Erwan TEGUH, Peter P. SUTEDJA, Namira LAHUDDIN | Analysts |
- 2018 has been volatile as market sentiment started off optimistically, turned sour by mid-1Q but has improved of late.
- Valuations, interest rate hike risks (rates not rising by as much) and oil prices (cooling, well below US$60/bbl) underpin a more constructive 2019 outlook.
- Politics could be a significant boost to business sentiment by 2Q19, which could propel the growth outlook well beyond 2019.
2018 inreview: a yo-yo year
It started off optimistically but quickly turned cautious by mid-1Q and cumulated in significant risk aversion by summer before turning more positive by mid-4Q. Three factors swayed sentiment: federal funds rate (FFR) uncertainty, oil price surge and subsequent Rp volatility.
JCI underperformed the bond market, much like in 2008/2013/2015 when risk aversion was high. Growth expectations were pared down on fears over currency (depreciated by 13% vs. US$ at the lowest point) and interest rates (+175bp in Jan-Nov 18) but showed resilience as domestic consumption, both private and public (+5.0% yoy and +6.3% yoy in 3Q18, respectively), pushed GDP up 5.2% and corporate earnings +12.5% yoy in 3Q18.
The past five years under President Jokowi saw the most expansive and fastest infrastructure development the country has everexperienced. However, the impact of reforms, such as opening up the country toforeign investors or transforming government institutions, has not been asobvious. The completion of major infrastructure projects should driveproductivity gains (from better logistics) and investment appetite may surprise on the upside, if politics strikethe right balance post the Apr 19 general election. Jokowi has a significantlead in the polls so far.
Risks mostly priced in
The era post quantitative easing (QE) and the start of the taper in 2013 led to JCI’s P/E de-rating to -2 s.d. (since Nov’11). The bond yield has been relatively stable, with the benchmark averaging 7.7% (vs. 8.0% currently) in the past 10 year supported by benign inflation, which fell from a peak of 8.8% in Aug’13 (mean at 5.1%) to 3.2% yoy currently. Rp depreciated by c.50% from the start of 2013. Market earnings growth decelerated from 18% in 2011 (averaging 11% in 2010/13) to a bottom of -1% yoy in 2015 before rebounding to 19% yoy in 2017, in line with GDP growth (peaked at 6.5% in 2011, bottomed at 4.9% in 2015), which is now holding at 5.1-5.2%. Foreign outflows in equity totalled c.US$5.7bn since the taper in 2013 and some US$4bn on a 12M rolling basis.
What are the catalysts?
The same three factors that swayed sentiment for most of 2018 remain the key swings. The market rally in mid-4Q18 was driven largely by risk premium compression as foreign inflows appeared to rebalance the sharp outflows of the past 5 years. A market-friendly election outcome could lower risk perception equally. Any constructive reform post elections, such as energy subsidy curbs, could catalyse the stocks. With risks largely priced in, any upside could lift sentiment sharply, in our view.
Valuation dispersion should narrow
The defensive-to-cyclical P/E ratio rose to 1.9x currently (averaging 1.8x post taper). Valuation by growth/value dispersion widened despite earnings recovery in cyclical companies. For instance, Astra’s FY18F earnings are projected to exceed the previous peak in FY14. The deep cyclicals; for instance, property is at a 67% discount to NAV against a mean of51% or the floor of 83% during the global financial crisis (GFC) in Feb 09. We believe the steep dispersion should narrow if risk premium normalises, in turn if: political risk subsides; 2)currency swap cost normalises and bond spread stabilises; and 3) economicgrowth rebounds, albeit gradually.
Risk is lower than in 2005/08/13/15
A good indicator of risk is tomeasure the bond yield spread andcurrency swap cost. The sum of these and the level of CDS support the consensusview that Indonesia’s risk premium in facing FFR uncertainty in 2018 is lowerthan the past 4 external shocks in 2005 (oil price spike), 2008 (GFC), 2013(taper) or 2015 (Rmb unexpected devaluation).
Stability over growth
The Indonesian central bank,which initially defied rising external rates, succumbed to the pressure on Rp bylate- May 18 and has since turned more hawkish than expected. Improvement in tax collection (hence a lower fiscaldeficit than initial target of 2.2% of GDP; now eyeing 1.8-1.92%) and 175bprate hike from late-May to late-Nov stabilised Rp, which staged a robust rallyin Nov 18; although the currency is still down 7% YTD, it is an improvement vs 13%depreciation during the worst part of the year.That said, BI now says that rate decisions will be more data- dependentgoing forward and less handcuffed to FFR.
Earnings recovery remains ontrack
While growth concerns persist,earnings have held up well, supported by various government measures to keeppurchasing power intact. Rate increases and the impact of currency depreciationcontinue to cast a shadow over the 2019 growth outlook. Earnings recovery fromthe 2015 bottom, however, should remain on track unless: 1) banks’ NPLs spike(low probability); or 2) commodity prices crash. We project earnings growth toremain above nominal GDP growth going into 2019/20, which should help buffervaluation downside risk.
Valuations price in lots of risk
Although the risk premium currently suggests lower risk, market P/E has de-rated to -2 s.d. from average since Nov’11 and is now at the mean level of the period prior to 2012, when Indonesia was below investment grade. Investors’ positioning is defensive as the defensive/cyclical P/E ratio is at an all-time high. Foreign investors have sold US$5.7bn of equity since the taper and some US$4.0bn on a 12M-rolling basis, suggesting that outflow risk is perhaps not as severe as feared. Risk premium stabilisation should drive a near-term market rally. The growth outlook needs to improve to take JCI to the next level, in our view.
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