cc - indonesia strategy

Please see important disclosure at the back of this report

Strategy | 12 June 2014

2016 : the Year of Overcoming Challenges

2016: a year of challenges. Continued slow down in Chinas economy may bring further yuan devaluation. Low oil price, crash in junk bond market and a surprise pace in Fed Funds Rate rise may spark a capital flight out of emerging markets. Yet we expect JCI to end 2016 strongly on a pick up of consumer and private investments spending.

FIGURE 1. THE BOTTOM LINE MARKET OUTLOOK FOR 2016

Mar-134,545

Oct-134,000

Dec-13 4,000

Apr-144,800

Aug-145,200

Oct-144,800

Dec-145,200

Feb-155,100

Jul-155,000

Oct-154,500

Dec-15 4,700

Jan-164,500

May-164,500

Aug-164,250

Dec-165,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

6,000

Jan-

11

May

-11

Sep

-11

Dec

-11

Apr

-12

Au

g-12

Dec

-12

Apr

-13

Au

g-13

Dec

-13

Apr

-14

Au

g-14

Dec

-14

Apr

-15

Au

g-15

Dec

-15

Apr

-16

Au

g-16

Dec

-16

JCI JCI Fcast by Mansek

Source: Bloomberg, Mandiri Sekuritas

A stream of positive catalyts cuts in fuel price and BI rate, passage of the new Tax Amnesty Law should help maintain the Jakarta Composite Index (JCI) around the 4,500 level from Jan to May 2016.

We expect mid-year correction on the back of continued slow down in Chinas economy and Yuans depreciation, further crash in Chinas bourses, rising debt defaults due to low oil price and a faster than expected pace of Fed Funds Rate increases that might goad outflows from emerging markets. Pressures on the JCI would also come from disappointing 4Q15 and 1Q16 earnings performance. We expect the JCI to slide to 4,250 by August on the back of all these global pressures and weak domestic earnings.

Overcoming challenges by year end as we expect recovery in both consumer spending (thanks to the impact of cuts in fuel prices and stable inflation generally) and private sector investment spending (thanks to a clear shift in government policy stance towards reliance on market mechanism). After serial earnings disappointments in 2013, 2014 and 2015, we expect 2016 to see a substantive turn-around driven by recovery in these key economic factors, closing the year with the JCI at 5,000.

Top Picks we recommend continued defensive stance, but with a few stocks that might benefit from faster economic recovery TLKM, HMSP, GGRM, MIKA, SILO, BBNI, WSKT, LPCK and BSDE.

STRATEGY | THE BOTTOM LINE Strategy Update | 11 January 2015

UNDERWEIGHT

Last Price 2016F (Rp) PE EPS Gr.

TLKM 3,060 16.2 16.1%

BBNI 4,935 7.7 33.5%

LPCK 6,725 6.0 -10.0%

GGRM 54,500 18.5 7.8%

HMSP 91,000 36.0 12.1%

MIKA 2,210 42.4 29.7%

SILO 9,450 77.3 49.1%

BSDE 1,765 10.6 23.0%

WSKT 1,685 23.4 8.3%

As of: 11January 2016

Mandiri Sekuritas Analyst John Rachmat +6221 5296 9542 [email protected]

TOP PICKS

Please see important disclosure at the back of this report Page 2 of 88

Strategy | 11 January 2016

Table of Contents

Market Outlook and Mansek Top Picks ........................................................ 3We expect the first eight months of 2016 to be a highly volatile period. Positive domestic news would probably be overwhelmed by major negative global themes, but we expect the JCI to close the year strongly once clear signs of a recovery in consumer and private investments spending emerge. .......................................... 3

Global Pressures on Indonesian Equities ................................................... 12Global factors in our opinion will exert strong downward pressures on the JCI in mid 2016 : continued slow-down in Chinas economy and Yuan depreciation, oil bond defaults and capital flight out of emerging markets. Corporate earnings would also likely to disappoint in 4Q15 and 1Q16.................................................... 12

2016 : The REAL Saviour ............................................................................. 28We see two drivers for recovery towards the end of 2016: strong pick up in household consumption and in private investment spending, on the back of potential further cuts in fuel price, and a shift towards a pro-business stance in government policy. We expect signs of this recovery to emerge in 3Q16. ........................... 28

Riches in Indonesian Equities How ? ........................................................ 33In Dec 2012, the first issue of The Bottom Line was published. To celebrate, we review here those factors that had been proven successful in helping investors to profit from investing in Indonesian equities. The conclusion is that Asset Allocation is key whilst Buy and Hold often brings excessive pain. ................................... 33

2016 : Sectoral Outlook .............................................................................. 45Appendix 1. Earnings Performance 2012-15 ............................................. 58Appendix 2. 12m Roll Fwd PER and Correlation......................................... 60Appendix 3. Mandiri Sekuritas Earnings Guide ......................................... 86



Market Outlook and Mansek Top Picks

We expect the first eight months of 2016 to be a highly volatile period. Positive domestic news would probably be overwhelmed by major negative global themes, but we expect the JCI to close the year strongly once clear signs of a recovery in consumer and private investments spending emerge.

2016 : The Year of Overcoming Challenges

The Bottom Line expects the Jakarta Composite Index (JCI) to close 2016 at 5,000 level, just under 9% appreciation from its 2015 ending level of 4,593. Yet the stock market is likely to go through severe gyration on the way there. See Figure 2.

FIGURE 2. THE BOTTOM LINE MARKET OUTLOOK FOR 2016

Mar-134,545

Oct-134,000

Dec-13 4,000

Apr-144,800

Aug-145,200

Oct-144,800

Dec-145,200

Feb-155,100

Jul-155,000

Oct-154,500

Dec-15 4,700

Jan-164,500

May-164,500

Aug-164,250

Dec-165,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

6,000

Jan-

11

May

-11

Sep

-11

Dec

-11

Apr

-12

Au

g-12

Dec

-12

Apr

-13

Au

g-13

Dec

-13

Apr

-14

Au

g-14

Dec

-14

Apr

-15

Au

g-15

Dec

-15

Apr

-16

Au

g-16

Dec

-16

JCI JCI Fcast by Mansek

Source: Bloomberg, Mandiri Sekuritas

A series of positive catalysts emerging in early 2016 should help maintain the JCI gyrating around the 4,500 level:

Cut in subsidised fuel price (done already on 5th Jan 2016), and Cut in the benchmark BI rate (we expect two rounds of 25 bps each in Q1

2016), and

Tax Amnesty Law to be passed by the Parliament (likely by Feb 2016). The cuts in subsidised fuel prices (by 4.7% to Rp 7,050 per litre for gasoline and by 15.6% to Rp 5,650 per litre for diesel fuel sold in Jawa, Madura and Bali slightly lower percentage cuts for fuel sold outside these areas) should reduce inflation by 0.2 to 0.3 ppt in our economists estimation. The Bottom Line believes the Government enjoys a significant scope to cut these prices further assuming crude oil price of USD 35 per barrell and an average exchange rate of Rp 14,000 per USD, the economic price of premium (the name by which subsidised gasoline is known in Indonesia) is Rp 5,900 per litre, some 16.3% lower than the new price applied on 5th Jan 2016.

The soothing effect that cuts in fuel prices will have on inflation also reinforces our economists expectation that the central bank would cut its benchmark BI rate twice by 25 bps each before the Q1 2016 ends. The combined effect of these fuel price and interest rates cuts on the economy should be strongly positive, in our view, and so our economists project real GDPgrowth accelerating to 5% in 2016 (vs 4.7% in 2015).



The passage of a new Tax Amnesty Law is critical to the JCI, in our opinion. The property sector, for example, had suffered terribly in 2015 our property analysts estimate that almost all property firms in Mansek Universe would post lower marketing sales than the original company guidance issued at the beginning of 2015. (The sole exception is Lippo Cikarang, thanks to strong sales in its Orange County project in Cikarang.) See Figure 3. We ascribe this development to the fact that property transactions attracted heightened scrutiny from the tax authorities in 2015. Without passage of the new Tax Amnesty Laws, therefore, the property sector is likely to remain moribund in 2016.

FIGURE 3. FULL YEAR 2015 MARKETINGSALES (MGMT TARGET AND MANSEK ESTIMATES)

0

2,000

4,000

6,000

8,000

10,000

12,000

APLN CTRA SMRA LPCK BSDE PWON MDLN JRPT

Rp bn

Company guidance at begining of year Mansek estimate

Source: Company, Mandiri Sekuritas

In addition, efforts to raise tax revenue in 2016 would be boosted, as income that had for decades been evading taxation in the past would now be subject to taxation. The fact that the tax payers full assets and income would be legalized would also remove peoples fear of the tax effect of purchasing big-ticket assets such as properties, motor vehicles and others. This in turn would help spark growth in household consumption.

The combined effect of these positive catalysts should maintain the JCI oscillating around the 4,500 level in the early part of 2016 in our estimate. However, if not all of these positive catalysts get delivered (Bank Indonesia now sound more cautious about cutting the BI rate in the face of the Chinese Yuan depreciation, and internal strife within GOLKAR, the political party with the second largest number of Parliamentary seats, may delay the passage of the Tax Amnesty Laws), then the sharp correction in the Jakarta Composite Index may well start earlier and go deeper than our current projection here.

Two key factors in our opinion will deliver a sustainable recovery in equity valuation : recovery in consumer spending, and recovery in private sector investment spending.

We believe the sharp drop in crude oil price will result in WTI and Brent trading within the USD 25 to 35 per bbl band for most of 2016 (see the next section for a fuller discussion). This should allow the Indonesian government to cut the subsidised fuel price further, as we noted earlier. We expect the impact to be seen with household consumption spending accelerating from the normal 5% YoY growth starting in 3Q16.

The Indonesian government has also adopted market-friendly policies in recent months which should prompt the private sector to grow their investment spending. While the bulk of the effect would probably materialise towards the end of 2016, we believe some signs of this recovery in private investment spending should emerge starting in 3Q16. Hence we expect signs of economic improvement in August would mark the turn-around in the Jakarta Composite Index, allowing a strong close for the year.



Mansek Top Picks

While we do expect the JCI to close 2016 with a 9% appreciation, we design our current Top Picks to withstand the severe gyration that we expect to dominate in the first eight months of this year. Hence our Top Picks consist of mostly defensive names (continuing our current holding of TLKM, GGRM and BBNI and adding HMSP, MIKA and SILO), but also a few property and construction counters that should benefit whenever the JCI enjoys moments of rebounds (LPCK, BSDE and WSKT).

FIGURE 4. MANSEK TOP BUY PORTFOLIO

Ticker Company's Name Stock Price

11-Jan-16

Starting Stock

Price (Rp) Changes

Mkt. Cap (USDmn)

PER 2016F

(x)

2016 EPS Growth

Fcast

Target Price (Rp)

TLKM Telekomunikasi Indonesia 3,060 3,105 -1.4% 21,598.8 16.2 16.1% 3,225 BBNI Bank Negara Indonesia 4,935 4,990 -1.1% 6,649.2 7.7 33.5% 5,900

LPCK Lippo Cikarang 6,725 7,250 -7.2% 338.2 6.0 -10.0% 13,500 GGRM Gudang Garam 54,500 55,000 -0.9% 7,576.2 18.5 7.8% 56,000

SMRA Summarecon Agung (dropped) 1,565 1,650 -5.2% 1,631.0 19.9 -3.9% 1,600 PWON Pakuwon Jati (dropped) 464 496 -6.5% 1,614.5 9.9 32.2% 620

SOCI Soechi Lines (dropped) 490 475 3.2% 249.9 4.6 10.5% 810 LSIP London Sumatra Plantations (dropped) 1,235 1,320 -6.4% 608.8 5.5 10.8% 2,700

MPPA Matahari Putra Prima (dropped) 1,675 1,825 -8.2% 650.8 24.6 14.0% 2,175 HMSP HM Sampoerna (addition) 91,000 30,590.0 36.0 12.1% 111,000

MIKA Mitra Keluarga Karyasehat (addition) 2,210 2,323.3 42.4 29.7% 3,400 SILO Siloam International Hospitals (addition) 9,450 789.3 77.3 49.1% 11,000

BSDE Bumi Serpong Damai (addition) 1,765 2,342.8 10.6 23.0% 2,400 WSKT Waskita Karya (addition) 1,685 1,652.9 23.4 8.3% 1,900

MANSEK TOP BUY PORTFOLIO 962.4 1,000.0 (-3.8% from 30 December 2015) Jakarta Composite Index 4,465.5 4,593.0 (-2.8% from 30 December 2015) Source: Mandiri Sekuritas estimates, Bloomberg

FIGURE 5. MANSEK TOP BUY PORTFOLIO, DEC14 DEC15 FIGURE 6. MANSEK TOP BUY PORTFOLIO, DEC 2015 - NOW

878.7

804.2

600

650

700

750

800

850

900

950

1,000

1,050

1,100

Jan-

15

Feb-

15

Mar

-15

Apr-

15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep-

15

Oct

-15

Nov

-15

Dec

-15

J C I

Mansek Portfolio

972.2

962.4

950

960

970

980

990

1,000

1,010

1-Ja

n

4-Ja

n

5-Ja

n

6-Ja

n

7-Ja

n

8-Ja

n

11-J

an

J C I Mansek Portfolio

Source: Mandiri Sekuritas estimates, Bloomberg Source: Mandiri Sekuritas estimates, Bloomberg



HM Sampoerna: The Pack Leader (HMSP; Buy; TP:Rp111,000)

By Matthew Wibowo

FIGURE 7. FINANCIAL SUMMARY YE Dec (Rp Bn) 2013A 2014A 2015F 2016F 2017F

EBITDA 14,807 14,235 14,337 15,043 17,265 Net Profit 10,818 10,181 10,484 11,751 13,210

Fully-Diluted EPS (Rp) 2,325.2 2,188.2 2,253.3 2,525.6 2,839.1 Fully-Diluted EPS Gr. (%) 8.8 (5.9) 3.0 12.1 12.4

P/E Ratio (x) 39.1 41.6 40.4 36.0 32.1 EV/EBITDA (x) 28.7 29.9 29.5 28.1 24.5

P/B Ratio (x) 29.9 31.4 12.2 11.7 11.2 Dividend Yield (%) 2.3 2.5 2.4 2.4 2.7

ROAE (%) 78.8 73.6 43.5 33.1 35.7 Source : Company, Mandiri Sekuritas estimates

HM Sampoerna (HMSP IJ)s sizable exposure in growing mild cigs segment, coupled with their ability to sustain/improve their high-base market share are key competitive advantages, in our view. Its dominant market share and excellent management team justify premium valuation. Buy with TP of Rp111k/sh. BUY. Mild is the future. Mild cigs are estimated to deliver faster volume growth than other cigs segments on the back of rising middle class, hence affordability, prestige, and health becoming the key issues here. Historical data has shown a substantial volume improvement in mild segment during the past 10 years, representing about 42% of total national cigs sales volume in 2014 (from 16% in 2005). HMSPs A Mild brand has first-mover advantage in this segment, which commands the single largest market share of 14% from total Indo cigs market. The ability to sustain/improve market share. We like the companys ability to gain c.10% market share in the past 10 years despite burgeoning new comers offering cheaper products in the market. Their A Mild market share has continued to grow to 15% in Sep15, from 14.1% in Sep13. Excise tax in favor of SKT? Under Jokowi's era, we believe excise tax will likely be in favor of hand-rolled (SKT) products given their focus on employment and economic growth. Based on the latest excise tax details for 2016, the highest increase of c.16% is for Tier 1 machine-made (SKM) and white cigs (SPM), while only 10-11% hike for Tier 1 hand-rolled (SKT). The excise tax will be applicable to HMSP at c.15% which we are positive can be fully passed on to the consumers. Its a Buy. We have buy call on HMSP with TP of Rp111k/sh based on 39x 2017 EPS as we see that the company will continue to be the market leader for cigarettes in the country. Note that Unilever as a dominant player in home personal care segment (coupled with stable margin and superior return) has been trading at c.110% average premium to consumer sector since 2008.



FIGURE 8. MARKET SHARES FIGURE 9. PROFITABILITY COMPARISONS VERSUS PEERS (9M15)

21%17%

80%

35%

13%6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

SKT Dji Sam Soe

SKT Kretek SPM Marlboro

SKM LTLN Sampoerna

A

SKM LTLN U Brand

SKM Magnum

24.0%

20.7%

29.8%

15.9%12.7%

9.7%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

HMSP GGRM WIIM

Gross margin Op margin

Source: Company Source: Company

Mitra Keluarga Karyasehat: Solid Hospital Operator (MIKA; Buy; TP:Rp3,400)

By Matthew Wibowo


EBITDA 543 615 739 874 1,035

Net Profit 399 517 584 758 886 Fully-Diluted EPS (Rp) 27.4 35.5 40.1 52.1 60.9

Fully-Diluted EPS Gr. (%) 38.0 29.7 13.0 29.7 17.0 P/E Ratio (x) 80.7 62.2 55.0 42.4 36.3

EV/EBITDA (x) 57.4 50.8 40.6 34.1 28.7 P/B Ratio (x) 19.0 18.5 9.9 8.7 7.6

Dividend Yield (%) 0.0 0.0 0.9 0.9 1.2 ROAE (%) 26.7 30.1 23.4 21.8 22.3

Source : Company, Mandiri Sekuritas estimates

PT Mitra Keluarga Karyasehat (MIKA), is the largest private hospital operator in Indonesia by patient volume. It offers sustainable earnings growth potential given underserved market, coupled with excellent return on the back of its operational efficiency and fast maturing stage of their new hospitals. We have BUY recommendation with TP of Rp3,400/sh. Vast growth opportunity in underserved market. We expect MIKA to see revenue growth of 15.6% CAGR 2014-17F supported by 14.9%-16.0% of inpatient revenue and outpatient revenue growth respectively during similar period. Key growth drivers include: 1) new hospital and operational bed capacity expansion, 2) expectation of faster patient turnover, and 3) higher revenue base per patient. As part of Kalbe group, we view that MIKA's expansion plan (1 in 2016F and 2 in 2017F) is feasible and the delivery is expected to be on schedule. MIKAs ROIC stood at 58.8% in FY2014, the highest among hospital players. High margin performance. We expect NPAT to grow at 19.7% CAGR 2014-17F with gross margin improving to 46.1% in 2016F. MIKAs management pursues higher operational cost efficiency in the existing hospitals which will come from 1) standardizing the procurement of drugs, medical supplies, and equipment across all hospitals, 2) reducing the number of products used in operations, 3) maintaining number of suppliers to increase bargaining power, 4) integrating end-to-end hospital information system.



A cash rich company. MIKA has no debt currently and its FCFF grew by 35% CAGR to Rp478bn in FY2014, which will be sufficient to support its hospital expansion plans onward. Assuming US$10-15mn of investment cost to build a new hospital, MIKA has the capability to build one-to-two hospitals annually given its Rp2.4tr net cash position and Rp832bn operating cash inflow as per 2016F. A buy call. We have TP of Rp3,400/sh based on 45x EV/EBITDA 2017F. Risks include declining patient volume due to BPJS and delay in the execution of new hospitals.

FIGURE 11. EBITDA AND NET MARGIN PERFORMANCE FIGURE 12. SALES BREAKDOWN BY TYPE OF SERVICES

-

8.0

16.0

24.0

32.0

40.0

2011

2012

2013

2014

2015

F

2016

F

2017

F

EBITDA Margin Net Margin

(%)

0%

20%

40%

60%

80%

100%

12M

11

12M

12

12M

13

12M

14

3M15

6M15

9M15

Drugs & Medical supplies Medical support servicesInpatient accomodation Operating roomsOthers

Source: Company, Mandiri Sekuritas estimates Source: Company

Siloam International Hospitals: Expansion Mode (SILO; Buy; TP:Rp11,000)

By Matthew Wibowo


EBITDA 303 487 558 773 1,096

Net Profit 50 63 95 141 245 Fully-Diluted EPS (Rp) 43.1 54.1 82.0 122.3 211.8

Fully-Diluted EPS Gr. (%) (1.2) 25.5 51.6 49.1 73.2 P/E Ratio (x) 219.1 174.6 115.2 77.3 44.6

EV/EBITDA (x) 35.9 22.8 20.2 14.8 10.5 P/B Ratio (x) 6.8 6.6 6.3 5.8 5.2

Dividend Yield (%) 0.0 0.0 0.1 0.1 0.1 ROAE (%) 5.4 3.8 5.6 7.8 12.3

Source : Company, Mandiri Sekuritas estimates

Siloam International Hospitals (SILO), established in 1996, is a subsidiary of Lippo Karawaci group (LPKR). We expect SILO to see a robust earnings growth on the back of aggressive hospital expansion plans, building strong footprints in the country, albeit execution risk remains. Buy with TP of Rp11,000/sh. Strong revenue growth potential. We expect SILO to book strong revenue growth of 22.8% CAGR 2014-2017F and NPAT growth of 57.6% CAGR during similar period. Growth catalysts lie on the management's capability to deliver its aggressive hospital network expansions, higher revenue per patient, and maturing existing hospital profiles. Additionally we view SILO's outstanding track record as the largest private healthcare provider with 20 operational hospitals and 2,578 operating beds across 15 cities in Indonesia should help to increase patient volume in line with its participation in BPJS program.



Short-term margin pressure, yet long-term dominance. In the short-term, SILO is likely to experience a hike in operating expenses, yet will dominate the market in the longer-term assuming good expansion execution. Note that SILO has an aggressive expansion target of 50 hospitals by 2017F. Among the listed private hospital operators in Indonesia, SILO reported the highest increase in SG&A at 46.0% CAGR 2012-14 versus SAMEs 24% CAGR and MIKAs 18% CAGR during similar period. We estimate gross margin to decline to 28.0% in 2015F before increasing to 28.6% in 2016F driven by maturing existing hospital profiles. Still need third party funding. SILO has net gearing of 10% with gross debt of Rp450bn in FY2014 to support four new hospital developments during the year. Its FCFF stood at negative (-Rp155bn) in the same period. We expect the companys FCFF to be at negative in the next three years given its aggressive expansion phase. Maintain Buy, TP Rp11,000. We derived our TP of Rp11,000/sh based on 12X EV/EBITDA 2017F. Key risks in the business include delay in the execution of new hospitals, sustainability payment from BPJS Kesehatan, and limited supply of medical personnel in the industry.

FIGURE 14. EBITDA AND NET MARGIN PERFORMANCE FIGURE 15. SALES BREAKDOWN BY TYPE OF SERVICES

-

1.0

2.0

3.0

4.0

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

2011

2012

2013

2014

2015

F

2016

F

2017

F

EBITDA margin Net Profit margin

(%) (%)

0%

20%

40%

60%

80%

100%4Q

12

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

Medical Support Services Drugs & Medical SuppliesInpatient accomodation Operating roomsOthers




Bumi Serpong Damai: Attractive valuation (BSDE; Buy; TP:Rp2,400)

By Liliana Susanti


EBITDA 2,910 2,632 3,333 3,676 3,981 Net Profit 2,691 3,821 2,499 3,073 3,532

Fully-Diluted EPS (Rp) 146.5 208.0 136.0 167.2 192.2 Fully-Diluted EPS Gr. (%) 109.3 42.0 (34.6) 23.0 15.0




AEON success could provide a boost to its commercial and residential estate. We think that there is a potential for BSD City to become a commercial hub. With the success of AEON mall, BSD City could boost its commercial land sales. With landbank limitation in Alam Sutera and Summarecon Serpong, these companies could not serve landed residential market under Rp2bn. BSDE still can launch landed residential property priced under Rp2bn per unit. Plenty of projects ready to launch. BSDE has plenty of new projects that could be launched once the market improves. These include Aerium condominium at Permata Buana, Tanjung Barat project near Lenteng Agung, project in Benowo, potential mixed-used development projects in Surabaya. These projects could contribute up to Rp4-5tn of marketing sales per annum. Attractive valuation. BSDE is trading at FY16F P/E of 11x and 61% discount to NAV. The company is trading at a discount compared to average big cap property companies P/E of 14x. We maintain Buy on BSDE with PT of Rp2,200.

FIGURE 17. STEADY MARKETING SALES FIGURE 18. MARKETING SALES BREAKDOWN

BSD City Serpong; 59%

Kota Wisata Cibubur; 6% Grand Wisata

Bekasi; 7%

Taman Permata Buana; 1%

Others; 5%

Nava Park; 6%

Aerium Taman Permata Buana;

0%Rasuna

Epicentrum; 10%

Kalimantan projects; 6%




Waskita Karya: Exceeding Expectations (WSKT; Buy; TP:Rp1,900)

By Aditya Sastrawinata


EBITDA 666 832 1,538 1,790 1,937 Net Profit 368 502 751 977 1,034

Fully-Diluted EPS (Rp) 38.2 52.1 66.5 72.0 76.2 Fully-Diluted EPS Gr. (%) 44.9 36.3 27.7 8.3 5.8




The new big boy in town. Waskita is now the largest construction company by market capitalization and equity at Rp22.7tn and Rp8.7tn respectively thanks to their successful rights issue back in June 2015. They enjoy a first-movers-advantage of already receiving the Government Equity Injection (PMN) because the PMN of WIKA and PTPP is currently clouded by political uncertainties in the parliament. This extra capital can now be utilized to take on large infrastructure projects and establish a lead in orderbook among their peers. Strong contract achievement. As of 11M15, WSKT leads the industry with Rp27.9tn new contracts (+78% YoY) or 93% of their full year target. Notable projects include the 500kV electricity transmission project in Sumatra (Rp6.7tn), Solo-Kertosono toll road (Rp5.5tn), and Bakaheuni-Terbanggi toll road (Rp2.4tn). The company guides a new contract target of Rp40tn (+33% YoY) for 2016 of which Rp20tn is from toll road projects, Rp10tn from government (including Rp7tn from LRT project in Palembang), and Rp10tn from SOEs and private combined. We deem this as a realistic target given that many of the toll road projects are self-owned while the LRT was a direct appointment by the President.

Expect consensus to gradually upgrade earnings. We believe the abundant projects won by Waskita in 2H15 have not been fully priced in by the market. As such, we foresee analysts to revise their earnings and target price upwards in the near future.

WSKT is our top pick within the Construction sector with a TP of Rp1,900 by valuing the construction segment at 23x P/E16F and the toll road segment using DCF with a WACC of 10.8%. Key risk is cash flow management. Many of WSKTs projects are turnkey-based which means that cash will only be transferred once the project is fully completed.

FIGURE 20. NEW CONTRACTS COMPARISON VERSUS PEERS FIGURE 21. PROFITABILITY COMPARISON VERSUS PEERS 9M15

0

5,000

10,000

15,000

20,000

25,000

30,000

ADHI PTPP WIKA WSKT

2013 2014 11M15

Rp bn

9.9%

13.4%12.1% 12.1%

2.5%

4.3% 4.8% 4.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

ADHI PTPP WIKA WSKT

Gross Margin Net Margin

Rp bn

Source: Company Source: Company, Mandiri Sekuritas estimates



Global Pressures on Indonesian Equities

Global factors in our opinion will exert strong downward pressures on the JCI in mid 2016 : continued slow-down in Chinas economy and Yuan depreciation, oil bond defaults and capital flight out of emerging markets. Corporate earnings would also likely to disappoint in 4Q15 and 1Q16.

All eyes on Chinas economy

Stock markets world-wide opened 2016 with a tremble, thanks to the steep drop in the Chinese equity bourses. Clearly the health of Chinas economy has an outsized effect on global equities. Unfortunately the outlook is not encouraging, in our opinion, and we expect more pain in the form of continued slow down in Chinas economy, continued depreciation of the Chinese Yuan. All these open up a significant downside potential on China equities and the JCI in our estimation.

FIGURE 22. CHINA'S ECONOMIC GROWTH

0

2

4

6

8

10

12

14

16

18

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

China, real GDP (%, yoy)

Source: CEIC

Since peaking at 14.9% in Q2 2007, Chinas economic growth has been steadily slowing down to 6.9% in Q3 2015. See Figure 22. More importantly in our view, both the Chinese government and the market consensus expect it to slow down further in 2016. The IMF, for example, expects Chinas economic growth to decelerate to 6.3% this year.

FIGURE 23. CHINA PMI FIGURE 24. CHINA RETAIL & MANUFACTURING GROWTH

35

40

45

50

55

60

Jan-

05

Nov

-05

Sep-

06

Jul-0

7

May

-08

Mar

-09

Jan-

10

Nov

-10

Sep-

11

Jul-1

2

May

-13

Mar

-14

Jan-

15

Dec

-15

Caixin Gov't

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

1995

1996

1997

1998

1999

2000

2002

2003

2004

2005

2006

2007

2009

2010

2011

2012

2013

2014

% YoYRetail Sales (YoY)

Industrial Production (YoY)

Source: Bloomberg Source: Bloomberg



Leading indicators indicate further weakening. Chinas official Purchasing Managers Index (PMI) reached 49.7 in Dec 2015 (vs 49.6 in Nov). PMI levels below 50 indicate contraction. The private Caixin PMI, focusing on smaller and medium-sized companies, fell to 48.2 in Dec 2015 (vs 48.6 in Nov), showing contraction for the tenth month. Data suggested that client demand was weak both at home and abroad, the press release said. See Figure 23.

FIGURE 25. CHINA'S SHARE OF WORLD CONSUMPTION OF VARIOUS COMMODITIES

31%40%

45%46%

46%48%49%

50%54%

60%

0% 10% 20% 30% 40% 50% 60% 70%

CottonLead

SteelZinc

Tin

CopperCoal

Nickel

AlumuniumConcrete

10%11%

12%13%

17%22%

23%28%

30%30%

0% 5% 10% 15% 20% 25% 30% 35%

Palm OilSorghum

OilUranium

WheatCornGold

Soybean MealRice

Soybean Oil

Source: - World Bureau of Metal Statistics (first six month of 2015 fore refined metals, slab zinc) - World Gold Council (2014 for gold) - BP Statistical Review of World Energy 2015 (2014 for oil, natural gas) - Metalytics via Morgan Stanley (2015 estimate for finished steel) - U.S. Department of Agriculture (2013-14 season for others)

Why does Chinas economy matter to the global equity investors outside China ? China is the worlds second largest economy, and has been a strong contributor to world economic growth for a number of years. The countrys manufacturing sector has been a huge buyer of raw materials and energy from countries such as Australia, Brazil, Chile, Russia, Indonesia and Malaysia. China consumes, for example, 60% of global concrete usage, 54% of world aluminium consumption, 50% of nickel, 49% of coal and so on. See Figure 25. Hence we believe the slow down in Chinas economic growth is the reason for the collapse in commodity prices, and so the continued subdued outlook for Chinas economy in 2016 spells further pain for commodity producers.

FIGURE 26. INDONESIAN EXPORT 2014 (US$ BN) FIGURE 27. GDP GROWTH EXPECTATION IN 2016

Japan13%

China10%

Singapore10%

United States9%

India7%

South Korea6%

Others45%

2014 GDP (USD bn) GDP YoY (%)

9M 2015 2016F

United States 17,348 2.1 2.8

China 10,357 6.9 6.3

Japan 4,602 1.0 1.0

India 2,051 7.4 7.5

South Korea 1,410 2.7 3.2

Singapore 308 2.2 2.9

Source: CEIC Source: IMF



In addition, President Xi Jin Ping calls for rebalancing China growth towards services, consumption and high-tech innovation over exports and manufacturing. Indeed while industrial production growth continues to slump, retail sales are actually picking up. See Figure 24 above. The days of China relying on its role as the world centre for mass manufacturing are over in our opinion. Any hope for recovery in commodity prices in the foreseeable future due to resurging Chinese demand is likely to be disappointed.

The continued slow down of Chinas economy is also bad news to Indonesias exports prospects. Japan and China are Indonesias main exports partners see Figure 26. The IMF is forecasting stagnating or slowing down growth in Japan and China for 2016 thus putting immediate pressure on Indonesias economy.

Therefore a continued slow down in Chinas economy will dampen Indonesias exports through both lower commodity prices, and lower volume exported to China itself.

Significantly more pain still to come on Chinas stock indices

As if the direct impact from Chinas economic slow down is not enough, we also have to contend with the impact of dropping equity valuation in China.

After a 30-50% rally in mid 2010, reflecting the strong recovery in Chinas real GDP growth (from a low of 6.2% YoY in Q1 2009 to 12.2% YoY in Q1 2010) the Chinese equity bourses spent the next four years moving generally sideways. See Figure 28 below. This is entirely in line with the countrys economic development as its growth rates gently decelerated throughout these times. However the Chinese bourses suddenly shot up by 130% (Shenzen Composite Index) and by 160% (Shanghai Composite Index) from June 2014 to their peaks in June 2015.

FIGURE 28. CHINA EQUITY INDICES IN RECENT TIMES

0

1,000

2,000

3,000

4,000

5,000

6,000

Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15

Shanghai Shenzhen

Source: Bloomberg

We ascribe this huge stock market rally to a number of reasons, none of which however has anything to do with an improving economy :

1. Surge in margin lending

Margin trading in equities only became legal in China in October 2011. It did not immediately become popular because the requirements were pretty demanding at first the customer must have had a registered account for 18 months, and deposit stocks and cash to the value of at least CNY 500,000. The minimum length of account history was shortened to 6 months in 2013 by CSRC (China Securities Regulatory Commission).



FIGURE 29. CHINA MARGIN LENDING BALANCE

0

500

1,000

1,500

2,000

2,500

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Dec

-14

Mar

-15

Jun-

15

Sep-

15

Dec

-15

CNY bln

Source: Bloomberg

Online peer to peer (P2P) lending accounts changed this landscape. Investors can borrow up to 5 times his collateral (vs 3x at stock-brokers traditional margin lending), and some P2P online lenders required its investors to deposit CNY 2,000 only. In the face of this competition, conventional stock brokers soon relaxed their own conditions, and margin lending boomed.

Before long, China banks participated by treating margin loans made by stock brokers to their customers as collateral for loans to the stock brokers themselves. The brokers also turned to the stock markets to raise new equity Galaxy Securities, GF Securities and Haitong Securities raised over USD10bn in China and Huatai Securities raised USD4.5bn in Hong Kong in 2015, feeding more ammunition to this frenzy. Chinese stock brokers are clear beneficiaries of this boom in margin lending, a business that generated far greater profits than underwriting or financial advisory services. The balance of outstanding margin loan shot up from CNY 392 billion in May 2014 to its peak of CNY 2.27 trillion (USD365bn) in June 2015 almost a six-fold increase in one year. See Figure 29 above.

2. Cuts in interest rates

The Peoples Bank of China has been aggressive in cutting interest rates beginning Nov 2014 after leaving them unchanged since Jun 2012. One-year deposit rate was cut seven times from Nov 2014 to Oct 2015, halving it from the 3.0% level reached in Jun 2012 to 1.5% in Oct 2015. The one-year lending rate was also cut from the 6% level to 4.35% over the same period. See Figure 30. One of the effects of these interest rate cuts is to make alternative investments to bank deposits more attractive to the Chinese savers, helping to feed the frenzied entry into stock markets.

FIGURE 30. CHINA INTEREST RATES RECENT HISTORY

One Year Deposite Rate One Year

Lending Rate June 2012 3.00% 6.00% November 2014 2.75% 5.60% February 2015 2.50% 5.35% May 2015 2.25% 5.10% June 2015 2.00% 4.85% August 2015 1.75% 4.60% October 2015 1.50% 4.35%

Source: Peoples Bank of China



3. Steep rise in public participation

The number of new brokerage accounts opened in the first five months of 2015 jumped to almost 18 million accounts, exceeding the total number of new brokerage accounts opened in the previous four years, according to the Financial Times. In total there are 258 million accounts open on the Shanghai and Shenzhen stock exchanges as at Jun 2015, according to Credit Suisse, a greater number than most countries population.

This is entirely understandable. The Chinese household savings rate had doubled from 15% of disposable income in 1990 to about 30% in 2010, according to studies by the Federal Reserve Bank of San Francisco. In recent times, the Chinese tend to invest their excess savings into real estate. However, with bubbles in the housing markets starting to be deflated by over building, the equity bull rally was just too irresistible in our view.

4. Shanghai Hong Kong Stock Connect

The Shanghai Hong Kong Stock Connect is a cross boundary investment channel that links the Shanghai Stock Exchange to the Hong Kong Stock Exchange. It was launched on 17th Nov 2014, allowing investors in both markets to trade shares directly in the other bourse through their local brokers.

Through this investment channel Shanghai stocks attracted CNY121bn (USD19.7bn) in inflows in its first year of operation, according to the Shanghai Stock Exchange. Hong Kong stocks attracted CNY92.4bn in inflows over the same period, according to Hong Kong Exchanges and Clearing Ltd (HKEx). While the flows were relatively modest to the total trading volume, they nonetheless contributed to the 2014/15 rally.

Such a robust rally in the face of a slowing economy is unsustainable, in our view. Last December, Chinas Ministry of Finance reported the latest data on state-owned firms profitability. For the Jan Nov 2015 cumulative period, they posted CNY 2.04 tn (approximately USD 316 bn), representing a -9.5% YoY decline. State owned financial companies account for roughly a third of the cumulative profit decline. At the same time, Chinas public and private sector debt have been growing at a fast pace. According to BlackRock Investment Institute, outstanding loans to companies, households and the public sector as a ratio to the countrys GDP have more than doubled from 121% in 2000 to 282% in 2014. See Figure 31.

FIGURE 31. CHINA DEBT AS A SHARE OF GDP

23% 42%55% Government7%

24%

65%Financial

institutions83%

72%

125%Non-financial

corporate

8%

20%

38% Households

121%

158%

282% Total

2000 2007 2014

Source: BlackRock Investment Institute and McKinsey Global Institute, February 2015 Note; 2014 data are as of the second quarter



China therefore needs to engineer a soft landing whereby falling profitability and decelerating economic growth do not spark waves of debt defaults. Happily for the rest of the world, Chinas financial system remains isolated. Hence even if a full-blown debt crisis should develop in China, few global banks would be affected.

FIGURE 32. DECLINES IN REGIONAL BOURSES WHEN CHINA INDICES DROPPED (JAN 2016)

-9-8-7-6-5-4-3-2-10

Chi

na (S

hang

hai)

Chi

na (S

henz

hen)

Indo

nesi

a (J

CI)

Sing

apor

e (S

TI)

Mal

aysi

a (K

LCI)

Thai

land

(SE

T)

Phili

ppin

(PS

Ei)

Hon

gkon

g (H

SI)

Kore

a (K

ospi

)

Japa

n (N

ikke

i)

Indi

a (N

ifty)

Taiw

an (

TAIE

X)

4-Jan-16

7-Jan-16

Source: Bloomberg

All the same The Bottom Line views the 130-160% bull rally in the Shanghai and Shenzhen stock markets from mid 2014 to mid 2015 in the face of an over-leveraged corporate sector, declining profitability and slowing-down economy as total hubris. We expect the China indices to return to their original starting point in June 2014 (2,048 for the Shanghai Composite Index and 1,097 for the Shenzhen Composite Index) before fair values are restored, implying another -34.5% and -44% decline in the Shanghai and Shenzhen indices respectively.

Unfortunately the Chinese stock markets have a sizeable impact on other equity bourses across the world. The first trading week of Jan 2016 saw two occasion when trading was halted by the new circuit breaker system (Monday 4th Jan and Thursday 7th Jan 2016). In each occasion stock markets in other countries also suffered, regardless of their domestic consideration see Figure 32 for some examples. So were the Chinese bourses to suffer 30%+ decline, it goes without saying that the Jakarta Composite Index will come under severe pressure too.

Is that inevitable though ? Isnt Chinas authorities taking extreme measures to stop the crash and stabilise the markets ? Indeed, here is a list of actions taken :

Freezing proposed IPOs (4th Jul 2015) to keep investors being focused on buying stocks already listed in the markets;

Government sponsored stock purchases (early Jul 2015) China Securities Finance (CSF) Corporation is lending CNY260bn (USD$42bn) to 21 brokerage firms to purchase blue chip stocks. This figure is on top of the USD20bn that the brokerage firms already vowed to buy.

Trading suspension (8th Jul 2015) The government allowed half of Chinas stocks on the stock exchanges to halt trading activities. At least 1,430 out of 2,800 companies traded in the Shanghai and Shenzhen stock markets pulled their shares out of the market.



Announcement 18 (8th Jul 2015) Chinas stock regulator introduced Announcement 18, threatening severe punishment for any senior managers or shareholders with stakes of 5% or more from selling shares of a listed company during the following six month period. This rule expired on 8th Jan 2016, and has now been replaced with a new rule that allows those major shareholders to sell a maximum of 1% of total shares outstanding within the next three months (meaning, until 8th April 2016).

Restriction on short selling (3rd Aug 2015) Under the old rules, investors are able to go short in the morning and cover their shorts before the market close the same day and lock in their profits. With the new regulation, investors cannot cover their short position in the same day, but have to wait until the next day at the earliest.

Persuasion (ongoing efforts) state-owned media were continuously persuading the general public to keep on purchasing more stocks through various campaigns.

Naturally if you halt trading, ban large shareholders from selling, and flood the market with state-funded buy orders, a semblance of calm would descend into the markets. This however is fake calmness, in our opinion. A frozen market will not be able to find its natural bottom. The mispricing of equity values remains, and the double trading halts in the first week of Jan 2016 show that when correction finally materialises, such market intervention can cause investors to panic instead.

The anatomy of the China stock market crash reminds The Bottom Line of the dot com bubble at the start of this century. If we super-impose the tech-heavy NASDAQ index during the period 15th Apr 1999 to 29th Dec 2000 to the current Shanghai Composite Index (1st Jul 2014 to now), the readers can see uncannily similar pattern. See Figure 33.

FIGURE 33. PATTERN OF A CRASH : SHANGHAI COMPOSITE INDEX VS NASDAQ INDEX

Jan. 7, 2016 3,125.0

Dec. 29, 20002,470.5

0

1,000

2,000

3,000

4,000

5,000

6,000

Shanghai

Nasdaq

IRRATIONAL RALLY CRASH REBOUND FINALCRASH

Source: Bloomberg

No, The Bottom Line is not proposing that history repeats itself exactly but the pattern certainly does. The crisis consists of four elements : (a) the original massive rally that lack fundamental justification, jolted by (b) severe crash, interrupted by (c) seemingly convincing recovery (either stock brokers convince the world that all the bad news are already in the price, and current valuation looks cheap compared to 3 months ago, or the authorities step in and send you to jail for posting a sell order), but this fleeting joy is then rudely broken up by (d) the final leg of the crash that bring valuation back all the way to its starting point.



And then there is the Chinese Yuan

The other mechanism by which a slowdown in Chinas economy might be impacting Indonesias stock market is through its currency the Chinese Yuan (CNY).

FIGURE 34. USDCNY (DEC 2004 TO NOW)

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

Dec

-04

Jun-

05D

ec-0

5Ju

n-06

Dec

-06

Jun-

07

Dec

-07

Jun-

08D

ec-0

8Ju

n-09

Dec

-09

Jun-

10D

ec-1

0Ju

n-11

Dec

-11

Jun-

12

Dec

-12

Jun-

13D

ec-1

3Ju

n-14

Dec

-14

Jun-

15D

ec-1

5

Source: Bloomberg

The Chinese Yuan was pegged to the USD at CNY 8.30 per USD from 1997 to 2005, but on 21st Jul 2005 the Peoples Bank of China (PBOC) released that peg and applied a dirty float instead. Every morning the PBOC announced a daily midpoint exchange rate, and forex brokers are allowed to trade the currency (the reference is the USDCNY exchange rate) within a band surrounding this mid point. In the beginning, the trading band was 0.3% (Jul 2005), and it was subsequently relaxed to 0.5% (May 2007), 1% (Apr 2012), and 2% (Mar 2014). On 24th Jul 2015, the PBOC announced that it would widen the trading range further to 3%, but no timeline has been set.

FIGURE 35. CHINA EXPORTS VALUE (LHS) AND GROWTH (RHS)

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

-100

-50

0

50

100

150

200

250

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep-

15

Nov

-15

US$ bn

China Export %YoY

Source: Bloomberg



What spurred Chinas monetary authority to devalue the Yuan was its worsening export performance. Throughout the first half of 2015, Chinas exports had been declining (the exception was Feb 2015 due to base effect of a one-off weak showing in Feb 2014). In Jul 2015 Chinas exports fell again, by -8.3% YoY when consensus expectation at the time was for a -1.5% YoY decline only. See Figure 35.

So on 11th Aug 2015 the PBOC set a midpoint exchange rate that represented a 1.87% devaluation, the biggest one-day change since 1993 at the time. This was followed the next day by another 1.62% devaluation against the USD. Taken together this decision represented the largest yuan depreciation for 20 years then. The PBOC also changed its method to set the midpoint exchange rate which in essence let the free markets to have more influence over the Yuan.

The impact on other emerging market currencies were well spread. Whereas developed economies currencies such as the Japanese Yen and Euro appreciated against the US dollars over this two day period (10th to 12th Aug 2015), emerging market currencies such as the Indonesian rupiah, Malaysian ringgit, Brazilian real, South African rand and Thai bath depreciated significantly, as did the currencies of the Asian Tigers such as Korean won and Singapore dollars. See Figure 36.

FIGURE 36. IMPACT OF YUAN DEVALUATION ON REGIONAL CURRENCIES (1012 AUG 2015)

-2.8% -2.7%

-2.3% -2.3%

-1.2% -1.2%

-0.8%-0.6%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

USD

CN

Y

USD

IDR

USD

KRW

USD

MYR

USD

BRL

USD

SGD

USD

ZAR

USD

THB

Source: Bloomberg

Why should there be such a strong impact ?

One of the key reasons is beggar thy neighbour. China and other economies export to many similar destination. Figure 37 lists out the top 19 destination for Chinas exports, the value of Chinas exports in 2014 to these destination and the values of a selection of other countries exports to the same destination. We record the 2014 exports value for the other (non China) countries in this Table only if those destination happen to be included in the other non-China countries Top 20 export destination also.

So what Figure 37 below shows is that of Chinas 19 top export destination, between 11-15 of them are also among the Top 20 export destination for Brazil, South Korea, Thailand, Singapore, Malaysia and Indonesia. China is competing with these other countries for much the same export markets. Hence, the Chinese Yuans depreciation would give Chinas products a pricing edge hence the term beggar thy neighbour as what China gains from the depreciation of its currency comes out of its neighbours loss in market share. To prevent this outcome, the other countries currencies need to depreciate too and the financial markets, being always forward-looking, pre-empted this eventuality by promptly depreciating most other emerging market currencies.



FIGURE 37. TOP 20 EXPORTS DESTINATION FOR CHINA AND OTHER REGIONAL ECONOMIES (2014)

No Destination Country Exporting Countries

China Brazil South Korea Thailand Singapore Malaysia Indonesia

1 United States 397.1 27.1 70.6 19.7 24.2 24.0 16.6

2 Hong Kong 363.1 3.3 27.3 11.3 45.1 12.6 2.8

3 Japan 149.4 6.7 32.2 25.3 16.7 21.8 23.1

4 South Korea 100.3 3.8 4.5 16.7 8.6 10.6

5 Germany 72.7 6.6 4.5 5.4 5.5 2.8

6 Netherlands 64.9 13.0 4.6 7.3 7.2 4.0

7 Vietnam 63.7 22.3 7.9 12.9 7.9

8 United Kingdom 57.1 3.8 4 2.4

9 India 54.2 4.8 12.8 9.7 11.1 9.7 12.2

10 Russian Federation 53.7 3.8 10.1

11 Singapore 48.9 23.9 33.3 10.4 16.8

12 Malaysia 46.4 7.6 49.0 12.7 9.7

13 Australia 39.1 10.3 10.1 15.5 9.3 5.0

14 Indonesia 39.1 11.4 9.7 38.4 9.5

15 United Arab Emirates 39.0 3.6 6.1 3.6 2.5

16 Brazil 34.9 8.9

17 Thailand 34.3 7.6 12.3 15 5.8

18 Mexico 32.3 3.7 10.8

19 Canada 30.0

20 China 40.6 145.3 25.1 51.5 28.2 17.6 Total Match with China's Export Destination

11 14 15 14 15 13

Source: World Integrated Trade Solution, World Bank

What then should investors expect of the Chinese Yuans outlook ?

We sense that the authorities favour further depreciation. An influential government economist interviewed by Reuters suggested that the Yuan should be allowed to depreciate by another 10-15% against the USD over an unspecified time frame (Reuters, Pressure on China central bank for bigger yuan depreciation, 7th Jan 2016). The main motivation for such a move is that letting the Yuan depreciate could help cushion many of Chinas debt-laden companies as the government pushes supply-side reforms.

In addition, currency depreciation can be used as an alternative to monetary and fiscal policy. Given that the Chinese government has tried fiscal stimulus (USD586bn following the 2008 global credit crisis, mostly in infrastructure spending) and monetary loosening (six interest rate cuts starting in Nov 2014) without achieving a sustainable turn-around in its decelerating economic growth, the addition of currency depreciation as a policy option must look attractive in our opinion.

Lastly, China is also aiming to let the Yuan move more flexibly in line with market forces to add legitimacy to its recent inclusion in the IMFs special drawing rights (SDR) currency basket, a key asset in terms of international reserves.

Yet allowing the Yuan to depreciate too fast would create market panic. The PBOC did use its huge forex reserves to slow down the pace. The central bank datas published on 7th Jan 2016 show that its forex reserves fell by USD512.66bn in 2015 to USD3.33tn. They dropped by USD107.9bn in Dec 2015 alone, ironically a bigger amount than Indonesias entire forex reserves as at the end of 2015 (USD105.93bn).

Overall though, The Bottom Line believes there is a significant risk that the Chinese Yuan would could continue depreciating gradually over 2016. At some point we expect this trend to put substantial selling pressure on other emerging market currencies, including the Indonesian rupiah, and hence on the Jakarta Composite Index.



Flight to Safety : Oil Glut and the Emerging Markets

The crude oil crash offers another dimension of risk to the Indonesian equities.

Brent and WTI price went from USD 115 and USD 107 per bbl respectively in June 2014 to the USD 33 per bbl level today. See Figure 38.

FIGURE 38. CRUDE OIL PRICE

WTI 33.16

Brent33.55

0

20

40

60

80

100

120

140

16019

90

1991

1993

1995

1997

1999

2001

2002

2004

2006

2008

2010

2012

2013

2015

USD/barrel

WTI Crude Oil

Brent Crude Oil

Source: Bloomberg

The crash happens because Saudi Arabia, the worlds top crude oil exporter, launched a price war starting in mid 2014 by keeping its production level abnormally high to drive certain key competitors (particularly the US shale oil drillers) out of business, in our opinion. The same applies to the refining sector Saudi Arabia has been flooding the market with refined fuel and decimating oil refining margins world-wide.

Will this continue ?

FIGURE 39. COST OF PRODUCING OIL (USD PER BBL)

$0 $10 $20 $30 $40 $50

Kuwait

Saudi Arabia

Iraq

UAE

Iran

Russia

Venezuela

USA

Canada

Brazil

Capital Expenditure

Operational Expenditure

Source: Rystad Energy



It will, if we follow the rationale of Saudis decision. Kuwait and Saudi Arabia are the worlds cheapest producer of crude oil, with production cost of USD 8.50 and USD 9.90 per bbl respectively in 2015, according to the oil and gas data intelligence and consulting firm Rystad Energy. By contrast in the US oil production cost on average USD 36.20 per bbl, and in Canada they cost USD 41.00 per bbl. See Figure 39. Hence by driving crude oil price below USD 35 per bbl and keeping it there for considerable period, there is every reason to expect many US shale oil producers would fold.

But low oil price hurts all oil producers, Saudi Arabia included. Can it continue to bear the pain ?

The answer is No to the oil bulls. Oil producers have an incentive to produce as much as possible, rather than cut production, in order to make up for the lower prices. Indeed US shale oil producers, as well as other non OPEC producers such as Russia, Brazil and Norway have all increased production as the price war intensifies. This was achieved through an impressive array of efficiency drives: thousands of workers laid off, focusing rigs on the biggest gushers only (in the process idling more than 60% of rigs in the US) and fracking faster by applying cutting-edge technology. Meanwhile the IMF predicted earlier last year that the Saudi government budget deficit would reach USD140bn (or 21.6% of GDP) in 2015. So the oil bulls argue that the Saudis would blink first and start cutting their oil production, and thus ending the price war and sending oil price back up, later in 2016.

FIGURE 40. SAUDI ARABIAN GOVERNMENT BUDGET BALANCE

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

(600)

(400)

(200)

-

200

400

600

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

Budget balance (SAR bn)

% of GDP (RHS)

Source: Bloomberg

We do not share this view we think the WTI and Brent would be trading within the USD 25 to 35 per bbl band for most of 2016.

Our reason is that we believe Saudi Arabia is well positioned to withstand the fiscal pain, and has taken step to fortify its resilience. The Saudi government announced in late Dec 2015 that it estimated its budget deficit to reach 367 billion riyals (USD98bn), or 16% of GDP in 2015 far lower than IMFs USD140bn and 21.6% of GDP forecast (also lower than 20% of GDP concensus forecast in Bloomberg). See Figure 40. Its 2016 state budget plans to slash government spending by 840 billion riyals, mostly by cutting energy subsidies. Its 2016 government budget deficit is projected to narrow to 326.2 billion riyals, or 10.8% of GDP according to estimates by Abu Dhabi Commercial Bank.



So the Saudis appear well aware of the costs of the price war, and have taken painful steps to deal with them. Most importantly, the subsidy cuts had not sparked any social unrest, signalling a good chance that the budget targets would be met in 2016.

In fact, IMFs World Economic and Financial Survey (published on 15th Oct 2015) studies this issue of how much fiscal space oil-exporting countries have, comparing the size of governments financial assets (also referred to as fiscal buffers) with the government budget deficits. It concludes that Saudi Arabias fiscal buffer can last five years whereas Kuwait, Qatar and the United Arab Emirates can last more then 20 years. Please note the IMF study arrives at this conclusion using assumption about 2015 deficit which has now proved too pessimistic so the real resilience of Saudis finances may well be significantly more than just five years. Therefore The Bottom Line sees little reason why the Saudis should blink and end the price war in 2016.

Finally, the crude oil inventory in the US remains at elevated level see Figure 41. All these evidence indicate to us that oil price would remain depressed in 2016.

FIGURE 41. US CRUDE OIL INVENTORY FIGURE 42. HIGH YIELD BOND AND HIGH YIELD ENERGY BOND INDICES

200

250

300

350

400

450

500

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

mn barrels

80

90

100

110

120

130

140

370

380

390

400

410

420

430

440

450

460

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Ma r

-15

Apr

-15

May

-15

May

-15

Jun-

15

Jul-1

5

Jul-1

5

Aug

-15

Sep-

15

Sep-

15

Oct

-15

Nov

-15

Dec

-15

Dec

-15

Barclays High Yield Bond Index (LHS)

Bloomberg USD High Yield Corporate Bond Index Energy (RHS)

Source: Bloomberg Source: Bloomberg

As a result, the high yield bond markets are plummeting now to levels not seen since 2009. See Figure 42. Investors are reminded that a lot of high yield (junk) bonds had been issued in recent years, taking advantage of the low interest rate environment, and that sustained low levels of oil price may result in a wave of debt defaults by energy companies. Many oil companies had hedged their crude oil selling price until summer 2016 at prices much higher than the current level, according to Babson Capital Management, an investor in high yield bonds. Once that hedge protection expires, the risk of waves of debt default would become prominent in our view. Indeed Standard & Poors Rating Service warned last Dec 2015 that a stunning 50% of energy junk bonds are distressed (meaning, they are at risk of default).

Focused Credit, a bond fund managed by Third Avenue, announced in Dec 2015 that it was blocking its investors from redeeming their investments. The fund would be wound down, its assets had lost two-third of its value in seven months to USD788mn when the announcement came. Another bond fund, Lucidus Capital Partners, has liquidated its entire portfolio and announced in mid Dec 2015 that it would return its USD900mn asset under management to its investors. The Bottom Line believes this is just the beginning.



FIGURE 43. MSCI EMERGING MARKETS INDEX VS S&P 500 INDEX RELATIVE

162.5

69.0

020406080

100120

140160180

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

S&P 500 MSCI EM

99.3

83.0

60

70

80

90

100

110

120

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep-

15

Oct

-15

Nov

-15

Dec

-15

S&P 500 MSCI EM

Source: Bloomberg

The danger with this crash in the high yield bond market is that it might spark a general flight to quality. Should investors start to cast their wary eyes and ask what other asset classes might follow the path of the high yield bonds, we fear that emerging markets might be that next target.

Indeed, similar to the high yield bond market (whose performance has not been too healthy even before this still-developing crash), emerging market as an asset class has badly under-performed US equities. Figure 43 show that the MSCI Emerging Markets Index under perform the S&P 500 index both in the one-year time frame (down 17% vs S&P 500s 0.7% decline) as well as in the five-year time frame (down 31% vs S&P 500s 62.5% appreciation in value).

A faster than expected pace of FFR increases

This flight to quality scenario actually faces another risk that might exacerbate its effect, namely the risk of a faster pace of Fed Funds Rate (FFR) increases than what the markets expect.

During the run up to the first increase in the benchmark Fed Funds Rate in nine years last Dec 2015, the capital markets were very focused not only on the possible rate rise (which was universally expected to materialise) but also on the Feds statement of how it sees the possible pace of future increases.

Therefore when the Federal Open Market Committee, the arm of the US Federal Reserves that determines the course of monetary policy, finally decided to lift the benchmark Fed Funds Rate on 16th Dec 2015 by 25 bps to 0.25-0.50%, capital markets world-wide felt a great relief that its accompanying statement gave out a dovish tone, describing its plan to raise the Fed Funds Rate at a "gradual" pace. This choice of word is considered significantly more dovish than "measured pace", an expression that had appeared in the past. On the day of that announcement, the American stock indices closed strongly - NASDAQ and Russell 2000 went up by over 1.5%, the S&P 500 by 1.45% and the DJIA by 1.28%.

However, there is a major difference between what the FOMC and the capital markets understand as "gradual". The dot plot, part of the FOMCs Summary of Economic Projections released along with the policy decision statement, shows where each member of the FOMC thinks the Fed Funds Rate should be at the end of the year for the next few years and in the longer run. The dot plot released in Dec 2015 suggests that median estimates for Fed fund rates in 2016 lie between 1.25% and 1.50%. This implies there will likely be four rate hikes in 2016, of 25 bps each. See Figure 44.



FIGURE 44. FED FUNDS RATE FORECAST BY FOMC MEMBERS (AS AT DEC 2015)

Source: The US Federal Reserves

The futures market begs to disagree. It has only priced in two rate hikes (25 bps each) with Jun and Dec 2016 (or Feb 2017) being considered most likely months for these raises. See Figure 45.

FIGURE 45. FED FUNDS RATE IMPLIED FORECAST BY THE FUTURES MARKET (8 JANUARY 2016)

Probability

of hike Probability

of cut 0% -

0.25% 0.25% -

0.5% 0.5% - 0.75%

0.75% - 1.0%

1% - 1.25%

1.25% - 1.5%

1.5% - 1.75%

27-Jan-16 0.0% 8.0% 8.0% 92.0% 0.0% 0.0% 0.0% 0.0% 0.0%

16-Mar-16 40.5% 4.5% 4.5% 55.0% 40.5% 0.0% 0.0% 0.0% 0.0%

27-Apr-16 46.0% 4.0% 4.0% 50.0% 41.9% 4.0% 0.0% 0.0% 0.0%

15-Jun-16 62.0% 2.7% 2.7% 35.3% 44.5% 16.2% 1.3% 0.0% 0.0%

27-Jul-16 66.2% 2.4% 2.4% 31.4% 43.4% 19.6% 3.1% 0.2% 0.0%

21-Sep-16 75.0% 1.7% 1.7% 23.3% 40.0% 26.2% 7.7% 1.0% 0.0%

2-Nov-16 78.8% 1.4% 1.4% 19.7% 37.3% 28.5% 10.8% 2.1% 0.2%

14-Dec-16 84.7% 1.0% 1.0% 14.3% 32.1% 31.1% 16.0% 4.6% 0.8%

1-Feb-17 87.5% 0.8% 0.8% 11.7% 28.5% 31.2% 19.0% 6.9% 1.5% Source: Bloomberg

So while both the capital markets and the Federal Reserves use the word gradual, they seem to mean different things. Of course, as the Fed has repeatedly said, its decision on further rate rises will depend on how the economic data evolves. We do not rate this risk too highly, but it is not impossible either that the American economy would grow more strongly in 2016 than current market expectation.

Corporate earnings need to start delivering

However, if all the risks that Indonesian equity values face today relate to global issues, then their intrinsic values that are independent of these global themes would make the JCI an absolute bargain.

Alas no such easy killing is available here. Indonesias corporate earnings also need to start delivering or else. Figure 46 shows how the Jakarta Composite Indexs valuation stacks against other regional indices, in terms of 12-month trailing PE ratio. In fact at 25.7x, the JCI is markedly more expensive than most other indices bar the Shenzhen Composite Index.



FIGURE 46. 12-MONTH TRAILING PE RATIOS OF REGIONAL INDICES

12.8 13.816.4 16.5 17.6 17.8

19.325.7

45.4

0

10

20

30

40

50

Sing

apor

e (S

TI)

Kore

a (K

ospi

)

Chi

na (S

hang

hai)

Thai

land

(SE

T)

Mal

aysi

a (K

LCI)

USA

(S&

P 50

0)

Indi

a (S

ense

x)

Indo

nesi

a (J

CI)

Chi

na (S

henz

hen)

PE (x)

Source: Bloomberg

This reflects the fact that Indonesias corporate earnings performance has been poor in 2013, 2014 and again in 2015.

Please refer to Appendix 1 on p.58-59. What we did here is that we took note of 2012 EPS consensus forecasts as at Dec 2011 (for companies in Mansek Universe and a few others that we include in this analysis for their trading liquidity). We then compare these with the actual EPS performance in 2012, noting the over- or under-performance of each company. At the bottom of the Table, we aggregate these figures to give the readers a sense of how the Indonesian market had performed as a whole against the concensus forecast in that year. We do the same analysis for 2013 and 2014. For 2015, as the Full Year results have not been announced yet, we compare the projected EPS growth instead. So we take the concensus 2015 forecast as at Dec 2014, and we work out what % EPS growth in 2015 are implied by comparing it to the actual EPS result in 2014. We then compare these implied EPS growth expectation with the actual year-on-year EPS growth delivered at the 9M 2015 stage.

The results are not pretty. 2012 was the last year when the actual performance beat the consensus forecasts. 2013, 2014 and 9M15 had been disappointing and disappointing in a big way.

To look at this from a different angle, we note how many companies in this analysis managed to beat market expectation. In 2012, 94.3% of companies in this survey did better than consensus expectation. In 2013, the number slumped to just 37.3%. In 2014 it deteriorated further to 28.4%. And by the time we came to the 9M15 period, only 22.1% of the companies in our survey managed to beat the Streets expectation.

Hence the JCIs high trailing PER shown in Figure 46 above shows that current valuation already prices in quite an aggressive expectation that 2016 will witness substantially stronger earnings performance than in the past three years.

Given the preponderance of global issues that might put equity values world-wide at risk today, Indonesian equity is not cheaply valued in our opinion. This underlies our reason for keeping our Underweight rating for the market and maintaining a largely defensive posture in Mansek Top Picks.



2016 : The REAL Saviour

We see two drivers for recovery towards the end of 2016: strong pick up in household consumption and in private investment spending, on the back of potential further cuts in fuel price, and a shift towards a pro-business stance in government policy. We expect signs of this recovery to emerge in 3Q16.

Fuel-driven recovery in household consumption

Household consumption is the largest element of Indonesias economy, accounting for 55% of its real GDP in 2014. The precipitous drop in global crude oil price, if translated into the subsidised fuel price in Indonesia, should therefore have a significant effect on consumer purchasing power, and on household consumption eventually. We estimate that the economic price of the subsidised RON 88 (also called premium in Indonesia) should be Rp 6,400 and Rp 5,900 per litre respectively assuming Brent crude oil price of USD 40 and 35 per barrel respectively. This represents a scope for 9 to 16% further reduction from the current level of Rp 7,050 per litre respectively. See Figure 47.

FIGURE 47. SIMULATION OF ECONOMIC PRICE OF SUBSIDISED GASOLINE ASSUMING DIFFERENT BRENT PRICE LEVELS Simulation of Brent Price to Indonesia's retail fuel price (RON 88)

No Brent price (USD/bbl)

MOPS (USD/bbl)

Rupiah/US$ MOPS

(Rp/liter) Distribution & other costs

+ margin (Rp/liter)

Economic price before tax (Rp/liter)

Economic price after tax

(Rp/liter) 1 100 107.8 14,000 9,488 1,610 11,098 12,491

2 95 102.5 14,000 9,027 1,610 10,637 11,984

3 90 97.3 14,000 8,566 1,610 10,176 11,476

4 85 92.0 14,000 8,105 1,610 9,715 10,969

5 75 81.6 14,000 7,182 1,610 8,792 9,954

5 70 76.3 14,000 6,721 1,610 8,331 9,447

6 65 71.1 14,000 6,260 1,610 7,870 8,940

7 60 65.9 14,000 5,799 1,610 7,409 8,432

8 55 60.6 14,000 5,337 1,610 6,947 7,925

9 50 55.4 14,000 4,876 1,610 6,486 7,418

10 45 50.1 14,000 4,415 1,610 6,025 6,910

11 40 44.9 14,000 3,954 1,610 5,564 6,403

12 35 39.7 14,000 3,493 1,610 5,103 5,896

13 30 34.4 14,000 3,031 1,610 4,641 5,388 Source: Mandiri Sekuritas estimates

Presently our economic team is forecasting a 5.0% real GDP growth in 2016, driven among others by a 5.0% growth in household consumption. As the readers can see from Figure 48, growth in Indonesias household consumption has been decelerating since 2012. In our economists estimation, if the subsidised fuel price is cut to Rp 5,900 per litre, the impact would be to boost consumer spending to 5.2% growth rate this year. We expect signs of this recovery to be seen by 3Q16, helping the JCI to start appreciating around Aug 2016 when 3Q16 economic data would be released.

FIGURE 48. INDONESIA REAL GDP GROWTH BY EXPENDITURE %, yoy 2011 2012 2013 2014 1Q15 2Q15 3Q15 2015F 2016F

Real GDP 6.17 6.03 5.58 5.02 4.72 4.67 4.73 4.7 5.0

Household 5.05 5.49 5.38 5.14 5.01 4.97 4.96 5.0 5.0

Govt spending 5.52 4.53 6.93 1.98 2.65 2.13 6.56 5.0 5.5

Investment 8.86 9.13 5.28 4.12 4.37 3.69 4.62 4.0 5.8

Exports 14.8 1.61 4.17 1.02 -1.04 -0.09 -0.69 0.0 1.3

Import 15 8 1.86 2.19 -2.38 -6.98 -6.11 -1.0 2.2

Source: BPS, Mandiri Sekuritas



Pro-market policies should revive private investments

Numerous economists and strategists have developed almost a fetish adulation of public sector infrastructure spending, in our opinion. The governments realized capital spending in 2015 was Rp213.3tn, or just 77% of the budget target of Rp276tn. This has a direct impact on the Construction and other sectors. Of the five listed Construction counters in Mansek Universe, only Waskita Karya managed to meet its 2015 target for new orders during the year. The other firms posted strong growth YoY, but significantly missing the ebullient targets issued in the beginning of 2015. See Figure 49.

FIGURE 49. NEW CONTRACTS TARGET VS REALIZATION (11M15)

Company Target (Rp tn) 11M15 Realization (Rp tn) % YoY

Growth % of Target

ADHI 15.2 11.1 76% 73%

PTPP 27.0 21.0 31% 78%

WIKA* 31.6 25.3 26% 80%

WSKT 22.7 27.9 78% 123%

WTON* 4.0 3.5 35% 88% *= 12M15 Realization Source: Company

After such big misses last year, one would think that brokers would be more circumspect in forming their expectation for 2016. This is not the case, however. The Bottom Line believes that such high expectation might contribute to selling pressures on the JCI in early 2016 if earnings performance in 1Q16 fail to reflect the positive benefits of this supposed robust growth in public sector capital spending.

However the private sector forms the bulk (almost 70%) of the nation's infrastructure investments in the governments original plans. Unfortunately, for much of 2015 policy actions by the government had not been conducive for private investments in our opinion. These include :

instructing the management of Semen Indonesia (SMGR) to cut its selling prices by 5% (Jan 2015), and

cajoling the CEOs of Bank Mandiri (BMRI), Bank Rakyat Indonesia (BBRI), Bank Nasional Indonesia (BBNI) and Bank Tabungan Negara (BBTN) to lower their credit interest rates (Feb 2015), and

publicly musing about scenarios of 10-40% price cuts by Perusahaan Gas Negara (PGAS) and how they will benefit the economy (Apr 2015), and

floating the ideas of imposing maximum retail prices on essential goods, and instructing all state-owned enterprises which consume steel to buy them from

Krakatau Steel (May 2015), and

ordering toll road operators to cut their tariffs by 25-35% during the period 10 days prior to and 5 days after 2015 Lebaran (Jun 2015), and

banning the sales of beverages with alcohol content of less than 5% in mini mart or retail shops (Jan 2015), and

calling on rice millers and traders to put public good above profits (Sep 2015). The direct impact is negative. Gross fixed capital formation (GCFC), composed of both public and private sector investment spending, grew by 3.7% to 4.6% YoY only throughout the first nine months of 2015. See Figure 48. In early 2015, when our economists were still forecasting real GDP growth of 5.3%, this was based on GCFC growth of 6.2%. No mystery that the final economic growth in 2015 is likely to be nearer 4.7%. Likewise Foreign Direct Investments actually declined in 9M15. See Figure 50.



FIGURE 50. FOREIGN DIRECT INVESTMENTS INTO INDONESIA

Sector USD mn YoY Growth (%)

9M2012 9M2013 9M2014 9M2015 9M2013 9M2014 9M2015

TOTAL 18,252 21,203 21,745 21,337 16.2 2.6 -1.9

Primary Sector 4,481 5,093 5,500 4,592 13.7 8.0 -16.5

Food Crops & Plantation 1,272 990 1,623 1,421 -22.1 63.9 -12.4

Mining 3,157 4,061 3,793 3,089 28.6 -6.6 -18.6

Others 52 43 85 82 -18.1 98.8 -3.2

Secondary Sector 8,594 12,429 10,150 8,522 44.6 -18.3 -16.0

Food & Beverage 1,149 1,487 2,547 1,156 29.4 71.3 -54.6

Chemical & Pharmaceutical 2,477 2,562 1,978 1,477 3.4 -22.8 -25.3

Metal, Machinery & Electronic 1,284 2,633 1,543 2,099 105.0 -41.4 36.1

Automotive 1,308 2,791 1,602 1,482 113.4 -42.6 -7.5

Others 2,376 2,956 2,480 2,308 24.4 -16.1 -6.9

Tertiary Sector 5,177 3,681 6,095 8,224 -28.9 65.6 34.9

Electricity, Gas & Water 1,072 757 684 1,636 -29.4 -9.6 139.0

Construction 196 521 618 921 165.9 18.5 49.1

Transport & Communication 1,873 887 2,804 2,816 -52.6 216.0 0.4

Real Estate 328 492 806 1,481 49.8 63.8 83.8

Others 1,708 1,024 1,184 1,369 -40.1 15.6 15.7 Source: CEIC

Happily government actions in the recent past have reflected a major shift towards free market mechanism. For example :

Jasa Marga was due to raise its tariffs in a number of toll roads in Oct 2015, as stipulated by its contracts. Initially Director General of Bina Marga (Ministry of Public Works and Public Housing) Hediyanto W. Husaini announced that this would be delayed to Jan 2016, due to weak economic condition. In the end the tariffs were raised on 1st Nov 2015.

The price of natural gas supplies to manufacturers in Indonesia would be cut by USD 1 to 2 per mmbtu, starting from 1st Jan 2016. Whereas in the earlier part of 2015, the government was publicly musing that PGAS would be asked to bear the costs of these price cuts, this would now be borne by the government by reducing the governments royalty entitlements (Oct 2015).

The government launched Kartu Indonesia Sehat (KIS or Indonesias Health Card) in Mar 2015, aimed at the low income patients in particular. In the past, one might expect the drug manufacturers to be instructed to cut their generic drug prices, but the government has instead made use of market mechanism by raising the maximum foreign ownership of pharmaceutical manufacturers from 85% to 100%, and to offer various tax incentives for investors to produce active pharmaceutical ingredients (API) in Indonesia. At the moment, Indonesia still imports 90% of its APIs needs, according to Minister of Industry Saleh Husin, as quoted by Bisnis Indonesia (Jan 2016).

This shift towards market mechanism rather than government diktat would, in our view, remind investors world-wide about the attractiveness of Indonesia as destination for investments. Indonesia is the fourth most populous country in the world. See Figure 51.



FIGURE 51. 15 COUNTRIES WITH THE BIGGEST POPULATION (2014)

1,368 1,276

319 252 203 186 174 158 146 127 120 99 91 88 87

0

200

400

600

800

1,000

1,200

1,400

1,600

Chi

na

Indi

a

US

Indo

nesi

a

Braz

il

Paki

stan

Nig

eria

Bang

lade

sh

Russ

ia

Japa

n

Mex

ico

Phili

ppin

es

Viet

nam

Ethi

opia

Egyp

t

mn person

Source: IMF

Indonesia has a much lower dependency ratio (a measure of productive part of the population, taking the ratio of those NOT in the labour force to those currently working) compared to developed economies such as the US or Japan. See Figure 52.

FIGURE 52. DEPENDENCY RATIO (%) China India Indonesia Japan US Malaysia Philippine Singapore Thailand Viet Nam

1950 61 68 75 67 53 85 89 75 83 56

1955 71 72 73 63 60 88 96 77 81 66

1960 77 77 76 55 64 96 100 83 85 80

1965 80 81 81 46 63 98 102 86 89 95

1970 78 79 83 44 59 93 96 73 90 96

1975 77 76 81 46 52 85 91 59 85 91

1980 67 74 78 46 47 74 87 47 76 84

1985 55 73 72 44 46 72 83 42 63 79

1990 50 71 65 40 48 69 79 37 53 75

1995 51 69 60 44 53 65 75 40 49 71

2000 48 65 54 47 51 59 72 40 45 60

2005 42 60 51 51 50 58 68 39 44 50

2010 39 56 49 56 50 54 64 36 42 42

2015 40 52 46 63 52 51 60 36 41 41

2020 44 49 44 67 55 50 57 41 42 42

2025 46 47 43 69 58 51 56 51 45 42

2030 49 45 44 71 61 52 55 61 49 43

2035 54 44 47 76 62 53 54 71 54 45

2040 59 44 50 86 62 53 52 76 58 49

2045 61 45 53 92 62 53 52 79 62 54

2050 63 47 56 96 63 54 51 81 65 61

Source: UN Population

In many countries, large productive segment of the population does not necessarily imply good economic potential, if in fact they live in penury. Not so in Indonesia its size of the middle income has grown from 38% in 2003 to 62% of the population in 2013, according to the World Bank. See Figure 53.



FIGURE 53. CONSUMER CLASS BASED ON CONSUMPTION/DAY

62%43% 37%

38%57% 62%

0% 0% 0%

0%

20%

40%

60%

80%

100%

120%

2003 2010 2013Low Middle High

Source: World Bank

In short, many facets of Indonesias demographic and population levels and growth are highly attractive to potential investors in our opinion. This has the real potential of being turned into a massive engine of economic growth. The ratio of GCFC to real GDP has been hovering between 30 to 33% level only since 2008. Yet during the heyday of Soehartos years, it passed the 35% level for a number of years and touched just under 40% in late 1996. See Figure 54.

FIGURE 54. REAL GROSS FIXED CAPITAL FORMATION TO REAL GDP RATIO

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

Mar

-93

Sep-

94

Mar

-96

Sep-

97

Mar

-99

Sep-

00

Mar

-02

Sep-

03

Mar

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Sep-

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M

cc - indonesia strategy

Documents

year of challenges

year end

jci fcast

year of overcoming challenges

consumer spending thanks

private investments

report strategy

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