Indonesia Strategy:Melt up

Event

The JCI is currently in the midst of a veritable melt-up, somewhat akin to a marketcrash in reverse. While there has indeed been some good news of late, includingSri Mulyani’s appointment as MoF; strong consumer 2Q results; and thesuccessful passage of the tax amnesty, we believe the exuberance has gone toofar, and that views have become unbalanced, and perceptions selective (e.g. webelieve lacklustre cabinet appointments ex Sri Mulyani have been ignored). Thetemperature of the market looks too hot to us; we advocate caution.

Impact

Indonesian consumer-facing companies generally delivered better thanexpected earnings in 2Q16A – particularly those catering to low-endconsumers – and the market is inferring from this that there is now clearevidence that the broader economy is sharply accelerating. However, themarket appears to be overlooking the significant contribution the pull-forwardof seasonal Ramadan/Lebaran demand from 3Q into 2Q has played. LPPF’sheadline 2Q16A SSSg, for instance, was 40.0%, but the company noted onits conference call that it was only 7.0% adjusting for this timing-shift.

This is in fact only marginally higher than the 6.0% it booked in 2015.

In addition, government programmes, including the aggressive distribution ofsubsidised micro loans, may be contributing to rising low-end consumption. Itis worth remembering that these loans need to be paid back. Temporary, oneoffbenefits have also come from lower administered fuel prices and a sharp2Q16A pick-up in CPO prices, which has now already reversed. Interestingly,companies unexposed to these variables booked weak 2Qs (e.g. ACES).

In addition, outside of consumer, results have been far from universallypositive. The cement companies reported declining revenues and sharplylower earnings, and several of the construction contractors also reportedweak results. In addition, property earnings have been very weak as theproperty cycle continues to turn down; media results were lacklustre; andBMRI and BBNI both reported significant continuing deterioration in assetquality across their commercial books, suggesting many smaller businessesare still struggling. Indeed, Bloomberg 2Q compilations to date suggest thatJCI earnings as a whole have been broadly flat QoQ and YoY in 2Q16A.

Also very important for investors to bear in mind is that the fiscal balance wasin surplus in 2Q15A last year (0.3%), and shifted into deficit of 2.5–3.0% in2Q16A, in a seasonally-strong quarter for income collection. In other words,fiscal stimulus to the tune of 3% of GDP was provided in 2Q16A on a YoYbasis, which is a level of stimulus that would boost any economy in the world.

The issue, of course, is that the revenues are going to have to be found to payfor these programmes in coming quarters, or the programmes will need to bescaled back. The tax amnesty may or may not plug the gap. The market issure it will, but initial newsflow suggests that declarations are still proceedingslowly so far, and there has been virtually zero asset repatriations to date.

Outlook

The future is uncertain, and it is possible that the market’s bullishness is right,but we believe the outlook still remains subject to a lot more uncertainty thanthe market currently believes. Furthermore, in the long run, we believeunderperformance is highly likely given current valuation levels.