Market Outlook 2017: Better market outlook seen

Still going strong in 2017

Indonesian equities performed impressively in 10M16 (+18% and +25% in USD term) and we expect a repeat in 2017, as underlying fundamentals continue to support growth and a further re-rating. We think Indonesia’s fundamentals remain solid, forecasting GDP growth accelerating from 5.1% in 2016F to 5.3% in 2017F. The budget deficit is likely to stay manageable, inflation is near an historical low, low rate environment after 150bps cut by BI. We also witness continued strong signs of reforms which include tax amnesty (the most successful in the world) and ongoing initiatives to reduce governmental red tape and boost investment. We expect an increase chance that S&P may upgrade Indonesia’s rating to investment grade in 2017 due to more realistic budget which can improve the policy to be more effective and predictable. This will reduce the fiscal risk which has been the weak point of Indonesia’s rating.

Positioning for 2017

We see five investment themes in 2017: Bank, consumers, infrastructure, property and commodity. We still like bank as we believe fairly robust economic conditions will underpin loan growth and help ease NPL formation for 2017.  We predict consumer stocks to benefit from lower inflation and higher commodity prices, which increase consumer purchasing power. We also believe sector rotation is likely to be a key strategy in outperformance. Therefore we select some of the construction and property sectors stock who have lagged market return YTD. Contractors have witnessed a robust growth in their order backlog and we expect marketing sales recovery for property developer next year. We also like coal miners as they should benefit from improved coal prices. Based on our investment theme, stocks we like include: BBNI, INDF, LPPF, AISA, BSDE, BEST, WIKA, PTPP, and ADRO.

Accelerating earnings growth and scope for re-rating

Indonesia still trades on relatively inexpensive multiples at 16.7x forward PER, given our EPS growth forecast of 12% for 2017F, which accelerate from 8% in 2016F. This is still less than one-standard deviation above the mean trading range of the past five years. We see there are three reasons why we think the 16.7x forward PER may still be conservative and expect market to re-rate further. We believe market has yet to fully take into account:  1) the accelerating earnings growth, 2) the upcoming electricity tariff adjustments will reduce subsidies and 3) more realistic budget which can improve the policy to be more effective and predictable. This will reduce the fiscal risk which has been the weak point of Indonesia’s rating, leading to possible rating upgrade by S&P. Therefore, we maintain our YE-17 JCI target of 6,600, based on valuation of forward PER of 17.8x or +1stdev above historical mean.