NOMURA Global Market Research
Indonesia strategy: Outlook 2016 – Time for the big push
Release Date: December 10 2015
We expect an improvement in 2016, primarily driven by better government spending as a result of the recent deregulation and improved policy-making, supported by potential monetary easing. Valuation is now more reasonable, having de-rated from 23.9x to 19.4x since late January, potentially already pricing in most of the downside risks. While we are not expecting a sharp recovery, we expect earnings growth of 16.5%, from a low base, benign inflation and gradual recovery in consumption as the majority of the population adjusts to the new price levels.
Key sector themes in 2016:
- Lower inflation: Our economist expects inflation to trend lower next year (down to 4.7% from 6.4%), given a high base this year due to the fuel price hikes at the end of 2014. This should bode well for consumers, translating into higher disposable income.
- More stable currency: Our currency strategists forecast a more stable USD/IDR in 2016. With a more stable currency, consumer confidence should improve, leading to a pick- up in consumption. Companies would also be able to estimate costs better, leading to more stable gross margins.
- Gradual recovery as consumers adjust to new price level: While we do not expect a sharp rebound, we think that growth could be higher next year, as consumers gradually adjust to the new price levels.
As expected, 2015 has been a very tough year for consumer companies given deteriorating economic growth, rising inflationary pressure (as a result of the rather sharp fuel price hike in late 2014), sharply depreciating currency and limited support from government spending. While we had expected the pressure on revenues and earnings to subside, they actually persisted and worsened in 2015. On the other hand, gross margins for staple companies had been better than expected, a result of the lower commodity prices.
For 2016, our economist Euben Paracuelles is now a bit more constructive on the economy and has increased his GDP forecast to 5.2% from 4.7% previously, due to potential macro policy easing, and improvements in domestic demand as a result of significant increases in government spending. He is now more comfortable since recently he saw evidence that the domestic policy environment has become more proactive, and hence more growth friendly.
While we do not expect a sharp recovery, the expected gradual recovery has convinced us that both revenues and earnings, which we expect to grow by 7.1% and 6.6%, may have bottomed. In 2016, we expect consumer companies to start being able to raise prices again as consumers have adjusted to the new price levels, after this avenue has become very limited this year as affordability has become an issue. We also saw consumers trade down to more basic items, especially for the less personal or essential items in 2015.
Valuations have retreated to reflect the less than rosy earnings picture in 2015, and since we believe that earnings growth may have bottomed, we expect better performance for the sector, which YTD has corrected by 12.4%. Given the improving outlook driven by a gradual recovery in the economy, we are more constructive towards the sector. While we believe consumer discretionary will general perform better vis-à-vis the staples, as discretionary has suffered disproportionately going into the down-cycle, at this point we are only comfortable recommending Matahari Dept Store (LPPF IJ, Buy, TP: IDR19,000) for its lucrative target market, size and scale of operation and solid cash flow and balance sheet. On the staples side, we like Gudang Garam (GGRM IJ, Buy, TP IDR65,000) as we see a turnaround in its cash flow generation and its steep discount to its peers, such as HM Sampoerna (HMSP IJ, Neutral, TP IDR99,750). While we believe Gudang Garam deserves to trade at a discount, at currently a ~50% discount, the market looks too bearish on the name even after the recent run-up in prices.