revenue and profitability downside risks in the event

that Telkomsel loses its competitive advantage in voice and SMS services mainly in the ex. Java areas. Our previous scenario analysis reveals that TLKM’s share price could drop to Rp3,200 if it fails to keep its superiority in this segment.

EXCL’s slow turnaround progress. As it works on revamping itself, some of EXCL’s operational and financial metrics missed our and consensus expectations. This has resulted in the drop in its share price. Our scenario analysis also reveals that the market has priced in EXCL’s slow turnaround progress. The stock is currently trading at its five-year historical low EV/EBITDA of 5.0x, or at Rp2,200. EXCL’s subscriber addition might be marginal in the next few quarters, but its high-value subscriber acquisition will lead to consistent revenue and EBITDA growth. We think EXCL should perform better by pursuing this strategy rather than just growing its subscriber base – which has stagnant revenue and EBITDA growth, in our view.

ISAT’s slow 4G rollout and market awaits its subscriber acquisition post bonus data quota reduction. ISAT’s EV/EBITDA multiple is historically the lowest among the other operators given that its network infrastructure is lagging behind its peers. In need of subscriber growth, ISAT should provide the bonus data quota to attract more subscribers – this has caused revenue and EBITDA to grow at a slower pace vs. subscriber addition.

We think that ISAT might not be able to sustain this growth strategy, as its revenue and EBITDA growth will be compromised going forward. This is unavoidable as ISAT clinches more price-sensitive subscribers by dishing out free data quota. The next question is how ISAT will attract subscribers with this marketing strategy as we think that ISAT’s 4G rollout is lagging behind XL and Telkomsel's.

FY17 EV/EBITDA (X)



XL Axiata (EXCL IJ, Rp2,510, BUY, TP: Rp3,300). We think that XL Axiata (EXCL) offers the most appealing risk-reward profile, as it is now trading at its five-year historical low EV/EBITDA. It should be able to boost its profit performance after a two-

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Market Focus

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year strategy transition from engaging in traditional price wars to pursuing high-value subscribers that promises better profitability and shareholder returns.

Market Focus

2017 Outlook

DBS Bank Ltd recommendations are based an Absolute Total Return* Rating system, defined as follows:

STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

BUY (>15% total return over the next 12 months for small caps, >10% for large caps)

HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 16 Dec 2016 07:55:53 (SGT)

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Market Focus

2017 Outlook

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The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in the report. The DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. As of 16 Dec 2016, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately.

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Adaro Energy, Indo Tambangraya, Perusahaan Gas Negara recommended in this report as of 30 Nov 2016.

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Market Focus

2017 Outlook

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Market Focus

2017 Outlook

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market strategy-16-dec-2016 mf...be enough to counter the sentiment ... adaro energy 1,680 4,026...

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