Stability Over Growth

FY19F JCI target: 6,560 (5.9% upside) We set our JCI target for 2019F at 6,560, derived from 9.3% FY19F EPS growth and 16.1x FY19F PE (5-year mean). Our FY19F JCI target implies a 5.9% upside from closing level 2018. Meanwhile, we expect FY19F GDP to be slightly lower compared to this year due to: 1) synchronized global economic slow down led by US and China (top two Indonesia’s trade partners), and 2) normalizing household consumption in 2H19. Subsequently, we expect inflation to be 50-100 bps higher compared to our FY18E and USDIDR to be within 14,300 – 14,800 target range. Notwithstanding global economic volatility and US-China tension, we view domestic economy will remain resilient stemming from lower oil price, less FX volatility, and rising social spending.

As of 9M18, economic growth stood at a YoY reading of 5.17%, broadly inline with market projection of 5.15% and our target range of 5.1-5.2%. While GDP showed some sort of moderation compared to the previous reading (6M18 GDP: 5.27%), household consumption continued to display recovery as it grew by 5.03% YoY, followed by an uptick in fixed investment which strengthened by 6.93% YoY. Net exports, however, contributed negatively to economic growth due to: 1) mild increase in export following a high base in FY17, 2) lower-than-expected economic growth in the trading partner countries, and 3) accelerating raw material imports stemmed by infrastructure projects execution. As for FY19F, we expect GDP growth to be moderate at 5.0-5.1% range with government’s focus leaning toward
stability over growth to safeguard CAD and promote currency stability.

Consumption recovery to extend in FY19F

We expect consumption recovery to extend in FY19F as government maintains its focus on eradicating poverty and increasing social welfare. To accomplish the goal, IDR 387.3 Tn (up 32.8% from FY18E) was budgeted for social welfare programs including subsidies in 2019. One of which is PKH (Program Keluarga Harapan) which is doubled from IDR 17.3 Tn in 2018 to IDR 34.3 Tn in 2019 as it is viewed to be effective to reduce poverty.

In addition, government also increases the number of households to receive BPNT (Bantuan Pangan Non Tunai) from 10 millions in 2018 to 15.6 million households in 2019, as well as raises village fund from IDR 60 Tn in 2018 to IDR 73 Tn in 2019. The election year and excise tax absence may also serve as additional consumption boosters in FY19F. The fact that legislative and presidential elections will be carried out simultaneously in April 2019 may create a more festive campaign atmosphere in 1Q19, which may lead to better money circulation and boost low-end consumption.

The peak of BI’s tightening monetary policy

In FY18, BI raised 7DRRR by 175 bps in order to strengthen Rupiah stability
amidst escalated external pressure roused by US treasuries and some EM currencies’ plunging in FY18. Meanwhile, as Governor Warjiyo highlighted, these rate hikes should also be seen as BI’s efforts to be pre-emptive, front-loading, and ahead-of-the-curve as they anticipate further tightening from global central banks. The stance was further emphasized by the 25 bps hike during irregular meeting in May-18 and the unprecedented 25 bps hike in Nov-18 meeting. Nevertheless, BI left 7DRRR unchanged in Dec-18, despite the 25 bps FFR hike, as they feel comfortable with the latest economic development. To note, interest parity stood at the higher-end of the 300-400 bps spectrum as of Nov-18. As for FY19F, we believe that BI may raise rate up to a maximum 50 bps from current level; our base case scenario assumes two FFR hikes in FY19F. To add, some of the Federal Reserve committee members had lowered the long-term interest rate target and portrayed change of tone toward FFR outlook during the very last FOMC meeting in FY18 as they expect slower US economic growth in FY19F and as they hear rising chorus of concerns over trade war.

Slowing earnings growth led by big caps

Consolidated FY18E EPS growth of companies under our coverage is expected to stand at 9.9%, on the back of Big-4 banks contributing low-teens growth of 12.9% YoY through a ramp up in loan disbursement, which resulted in FY18E Big 4 banks consolidated LDR peaking at 94.5%. On the other hand, big market cap consumer staples companies (ICBP and UNVR) earnings were boosted by low commodity prices, strong domestic consumption, and one-off gains.

As for FY19F, Big-4 banks FY19F earnings are forecasted to moderate to 10.8% YoY growth due to slower loan disbursement. Loan growth will be more modest at 9.4% in FY19F. Meanwhile, in the consumer staples sector margin may deteriorate due to a potential pick up in soft commodity prices despite a more stable IDR. On another note, coal sector will contribute to the slow down due to declining coal price, widening discount spread between high and low CV coal, sluggish China coal imports, and peaking production.

Higher inflation primarily stemmed by commodity prices

As of 11M18, CPI has gone up by 3.2% YoY, with our FY18E forecast of 3.5-4.0%. This low inflation was attributable mainly to prudent government control over volatile food prices. Meanwhile, FY19F CPI is expected to rise by 50-100 bps from our FY18E due to the following reasons. First of all, PPI has been lagging as industry players face tighter competition. However, we expect this will eventually contribute to higher CPI in 2019. Secondly, commodity such as oil and CPO have been punished in 2018, which changes the landscape as the upside risk is currently greater. Lastly, there is potential that the government will prioritize addressing CAD by changing the price mechanisms on fuel and utilities in 2H19 depending on commodity levels.

What can we expect from the money flow?

There are three major events that will color 2019 money flow. Firstly, there will be a shift in money flow from DMs to EMs as growth in DMs slow down. Particularly, this favors Indonesia as an EM as it is highly attractive at current condition and valuation especially moving into 2019 as FX outlook continues to improve. Secondly, amongst JCI constituents, we see a shift in money flow from small freefloat market cap companies (HMSP and UNVR) to large free-float market cap companies (TLKM and ASII) as IDX issued a new methodology on LQ45 and IDX30 weighting. Thirdly, as lock-up period ends starting in 2019 for tax amnesty (TA) repatriated funds, which was IDR 147 Tn, there is potential that the amount will shift to other asset classes or overseas.

What to buy?

In all, we are bullish on consumption-related segments this year, especially ones with heavy domestic exposure. With that being said, our top picks for this year are: INDF (BUY, FY19 TP: IDR 9,200), ICBP (ADD, FY19 TP: IDR 11,650), SIDO (BUY, FY19 TP: 980), RALS (BUY, FY19 TP: 1,750), ACES (BUY, FY19 TP: 1,810), MAPI (BUY, FY19 TP: 1,030), GGRM (BUY, FY19 TP: 94,800), HMSP (ADD, FY19 TP: 4,360), and JPFA (BUY, FY19 TP: 2,500).

From the commodity sector, we like Plantation as we see positive catalysts on the CPO price may bolster sector’s attractiveness. Our top picks for Plantation are: AALI (BUY, FY19TP: IDR 14,900) and LSIP (BUY, FY19 TP: 1,600). On the flip side, we tone down our sector call on Banking due to our expectation of slowing earnings growth in FY19F, Coal due to price conundrum and potentially weaker demand from China, and Telecommunication as we see lingering data price war between telco players towards the end of FY18. As for interest-sensitive sectors, we view Property and Construction to be attractive at current valuations, though we prefer selective picking on both sectors due to limited upside risks for pre-sales and new contracts this year. Meanwhile, we reiterate our NEUTRAL stance on Automotive sector as we see competition in LMPV is not over yet and tight liquidity condition in the Financial sector may affect auto credit pricing and feasibility.

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