EQUITY RESEARCH

Wednesday, 9 January 2013

OVERWEIGHT
YE13 Target JCI Index (as of Jan 8, 2013) Market Cap. (Rp tn) US$ (bn) 5,040 4,397 4,217 429.1

Market Outlook
Structural transformation underway
Structural transformation underway Indonesias economy is going through profound structural changes. Previously, inflation ran in the high single digits, leading to double-digit interest rates. Financing costs were consequently relatively high and money would be invested in time deposits. Now, however, inflation has been brought down to much lower levels and this is likely to be sustained in the long run. As a result, we also have single-digit interest rates, which, in turn, pushes money into real asset investment. This macro-economic environment, characterized by benign inflation and low interest rates, more closely resembles that of developed economies - but with much better economic growth prospects. All in all, we believe the structural economic changes could ultimately translate into sustainable capital market growth accompanied by lower volatility. Relying on domestic strength Growth in the capital market will continue to be fueled by domestic economic activities. The main drivers for economic growth will be consumption and investment in addition to a slight recovery in exports. Government spending has increased but realization remains a problem. Nonetheless, assuming a similar budget spending ratio, government spending should increase. All in all, the domestic sectors - i.e. the consumer, manufacturing, retail and property sectors all stand to benefit, as do infrastructure and banks. The fate of the commodity sector, by comparison, hinges on global economic recovery, which still seems to be rather languid. The government needs to implement policies carefully Corporate governance in the private sector has remained prudent, marked by strong cash flow generation which has allowed companies to invest and expand their production capacity. We see healthy profitability in addition to sound balance sheet fundamentals. So far, we have not witnessed any currency financing mismatches - meaning tolerable exchange rate risks. Furthermore, gearing remains relatively low, allowing companies to gear up if needed. Against this backdrop, the government has a key role to play in maintaining a positive macroeconomic environment. In our view, the government will seek to manage policy implementation in a careful manner, especially in regard to energy subsidies, minimum wages, electricity tariffs, and the domestic coal obligation. Improper policy implementation could have negative ramifications on economic stability, triggering higher inflation and denting the peoples purchasing power - key variables which underpin the current strong growth. Our Target Index is 5,040 We have a Target Index of 5,040 for 2013, translating into PER FY13 of 15.9x, offering upside potential of 16.3%. In our universe of stocks, our top picks are BBRI, BMRI, GIAA, ICBP, JSMR, KLBF, MAPI, and SMGR. Among the smaller market cap stocks, we like BSDE, ASRI, GJTL, HEXA, and WINS.

Chandra S Pasaribu (62-21) 351 0748 chandra@danareksa.com Danareksa research reports are also available at Reuters Multex and First Call Direct and Bloomberg.

www.danareksa.com

See important disclosure on the back of this report

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A quick flashback
As it turned out, 2012 was an interesting year, marked by brisk domestic growth shielding the Indonesian economy from global turmoil. The main engines of growth were strong domestic demand and high investment appetite. Monthly numbers in various sectors reached record highs, evidence that the domestic growth was real and tangible. The investment data for both domestic and foreign investment was especially encouraging. Demographics also worked in Indonesias favor, as the country is blessed with a young and productive population, helping to create a dynamic workforce and growing demand in new markets, unleashing a positive chain reaction on the burgeoning economy. The missing piece of the puzzle still lies in the hands of the government, however. Realization of the government budget was disappointing and reached only around 70-80% of the amount budgeted at the beginning of the year. Interestingly, funds availability is not the obstacle to higher government spending as the government is actually sitting on more than Rp200tn of unspent funds from previous years. Rather, fears over corruption, lengthy and convoluted bureaucratic processes, as well as time-consuming land acquisition, have all played a part in the languid pace of government spending. Going forward, the administration will need to address multiple problems to accelerate budget spending accordingly. Exhibit 1 Main macro economy variables forecast
2008 6.0 5.3 11.9 3.7 11.1 11.2 8.5 9.3 10,950 9,753 2009 4.6 4.9 3.3 2.2 2.8 7.5 9.3 6.5 9,400 10,356 2010 6.2 4.7 8.5 4.7 7.0 7.1 6.8 6.5 8,991 9,074 2011 6.5 4.7 8.8 6.2 3.8 6.8 6.9 6.0 9,068 8,773 2012F 6.3 4.9 11.0 5.6 4.4 5.7 5.9 5.8 9,517 9,406 2013F 6.5 4.8 10.6 6.3 4.9 5.6 5.6 5.8 9,059 9,185

Indicator National Account Gross Domestic Product YoY growth, % Household Consumption YoY growth, % Gross Fixed Investment YoY growth, % Manufacturing Production YoY Growth, % Consumer Price Index Inflation rate, end of period, % Interest rate 3M deposit 3M deposit rate, average BI rate, end of period, % Exchange rate Exchange rate, eon of period Exhange rate, average Source: DRI

At the beginning of 2012, the prospects for the economy were overshadowed by uncertainty created by the governments indecisiveness over its fuel subsidies policy. After a lengthy political process the government finally decided not to reduce fuel subsidies. Nonetheless, the procrastination in regard to this policy decision created economic uncertainty and also raised inflationary expectations, since the general public took into account the possibility of fuel price increases. Inflation subsequently rose - a self-fulfilling prophecy. Closer to the end of the year, the government issued a restrictive regulation in the mining sector, which was to prohibit the export of raw materials such as tin and nickel - the governments raison detre being to create higher value-added as opposed to simply exporting raw materials. This is a good idea, we agree, but implementation was lacking and uncertainty was created in the market. Negative sentiment was also created when the government approved significant minimum wage hikes amounting to an average of 21.4% across the regions. Such sudden cost increases have not been compensated by higher efficiency in doing business, such as in the areas of transportation, infrastructure and government administration.

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The capital market discounted both the positives and the negatives The stock market reacted accordingly to both the positive and negative developments in the economy. The positives were reflected in a slew of mostly solid financial results in 1H12, continuing into 3Q12. However, countering these positive developments were the uncertainties over fuel subsidies, the rapid change in energy and mining regulations, and, of course, the huge and unprecedented hikes in minimum wages. The JCI started the year at around the 3,800 level and then trended higher to 4,200 by early May 2012. After this, the market experienced a steep correction, spooked by Europes economic woes and concerns over the prospects for the global economy. At the same time, the government was cornered by being indecisive over its fuel subsidies policy - creating a domestic overhang. As a result, the market plunged to the 3,600 level in early June 2012. However, after the announcement of sound financial results for 2Q12 and 3Q12, investor confidence returned, helping the JCI to rally to a new all-time high of 4,375 on 26 November 2012. The announcement of hefty minimum wage hikes created negative sentiment in the market. However, the blue chips brushed aside the concerns over this issue and stayed upbeat. Some profit taking took place at the end of the year due to both domestic concerns and global economic uncertainties. Taking profits is always an attractive option in uncertain times. Nonetheless, we firmly believe that Indonesia remains on the radar screen for many investors, although caution is warranted due to headwinds from government regulations. Exhibit 2. JCI Kaleidoscope 2012
4,600 Indonesia regains Investment Grade from Moody's (Baa3) Greece reaches a debt swapt Regulation on Mineral Exports Restrictions issued Greece parliamentary election Issue on fuel price increase by government Obama Re-elected Issue on US fiscal cliff 4,375 4,317 Recovery on China economy

4,400

4,200

4,000

3,800

BI Rate drops 25bps to 5.75%

Greece ask for reelection 3,655

Implementation on LTV regulation

3,600

3,400

3,200 19-Aug-12 29-Aug-12 17-Nov-12 11-May-12 21-May-12 31-May-12 27-Nov-12 1-May-12 2-Jan-12 1-Apr-12 12-Jan-12 22-Jan-12 11-Apr-12 21-Apr-12 9-Aug-12 2-Mar-12 17-Dec-12 27-Dec-12 12-Mar-12 22-Mar-12 10-Jul-12 20-Jul-12 30-Jul-12 10-Jun-12 20-Jun-12 30-Jun-12 18-Oct-12 18-Sep-12 28-Sep-12 11-Feb-12 21-Feb-12 28-Oct-12 7-Nov-12 8-Sep-12 1-Feb-12 8-Oct-12 7-Dec-12

Source: IDX, Danareksa Sekuritas

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A solid macro economy

The stability in 2012 of three main macro economy indicators - inflation, interest rates and the exchange rate - helped underpin a conducive environment for domestic consumption and investment. In 2012 we witnessed record high monthly sales for cement, automobiles and motorcycles. We note that Indonesia might have undergone a structural shift in its economy leading to lower inflation. In the past (i.e. pre-crisis 97/98), near double digits inflation was normal. At that time, Indonesia managed its inflation at a level slightly below 10% with interest rates in the high teens. After the Asia financial crisis, however, inflation tended to slow to mid-single digit levels coupled with interest rates in the mid teens. Recently, Indonesias inflation rate has been maintained in the low single digit region accompanied by single digit interest rates. It appears that Indonesias inflation is now more closely aligned with inflationary levels in neighboring countries, evidence, we believe, of a structural shift in Indonesias economy. Exhibit 3. Macro economy forecast breakdown by sector and consumption
Sector 1. Agriculture 2. Mining and Quarrying 3. Manufacturing 4. Electricity, Gas, and Clean Water 5. Construction 6. Trade, Hotel, and Restaurant 7. Transportation and Communication 8. Finance, Leasing, and Business Services 9. Services GROSS DOMESTIC PRODUCT 1. Consumption Expenditures: Household 2. Consumption Expenditures: Government 3. Gross Fixed Capital Formation 4. Export of Goods and Services 5. Import of Goods and Services 6. Total Consumption 7. Domestic Demand Source: DRI 2012F 2013F Q1 3.8 2.2 5.6 5.6 7.2 8.9 10.1 6.7 5.6 6.3 4.9 7.6 11.0 1.8 6.6 5.3 6.9 3.3 3.2 1.5 1.3 6.3 6.1 6.0 5.9 6.9 7.1 9.1 9.2 9.9 10.0 6.8 6.9 5.9 5.7 6.5 6.4 2013F, % Y-o-Y Q2 Q3 Q4 3.4 3.3 1.6 1.6 6.2 6.5 5.9 6.1 6.8 6.9 8.9 9.2 9.8 10.0 7.1 6.9 5.9 6.0 6.4 6.6 2013F, % Q-o-Q Q2 Q3 Q4 2.6 -0.3 2.9 4.6 4.1 4.9 1.7 1.8 2.8 2.8 4.7 -20.5 1.6 -0.3 3.4 1.8 1.3 2.5 3.5 3.1 4.5 1.2 4.0 2.7 1.3 0.6 3.0 1.3 3.4 -1.3 0.9 40.9 5.4 14.8 9.2 6.2 6.0

Q1

3.2 20.9 1.4 0.5 6.5 -1.7 6.3 -2.2 6.7 -3.9 9.1 -1.7 9.9 1.2 6.4 2.5 6.0 -1.2 6.6 1.5

4.8 5.0 4.6 4.8 5.0 0.6 1.0 2.3 6.5 4.2 6.3 6.1 7.9 -47.3 29.8 12.0 10.6 11.0 10.9 9.7 10.7 -4.2 6.2 3.2 10.3 6.5 10.1 11.8 12.6 -4.8 4.7 -1.6 11.0 6.9 9.9 12.3 14.5 -4.1 12.4 -2.7 5.0 4.9 4.8 4.9 5.5 -7.6 3.8 3.5 6.6 6.6 6.6 6.3 7.0 -6.6 4.5 3.4

DRI expects that inflation shall be sustained in the region of 4-5% in 2013 as in 2012. The main risk to inflation comes from higher commodity prices - especially those of rice and energy. The price of rice will be largely determined by how successful harvests are in the peak harvesting period of April/May. Usually, inflation tends to be high at the beginning of the year until the harvesting period. Another risk will come from energy costs - especially fuel. Note that Indonesia is currently a net importer of oil. Strong domestic growth has translated into higher-than-expected demand for fuel, especially cheap subsidized fuel. Last year, the government signaled its willingness to raise fuel prices in order to rein in fuel subsidies, if necessary. This policy was instigated in response to rising oil prices. The government would have needed to increase fuel prices if the average reference price (ICP) was above US$120.75 per barrel. Last year, however, the oil price never touched the threshold and the government ultimately decided not to increase fuel prices. Unfortunately, speculation over possible fuel price hikes did spike inflationary expectations. We believe that it is important for the government to keep speculative activities in check. Fortunately, the lower oil price has reduced the urgency to raise subsidized fuel prices. Hence, there is a good chance that 2012 inflation is at the low end of the range, due to the unexpected inflation arising from speculation on fuel subsidy reductions in 2012. Although the government has not stated any intent to raise subsidized fuel prices, discussions on this matter did resurface at the end of 2012.

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Bank Indonesia, acting as the central bank, continues to pursue a policy mix in how it manages interest rates. Nonetheless, our economist thinks that the central bank will not shift too far away from inflation targeting. This will remain the main consideration in managing interest rates. In 2012, low inflation allowed Bank Indonesia to maintain its BI rate at 5.75% for almost ten months. With the likelihood of low inflation being sustained in 2013, Bank Indonesia should be able to maintain its BI rate at 5.75%. Additionally, central banks across the globe are also tending to maintain low reference rates in consideration of the lethargic global recovery. This will give BI more room to maintain a low BI rate. Despite the low BI rate, the banking sector continues to enjoy a high interest margin of nearly 6.0%. Bank Indonesias policy to push down lending rates has proven to be less effective. In many other countries the net interest margin is much lower than in Indonesia, providing higher efficiency in the banking system. This shows that Indonesias banking industry has strong pricing power. In our view, low banking penetration with a highly concentrated banking industry has resulted in a less competitive environment to drive down the price of money (interest rates). The rupiah weakened in 2012 mainly due to negative sentiment created by heightened global uncertainty, capital outflows seeking safe havens and fears over the negative current account. By the end of 2012, the rupiah had weakened by 8.0% from Rp9,069/USD at the beginning of the year to Rp9,793/USD by the end of December 2012. The movements in the rupiah have gone against the regional pattern where local currencies have tended to strengthen against the US dollar. According to DRI, the fundamental value of the rupiah should be Rp9,236/USD. Compared to the current exchange rate of around Rp9,600/USD, the rupiah is therefore undervalued by 4-5%. Our economist states that the actual exchange rate should not deviate too much from its fundamental value. Therefore, we expect the rupiah to strengthen in 2013 rather than weaken. Furthermore, the quantitative easing undertaken in the US should weaken the dollar against other currencies, meaning that the rupiah stands to strengthen. Exhibit 4. The rupiah is forecast to strengthen in 2013
9,800 9,600 9,400 9,200 9,000 8,800 8,600 8,400 8,200 8,000 7,800

Forecast

Source: DRI

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13

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Exhibit 5. Several approaches to determine the rupiah exchange rate

Indicator Actual PPP Trend PPP REER Trend REER Competing Currency Econometric Fundamental Value Deviasi, % Source: DRI Dec-08 10,950 8,573 8,997 8,311 9,288 10,616 10,561 9,391 -14.2 Dec-09 9,400 8,512 8,330 8,648 8,935 10,333 8,587 8,901 -5.3 Mar-10 9,115 8,652 8,814 8,721 8,902 9,739 8,371 8,866 -2.7 Jun-10 9,083 8,784 9,381 8,791 8,887 9,617 9,249 9,118 0.4 Sep-10 Dec-10 8,924 8,982 8,837 8,856 8,888 9,109 8,732 8,901 -0.3 8,991 9,040 8,934 8,917 8,903 9,131 8,706 8,938 -0.6 Mar-11 8,709 8,990 9,104 8,974 8,930 8,738 9,093 8,971 3.0 Jun-11 8,597 8,956 8,808 9,028 8,971 8,615 9,236 8,936 3.9 Sep-11 8,823 9,043 8,559 9,080 9,023 8,845 8,800 8,892 0.8 Dec-11 9,068 9,108 9,113 9,131 9,086 9,233 9,555 9,204 1.5 Mar-12 9,180 9,106 9,859 9,182 9,156 8,913 9,380 9,257 1.0 Jun-12 9,480 9,207 9,510 9,233 9,227 9,153 9,268 9,266 -2.3 Sep-12 9,588 9,283 9,397 9,283 9,299 9,126 9,059 9,241 -3.6

Exhibit 6. Sound financial system to support the growing economy

Banking Pressure Index - Indonesia 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -0.14

Source: DRI

Domestic growth underpinning the economy DRI forecasts GDP growth of 6.5% in 2013, or slightly higher than 2012s estimated 6.3%. The main engines of growth remain domestic consumption and investment. Low inflation and low interest rates should be sustained in 2013. This will help induce a stronger appetite for consumption and investment. Note that domestic consumption accounts for about 55-60% of the total economy. As such, solid domestic demand is of vital importance in promoting further growth and stability. On the external front, DRI expects stronger export activities with a slightly brighter outlook in the global markets. Government expenditures, however, shall remain tempered since the government may not be able to accelerate infrastructure development.

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Exhibit 7. Rising consumer confidence to support domestic consumption

Consumer Confidence Index 110 105 100 95 90 85 80 75 70 65 60

Fuel price decreased Fuel Price Hike I Foodstuff price rose Fuel Price Hike II Jan-05 Jan-06 Jan-07 Jan-08 Jul-05 Jul-06 Jul-07 Inflation increase Fuel price hike III Jan-09 Jan-10 Jan-11 Jan-12 Jul-08 Jul-09 Jul-10 Jul-11 Foodstuff price rose

94.7

Source: DRI

Exhibit 8. Strong business confidence bodes well for capacity expansion

BSI 170 160 150 140 130 120 110 100 90 80 May-11 Nov-11 May-12 Mar-11 Mar-12 Jan-11 Sep-11 Jan-12 Sep-12 Jul-11 Jul-12 Present Situation Expectations

Source: DRI

Domestic consumption is expected to grow by 4.7% in 2013, or slightly slower than 2012s estimated 4.8%. Meanwhile, capital formation is expected to grow by 11.0% in 2013, or a bit higher than 2012s estimated 10.3%. We expect that both consumer confidence and business sentiment shall remain high in 2013, fuelling domestic consumption and investment. Both domestic and foreign investment numbers are impressive, given a welcome boost by Indonesias investment grade rating awarded in 2012. Now Indonesia is simply reaping the benefits. The low interest rate environment will encourage investment since financial returns are less attractive. Companies will be more willing to invest given the low interest costs.

Jul-12

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Exhibit 9. A negative balance of payments in the past supported growth through investments
US$ Bn 12 8 4 0 -4 -8 -12 Dec-81 Dec-82 Dec-83 Dec-84 Dec-85 Dec-86 Dec-87 Dec-88 Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11
Source: Bank Indonesia, BPS

%GDP 9 6 3 0 -3 -6 -9

Exhibit 10. Foreign investment realization by sector

Primary Sector Secondary Sector Tersier Sector 24.5%

28.4%

47.1%

Source: BKPM

Indonesias exports faced a challenging period in 2012 given Europes economic woes, the slowdown in China, and the slower-than-expected recovery in the US and Japan. All in all, Indonesias exports are expected to grow by 6.4% in 2012 and by a brisker 12.8% in 2013. Overall, our economist team feels that the worst is over. Already there are some encouraging signs that the US and Japan will continue to stimulate their respective economies to foster recovery. Falling inflation in China will help the Chinese government to promote more growth this year. Europes fate remains uncertain, however, since the beleaguered region has not found the magic formulae to heal its moribund economy. As for Indonesias imports, they are expected to grow 8.1% in 2012 and by a brisker 11.0% in 2013. Accelerated growth in imports reflects the strong growth in foreign and domestic investment. Currently, Indonesia is not able to manufacture capital goods such as sophisticated engines and other special equipment. The demand for these goods is met by imports. But as long as the imports are largely productive goods, we are not unduly concerned.

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Exhibit 11. Low exports contribution shielded the domestic economy from the global slowdown
Export ratio to Indonesia PDB 45.0 40.0 35.0 30.0 25.0 20.0 15.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 41.0 39.0 32.7 30.5 32.2 34.1 31.0 29.4 24.2 24.6 29.8 26.3

Source: BPS, Bloomberg and CEIC

Exhibit 12. Countries with high exports to GDP ratios are likely to be significantly affected by the global slowdown
Malaysia 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: CEIC, DRI 119.8 110.4 108.3 106.9 115.4 117.5 116.5 110.0 103.2 96.4 97.3 94.2 Phillippines 51.4 46.0 46.7 47.2 48.6 46.1 46.6 43.3 36.9 32.2 34.8 29.0 Singapore 192.3 187.8 188.8 207.4 219.3 229.7 233.4 217.7 241.4 224.8 207.2 209.0 Thailand 66.8 65.9 64.2 65.7 70.7 73.6 73.6 73.4 76.4 68.4 71.3 77.6 Korea 35.7 33.5 31.7 33.1 36.7 36.6 38.3 40.4 54.2 46.0 49.7 54.1 Taiwan Hong Kong 52.9 50.0 52.2 55.5 61.4 62.5 68.0 72.1 73.0 62.5 73.5 75.8 143.3 138.7 149.5 171.0 190.2 198.7 205.5 208.0 212.4 195.0 223.1 229.6

Government spending could be a key factor in promoting domestic growth. Higher government spending - especially in infrastructure - will have a trickle-down effect on the economy. It will directly create demand for capital goods and services. Furthermore, and just as importantly, it might create better efficiency in the economy since better infrastructure could lead to lower transportation and handling costs. Better provision of electricity could improve the production process, enabling the use of new machinery in an uninterrupted production process. Nonetheless, growth in government spending is expected to remain stable at 6.0% in 2013 (since the government will continue to struggle to promote accelerated infrastructure development, we believe).

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Exhibit 13. The Indonesian economy is still in its expansionary stage

LEI (LHS) 136 128 120 112 104 96 88 80 72 Mar-91 Mar-98 Mar-05 Nov-95 Nov-02 May-92 May-99 May-06 Nov-09 Mar-12 Jan-90 Jan-97 Jan-04 Sep-94 Sep-01 Sep-08 Jan-11 Jul-93 Jul-00 Jul-07 Expansion phase Expansion phase Expansion phase Recession Expansion phase CEI (RHS) 130 124 119 113 108 102 97 91 86 80

Source: DRI

The State budget The House of Representatives has approved the state budget. Some select underlying assumptions of the state budget are: 1. GDP growth of 6.8% 2. Interest rate SPN of 5.0% 3. Rupiah/USD exchange rate of Rp9,300/USD 4. ICP Oil price at US$100 per barrel 5. Oil lifting volume of 900k barrels per day 6. Gas lifting volume of 1.360 Mboepd The government intends to maintain its fiscal stimulus. Total government revenues are expected to grow to Rp1,529.7tn (+12.6% yoy) while expenditure is targeted to reach Rp16,83.0tn (+8.7% yoy). With higher revenues growth, the budget deficit is expected to decline to 1.7% of GDP or Rp153.3tn from 2012s budget target of 2.2% of GDP. The government also seeks to improve the tax ratio from 11.9% in 2012 to 12.9% in 2013. The government is keen to improve this ratio as it is still low on a regional comparison with countries such as Thailand and Malaysia having a tax to GDP ratio close to 15%. In short, the state budget remains prudently managed but with no significant change in the growth stimulus. Despite the state budgets seeming lack of stimulus, an improvement in the actualization of spending could be crucial. In previous years, the government spending ratio has only reached around 80-90% of the total budgeted amount although tax collection revenues have tended to be met. As such, the budged deficit has never reached the intended level. As a consequence, the government has almost Rp215tn sitting in its account in the central bank. Even in 2012, the government was not able to meet its spending target, with a shortfall of again around 90%.

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Exhibit 14. Summary of state budget 2013

2012 APBN-P Rp bn A. State Revenue and Grant 1,358,205.0 I. Domestic revenue 1,357,380.0 Tax Revenue 1,016,237.3 Non Tax Revenue 341,142.6 II. Grants 825.1 B. State Expenditures 1,548,310.4 I. Central Government Expenditures 1,069,534.4 Ministries/Agencies Expenditure 547,925.6 Non Ministries/Agencies Expenditure 521,608.9 Additional budget Adjustment for Education Non Education II. Transfer to region 478,775.9 Balance Fund 408,352.1 Special Autonomy & Adjusmnet fund 70,423.9 Total Budget for Education 310,847.9 % to State Budget 20.1 C. Primary Balance (72,319.9) D. Overall Balance (A-B) (190,105.3) % terhadap PDB (2.2) E. Financing (I + II) 190,105.3 Domestic Financing 194,531.0 Foreign Financing (4,425.7) Source: Ministry of Finance 2013 Diff. against APBNP 2012 Rp bn % 171,468.1 167,809.5 176,756.8 (8,947.2) 3,658.5 134,700.7 84,846.5 46,672.0 38,174.4 12,745.4 3,938.1 8,807.3 49,854.4 36,446.7 13,407.6 26,001.1 (0.1) 32,225.7 36,767.3 0.6 (36,767.3) (21,738.9) (15,028.4) 12.6 12.4 17.4 (2.6) 443.4 8.7 7.9 8.5 7.3

RAPBN Rp bn 1,529,673.1 1,525,189.5 1,192,994.1 332,195.4 4,483.6 1,683,011.1 1,154,380.9 594,597.6 559,783.3 12,745.4 3,938.1 8,807.3 528,630.3 444,798.8 83,831.5 336,849.0 20.0 (40,094.2) (153,338.0) (1.7) 153,338.0 172,792.1 (19,454.1)

10.4 8.9 19.0 8.4 (0.5) (44.6) (19.3) (19.3) (11.2) 339.6

The unspent budget is undesirable since the money could be used to improve the countrys infrastructure, raising Indonesias competiveness. Poor infrastructure means congestion on roads and at ports and airports, meaning higher handling and transportation costs for both goods and people. Inadequate electricity supply is also an obstacle to investment. Note that state electricity firm PLN is still struggling to meet the target of 10,000MW in phase one and two. As a result of poor infrastructure, the cost of doing business in Indonesia increases. This is reflected in the rising incremental capital output ratio (ICOR). In the period 1993-96, the ICOR was around 3.8. It then rose to 4.1 in 2003 and then to 5.1 in 1H12. This means that to create 1% of economic growth, Indonesia will need to invest 5.2% of GDP (a lower figure is better or more efficient). Exhibit 15. Rising ICOR is evidence of greater inefficiency in capital utilization
ICOR 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012* 15 25 20 35 30 Investment contribution to PDB 40

Source: DRI

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The unspent budget also weakens the financial balance. Raising tax revenues but not injecting the money back into the economy is simply tightening policy by accident. This unintentionally puts the brakes on economic growth. As such, we believe the government should make greater efforts toward addressing this issue. The homework: energy subsidies Total subsidies budgeted in the state budget amount to Rp317.2tn in 2013, or an increase of 29.4% from 2012. Of that amount, energy subsidies constitute 87%, consisting of Rp193.8tn (+41.1%) for fuel subsidies and Rp80.9tn (+24.6%) for electricity subsidies. The higher fuel subsidies are attributable to higher consumption volume of 46mn kiloliters in 2013 from 40mn kiloliters in 2012. Pertamina (the state-owned oil company) predicts that fuel consumption for 2012 could reach 45.3mn kiloliters. If this number is reached, the assumption of 46mn kiloliters for 2013 might well be understated. This would mean higherthan-expected fuel subsidies. Other key variables affecting the amount of fuel subsidies will be the oil price and the rupiah exchange rate. Lower-than-expected oil prices will mean lower fuel subsidies and vice versa, while a stronger rupiah will also mean lower fuel subsidies and vice versa. Exhibit 16. Fuel subsidies and its main assumptions
2012 Revised state budget Subsidies (Rp bn) - Subsidized fuel and biofuel (Rp bn) - Subsidized fuel (Premium) and biofuel - Kerosene - Diesel oil and biofuel - Subsidized LPG 3Kg tube (Rp bn) Parameter ICP (US$/barrel) Exchange rate (Rp/US$) Fuel and biofuel volume (000 Kl) Fuel selling price - Subsidized fuel (Premium) - Kerosene - Diesel oil and biofuel Source: DRI 137,380 91,891 51,698 7,883 32,310 29,126 105 9,000 40,000 4,500 2,500 4,500 2013 Diff to state budget Nominal % 56,425 54,571 35,497 153 18,921 (2,674) 41.1 59.4 68.7 1.9 58.6 (9.2)

State budget 193,805 146,462 87,195 8,035 51,232 26,452 100 9,300 46,000 4,500 2,500 4,500

Can fuel subsidies be reduced? On one side, there is the view that fuel subsidies should be reduced to improve the sustainability of the state budget and to improve the effectiveness of spending. There is also the argument that fuel subsidies are largely enjoyed by those who dont need them i.e. the fuel subsidies are unfairly targeted toward private vehicle owners. However, it should be remembered that public transportation in many of Indonesias major cities is poor and not a desirable option. So, rather than increasing fuel prices, the government is exploring the possibility of limiting fuel subsidies. For instance, it may seek to prohibit the use of subsidized fuel for private vehicles in greater Jakarta or even Java. Yet such a policy would be a nightmare to enforce and the government would need to build the necessary infrastructure to monitor and minimize the misuse of subsidized fuel.

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Reducing fuel subsidies will increase the flexibility of the budget, making it less dependent on the oil price. The money could be reallocated for infrastructure development. Reallocation of the budget is not the problem. What is the problem, however, is the governments inability to spend its budget on infrastructure. In this situation, who is the better spender? The general public enjoying subsidies and spending their money on consumption goods or the government spending the money on infrastructure? Unless the government is able to improve infrastructure development, it is wise for the government to keep the fuel subsidy policy unchanged. A reduction in fuel subsidies would also cause higher inflation which, in turn, would reduce the peoples purchasing power. DRI expects additional inflation of 0.7% for every 10% increase in subsidized fuel prices. Currently, subsidized petrol costs only around 50 cents per liter in Indonesia, probably only half the economic cost. This, however, encourages fuel smuggling to destinations out of Indonesia, putting an additional burden on the state budget. Electricity tariff hikes Electricity subsidies increased by 24.6% to Rp80.9tn in 2013, underpinned by 9% higher electricity demand, a weaker exchange rate and tariff hikes of 15%. The House of Representatives has agreed to increase electricity tariffs by an average of 15% in 2013. Nonetheless, the increase will not be across the board as tariffs for small households will remain unchanged. Moreover, the electricity tariff hikes will take place every three months to spread the burden across 2013. PLN is targeted to increase the electrification ratio and improve the energy mix towards coal and gas while, at the same time, reducing the usage of expensive high speed diesel. Exhibit 17. Electricit tariff in several countries
South Africa Russia South Korea Indonesia Australia US New Zealand Thailand India Singapore England Netherland Japan 0.02 0.05 0.06 0.06 0.06 0.07 0.07 0.08 0.08 0.12 0.14 0.14 0.16 US$/kWh

Source: Kompas Newspaper

Last year, PLN raised tariffs by 10% on average. In 2013, the modest electricity tariff increases should only have a very small impact on inflation. Electricity tariffs in Indonesia are still considered low, offering competitiveness from affordable energy costs. However, according to the Ministry of Energy, the economical cost of power generation is now around Rp1,261/ kWh (US$0.13). Based on 2011 data, from the total electricity generation, around 41% was generated using coal, 32% using fossil fuels such as high speed diesel, IDO and MFO, while gas contributed 24% and the remainder came from geothermal generation. If PLN could reduce its usage of fossil fuels and switch to gas, coal and geothermal generation, power

13

9 January 2013

generation costs could fall significantly. Improving the power generation mix should lead to higher efficiency. Transmission and interconnectivity also pose obstacles in increasing the electrification ratio, which currently stands at 74%. At the moment only Java-Bali and Sumatra have interconnections. Exhibit 18. Coal is the main source for electricity generation, although expensive fossil fuels still contribute significantly

Geothermal 3% Gas 24%

Fuel 32%

Coal 41%

Source: PLN

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9 January 2013

The Capital market

In 2012, developments on both the global and domestic economic fronts significantly affected sentiment in the capital market. Nonetheless, strong domestic demand gave a large boost to companies operating in certain sectors (especially the consumer, property, infrastructure, and banking sectors). In contrast, commodity-related stocks performed lethargically as weak global demand tempered commodity prices. Hence, Indonesias relatively low export contribution to GDP turned out to be a blessing in disguise, shielding the economy from the global slowdown. Continuing to perform The JCI was ranked eighth in the region in 2012, down from third-place in the previous year. Strong recoveries were seen in the Philippines, Thailand and India, leading these markets to outperform. However, in 2011 these markets had been hit hard by the global slowdown. All in all, the JCI was a more consistent performer, climbing 3.2% in 2011 and advancing a further 12.9% in 2012, supported by better corporate performance. For 2013, we believe that the JCI can retain its growth momentum, underpinned by positive macro economic factors such as benign inflation and strong domestic demand. In relative valuation terms, however, the JCI is already trading at a premium to the average for the global market. And we consider further out-performance difficult to achieve. Hence, in order for the JCI to post further gains, other markets will need to recover and this may depend largely on global economic recovery. Exhibit 19 Indonesia has performed moderately but consistently
Thailand Philippine India Jepang Hongkong Singapore S&P Indonesia Malaysia Korea Taiwan Dow Jones London Stock Exchage Rusia China 0 35.8 33.0 25.8 22.9 22.9 19.7 13.4 12.9 9.8 9.4 8.9 7.3 5.8 5.4 3.2 5 10 15 20 25 30 35 40 %

Source: IDX

Sector performance Supported by strong domestic demand, the outperforming sectors were the property, manufacturing, infrastructure, trade and distribution, and consumer sectors. Robust domestic demand has unleashed a positive chain reaction on the economy, boosting activities in the individual sectors. We have witnessed record high monthly production numbers for motorcycles, cement and in the automotive sector. Low interest rates and easy availability of financing have encouraged consumers to purchase more durable goods, including electronic equipment, cars, and motorcycles. And house purchases have been stimulated by banks willingness to make mortgage loans. Against this backdrop, significant capacity expansion has taken place in the cement and automotive industries. Investment numbers have been very strong indicating expansion in production capacity. Furthermore, demand for industrial estates has surged as companies seek out new locations for new factories and warehouses. The price of industrial estates has jumped from an average of only US$40 per sqm to above US$150 per sqm in strategic locations such as Bekasi (west of Jakarta).

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9 January 2013

Indonesias middle-income class of 55mn people are the new engine of growth. Demand from the middle-income class will go beyond staple foods and clothing. Demand will move into higher value-added goods such as processed foods, education, home appliances, recreation and services. As demand swings into higher value-added goods, the economy will grow further and more investment will be needed. As such, it is vital that the momentum growth is maintained through sufficient investment in capacity. To provide goods and services in a timely manner, the economy will need adequate supporting infrastructure, much of which will need to come from higher government spending in infrastructure. Based on the 2013 budget, the government has earmarked Rp201.3tn for infrastructure investment, targeting the construction of 15 new airports, 383km of new railways, and 19,370km of new inter-province highways. The underperforming sectors in 2012 were commodity-related such as coal and agriculture. These sectors will likely remain stagnant as long as global recovery fails to materialize. A key factor is undoubtedly cost management since only the lowest cost producers will survive. Low commodity prices might affect supply as small miners and plantation owners opt to halt loss-making operations, providing a cushion against further price declines. All in all, we feel that both sectors have bottomed - although recovery remains in question. Exhibit 20. Domestic-oriented sectors outperformed the market
Construction and Property Infrastructure Basic Industry Trade & Service Consumer Manufacture JCI Index Finance Agriculture Mining -26.4 -30 -20 -10 0 10 20 30 40 -3.9 % 50 15.7 12.9 11.9 19.0 29.7 29.0 27.3 42.4

Source: IDX

Sufficient liquidity but not great Trading liquidity was relatively stable with daily turnover of Rp4.8 tn in 2012, or similar to last years figure. Monthly trading value trended up at the beginning of the year due to growing confidence in the outlook for the domestic economy. However, investor appetite then diminished due to the negative sentiment created by the European financial crisis coupled with mounting fears that subsidized fuel prices would be hiked. Confidence was buoyed up, however, by the announcement of positive corporate results. In the banking sector, fears of NM compression were overdone. Other sectors such as the consumer and retail sectors continued to shine despite the government procrastination on fuel subsidies. Higher monthly trading value was seen after the announcement of the 1H12 results. In 2013, the bourse expects daily turnover to increase to Rp5.5tn Domestic market participants remained dominant in the market (they accounted for twothirds of the trading value). Most domestic investors are institutions as retail investors are still few in number. Based on KSEI (the custodian agency) data, the total number of accounts reached around 350,000 as of October 2012. This is still a very low number considering that

16

9 January 2013

there are 55mn people categorized as middle-class in Indonesia. Retail investors generally invest through mutual funds - both in equity and bonds. This has led to strong participation from institutional investors. There are three main types of domestic institutional investors, namely: 1) mutual funds, 2) insurance (this includes Jamsostek) and 3) pension funds. Mutual funds comprise assets from both retail and institutional money. Some small institutions get fund managers to manage their assets simply because of economies of scale. For the insurance industry, we suspect that participation has increased significantly due to strong growth in unit-linked products. Moreover, Bapepam-LK requires that insurance money raised in Indonesia is also invested in the Indonesian capital markets. As a result of the strong economic growth, Jamsostek (employment insurance) has more funds to invest as average salaries have increased and the formal employment base has widened. In total, Jamsostek has around Rp130tn of assets under management with around 20% invested directly in equities. The large corporate pension funds that invest directly in the capital market are usually the state-owned company pension funds such as Telkom, Pertamina, plantation companies and others. Nonetheless, the weighting of equities remains relatively low at around 10-15%. Most of the assets are invested in fixed income instruments such as government bonds and time deposits. Declining interest rates, however, might bring about a higher allocation in equities in a bid to meet return targets. Exhibit 21. Daily transactions turnover was down by 8.6% yoy to Rp4.5tn per day
Average Daily transaction (LHS) Rp trn 10.0 8.0 6.0 4.0 2.0 0.0 Apr-11 May-11 May-12 Jun-12 Aug-11 Sep-11 Aug-12 Sep-12 Nov-11 Nov-12 Dec-12
9,356 2,655 Nov-12 Oct-12 (3,074) Aug-12 Dec-12 Sep-12 Jul-12 123

JCI Index (RHS) 4,500 4,300 4,100 3,900 3,700 3,500 3,300

Jun-11 Jul-11

Oct-11

Dec-11 Jan-12

Feb-11 Mar-11

Feb-12 Mar-12

Apr-12

Source: IDX

Exhibit 22. Net foreign inflows reached Rp15.7tn in 2012

Rp bn 20,000 16,000 12,000 8,000 4,000 0 -4,000 -8,000 -12,000 -16,000 -20,000 17,515

5,186

9,069

4,115

2,565

2,991

2,123

2,130

2,455

646

1,465

1,644

4,587 (7,825) May-12 Jun-12 (1,973)

(4,009)

(2,266)

Aug-11

(8,449)

May-11

Nov-11

Jun-11

Oct-11

Dec-11

Mar-11

(1,503)

Mar-12

Apr-11

Sep-11

Feb-11

Source: IDX

Feb-12

Apr-12

Jan-11

Jan-12

Jul-11

413

Oct-12

Jan-11

Jul-12

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9 January 2013

Performance of the newcomers In 2012 there were about 22 IPOs and 23 rights issues raising total funds of Rp28.9tn or representing less than 1% of total market capitalization. The funds raised through IPOs reached Rp10.1tn, with the amounts raised varying from between Rp100bn up to Rp2.1tn. The relatively large IPOs were only MNC Skyvision with an IPO size of Rp2.1tn, BPD Jatim of Rp1.3tn and Waskita of Rp1.2tn. Despite the new IPOs, many large companies have yet to enter the capital market. Currently, Indonesias market cap to GDP ratio is around 50% (in US$ terms), still low on a regional comparison. This shows that the depth of the Indonesian capital market remains shallow. In other words, the capital market does not adequately represent the economy as a whole. Still missing are a number of state-owned companies such as the plantation companies which account for about 20-25% of the total CPO production, Pertamina (the state-owned oil company), PLN (the state-owned electricity company), Pelindo (port company), and Angkasa Pura (airport services). Furthermore, a number of large private groups in consumer products (such as the Wings group, the Djarum group and the Sosro group) have not been tempted to list their shares on the capital market. High returns from retained earnings coupled with bank loans appear to have been sufficient for these companies to fulfill their capital expenditures. With ROEs still around 20-30%, there is less reason to get listed. Exhibit 23. Indonesias market capitalization to GDP remains low; more new names are needed to create market depth
China Indonesia India Philippines Thailand United States United Kingdom Malaysia Singapore 0%
Source: Bloomberg

50%

100%

150%

200%

250%

Share price performance Of the twenty two newly listed companies since the beginning of the year, only two showed negative share price returns in 2012. The other companies recorded share price gains up to a remarkable 420%. This shows that listings on the stock exchange are beneficial for founding shareholders, unlocking the value of their respective companies. By listing their shares, companies are forced to improve corporate governance and implement more stringent financial discipline. Overall, the excellent share price performance of the newlylisted companies despite the global turmoil should encourage more companies to list their shares.

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9 January 2013

Exhibit 24. IPO in 2012

Listing date 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 PADI TELE ESSA BEST RANC TRIS KOBX TOBA MSKY ALTO GLOB GAMA BJTM IBST NIRO PALM NELY TAXI BSSR ASSA WIMM WSKT Total Minna Padi Investama 9-Jan-12 Tiphone Mobile Indonesia 12-Jan-12 Surya Esa Perkasa 1-Feb-12 Bekasi Fajar Industrial Estate 10-Apr-12 Supra Boga Lestari 7-Jun-12 Trisula International 28-Jun-12 Kobexindo Tractors 5-Jul-12 Toba Bara Sejahtra 6-Jul-12 MNC Sky Vision 9-Jul-12 Tri Banyan Tirta 10-Jul-12 Global Teleshop 10-Jul-12 Gading Development 11-Jul-12 Bank Pembangunan Daerah Jawa Timur 12-Jul-12 Inti Bangun Sejahtera 31-Aug-12 Nirvana Development 13-Sep-12 Provident Agro 8-Oct-12 Pelayaran Nelly Dwi Putri 11-Oct-12 Express Transindo Utama 2-Nov-12 Baramulti Suksessarana 8-Nov-12 Adi Sarana Armada 12-Nov-12 Wismilak Inti Makmur 18-Dec-12 Waskita Karya 19-Dec-12 No of Share mn 300 1,350 250 1,765 313 300 273 211 1,413 300 111 4,000 2,984 154 6,000 659 350 1,051 262 1,360 630 3,082 IPO Price Rp/share 395 310 610 170 500 300 400 1900 1520 210 1150 105 430 1000 105 450 168 560 1950 390 650 380 Last price Rp/share 1050 530 3100 680 780 340 590 1300 2475 305 1150 350 370 5200 245 460 197 860 1950 430 750 440 Return Ytd, % 166 71 408 300 56 13 48 -32 63 45 0 233 -14 420 133 2 17 54 0 10 15 16 Fund Raised Rp bn 118.5 418.5 152.5 300.1 156.5 90.0 109.0 400.3 2,147.5 63.0 127.8 420.0 1,282.9 154.2 630.0 296.6 58.8 588.7 509.9 530.4 409.5 1,171.3 10,135.9

Source: Bloomberg as of Dec 26, 12

Rights issues The capital market remains an attractive place for listed companies to raise additional capital. Some 23 companies conducted rights issues in 2012, raising proceeds of Rp18.8tn in total. Companies to conduct rights issues in 2012 included banks (such as Bank BTN, Bank Permata, and Bank OCBC-NISP) and two resource energy companies (Sugih Energy and Exploitasi Energy Indonesia). Banks were forced to raise more capital due to restrictive regulations from the Central Bank adopting Basel standards. Exhibit 25. Rights Issue in 2012
Listing date 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 FREN KIAS RAJA SUGI NISP BSIM TRIO TRIO SMMT ITTG MCOR SUPR BEKS MDRN BBTN COWL BNLI BIPP HOME CNKO INPC MYOH SRAJ Total Smartfren Telecom Keramika Indonesia Asosiasi Rukun Raharja Sugih Energy Bank OCBC NISP Bank Sinarmas Trikomsel Oke Trikomsel Oke Golden Eagle Energy Leo Investments Bank Windu Kentjana International Solusi Tunas Pratama Bank Pundi Indonesia Modern Internasional Bank Tabungan Negara (Persero) Cowell Development Bank Permata Bhuwanatala Indah Permai Hotel Mandarine Regency Exploitasi Energi Indonesia Bank Artha Graha Internasional Samindo Resources Sejahteraraya Anugrahjaya 22-Feb-12 1-Mar-12 14-May-12 21-May-12 5-Jun-12 29-Jun-12 2-Jul-12 2-Jul-12 2-Jul-12 11-Jul-12 12-Jul-12 28-Aug-12 13-Sep-12 2-Nov-12 23-Nov-12 30-Nov-12 6-Dec-12 14-Dec-12 17-Dec-12 20-Dec-12 21-Dec-12 26-Dec-12 27-Dec-12 No of Share mn 3,959 6,504 340 24,273 1,507 1,150 312 943 820 985 526 135 2,500 960 1,513 4,116 1,643 1,130 1,031 4,710 4,513 735 5,535 Excercise price, Rp 100 128 677 100 1000 250 856 856 500 104 200 4800 120 550 1235 220 1215 151 100 500 111 830 260 Fund Raised Rp bn 396 833 230 2,427 1,507 288 267 808 410 102 105 648 300 528 1,868 906 1,996 171 103 2,355 501 610 1,439 18,797

Source: Bloomberg as of Dec 26, 12

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State-owned companies potential There are currently 140 state-owned companies under the Ministry of State-owned enterprises, of which 18 are already listed on the IDX. The total assets of the state-owned companies reached Rp3,375tn in 2011 of which Rp1,934tn worth of the assets are already listed. This leaves unlisted assets of Rp1,441tn. To put this number into context, the total assets of all listed companies reached Rp4,271tn. Therefore, the unlisted SOE assets are about 34% of the total assets of listed companies. The Ministry of SOE is still keen to list SOEs in order to achieve: 1) better performance, 2) more stringent financial discipline 3) stricter corporate governance and 4) access to the capital market to raise funds. At the same time, however, the government wants to keep control and hold absolute majority stakes in SOEs. As a result, companies are constrained unless the government is willing to add more capital. Lately we have seen SOEs conduct rights issues followed by placements where the governments stake is diluted as the rights are sold to investors. This scheme will stop, however, as soon as the governments stake is diluted to 50.1%. Determining the potential market capitalization of the non-listed SOEs might provide an indication of the potential depth of the market. The total equity of non-listed SOE is about Rp657tn. The PBV of the JCI is around 2.83x in FY12. Using this multiple, the valuation of the remaining non-listed SOEs could reach Rp1,860tn or around 45% of the total current market capitalization. This shows that the capital market currently lacks depth. What is needed are more listings of both SOE and private companies.

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Exhibit 26. Financial Summary of state owned companies

2010 267 370 1,023 231 1,253 452 2,341 104 150 99 104 203 114 570 438 103 74 133 206 217 964 17 10 17 25 41 20 88 5,048 1,352 1,503 202 3.18 2011 312 415 1,410 272 1,682 536 2,945 119 155 158 147 305 110 689 590 208 119 213 332 248 1,378 21 7 34 31 65 22 116 5,527 1,533 1,760 241 2.77 2012E 349 472 1,621 313 1,934 620 3,375 135 184 181 169 351 169 839 527 214 146 244 390 301 1,432 24 12 40 41 81 27 144 6,077 1,679 1,993 271 2.33 657 1,860

ASSET Pertamina PLN SOE Listed - Banks SOE Listed - Non Bank Total SOE Listed Others SOE Total EQUITY Pertamina PLN SOE Listed - Banks SOE Listed - Non Bank Total SOE Listed Others SOE Total SALES Pertamina PLN SOE Listed - Banks SOE Listed - Non Bank Total SOE Listed Others SOE Total NET PROFIT Pertamina PLN SOE Listed - Banks SOE Listed - Non Bank Total SOE Listed Others SOE Total IDX Asset Equity Sales Net Profit PBV Equity SOE - Non Listed Market cap at 2.83x Rp tn Source: Ministry of State Owned Enterprises

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9 January 2013

Things to watch out for There have been signs that the government is showing more nationalistic tendencies, as reflected in the delayed Danamon merger with DBS, export restrictions on raw metals, renegotiations on the export gas price, and the negative investment list. A closer look at the facts, however, reveals a different picture. More restrictive banking The central bank has learnt lessons from the banking crisis back in 1997/98. As such, it takes a prudent stance in regard to how the banking industry should be managed. Adoption of Basel standards is a clear indication that the central bank wants the implementation of best practices in the banking industry. The recent move to increase the LTV for purchases of motorcycles, cars and homes was a preventive action intended to quell any speculative activities in such sectors. Nonetheless, a more restrictive industry will provide less room for earnings surprises as everything has its measure. At the same time, the banking industry is also expected to become more capital intensive. We think that the central banks intention is to consolidate the banking industry. This is because there are too many small banks that might need to be consolidated. Increasing the capital requirements will force smaller banks to consolidate by merging with each other or joining up with the larger banks. We might see more complexity as the oversight is carried out by Otoritas Jasa Keuangan (OJK/ Financial Service Authority). This new body will govern and monitor financial services (banks, insurance, the capital market, and other non-bank financial services). The protracted merger of Bank Danamon and DBS reflects the rapid acquisition of banks made by foreign investors. Before the financial crisis of 1997/98, foreign banks had relatively little business in Indonesia - either on the consumer or corporate sides. The national banks - either state-owned or private - were basically the main players in the banking industry. The list below shows that almost every major private bank recapitalized by the government has been sold to foreign investors. Even smaller healthy banks like NISP and Bank Ekonomi have been acquired by foreign names. This demonstrates that Indonesia is a very friendly place for foreign investors. By contrast, Indonesian banks have very little presence in the region since they do not enjoy the freedom and flexibility to invest in the regions financial sector. In short, the central bank is asking for reciprocal treatment before allowing further expansion by foreign investors in the country. Exhibit 27. Pre and Post crisis 1997/1998 ownership in medium sizes banks
Banks Bank Danamon Bank Lippo Bank Niaga Bank Bali BCA BII BDNI NISP Bank Summa Bank Buana Bank Ekonomi Previous Owner Usman Admadjaja Mochtar Riyadi Julius Tahija Jaya Ramli Sudono Salim Eka Tjipta Widjaja Samsul Nursalim Partawidjaja William Soeryadjaya Katuari family Current owner Temasek Khazanah Standard Chartered & Jardine Farallon Maybank Closed OCBC Closed UOB HSBC Note Merged to CIMB Niaga Changed to Bank Permata Linked to Djarum Group

Source: Danareksa Sekurias

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9 January 2013

Capturing more value-added Under regulation No.7/2012 dated February 6, 2012 issued by the Minister of Energy and Mineral Resources, mining companies which hold IUP Operation and Production licenses and/or Contracts of Work are prohibited from exporting unprocessed mineral ore. The new regulation standardizes the minimum content for each mineral which can be exported. There have been some discussions concerning an export tax on coal. However, implementation of a new ruling would prove to be difficult since most of the major coal mining contracts are under the CCOW first generation which would offer protection from such changes. It is clear that the government is keen to protect non-renewable resources - especially those that are being exported in unprocessed form. We believe that the government wants to capture more value-added from non-renewable resources. This is why the government banned exports of unprocessed minerals and why it seeks to increase export taxes on coal exports. In the long term, these policies should be beneficial for the economy since they will create more value-added, boosting employment opportunities and raising purchasing power. However, the short-term consequences are less positive, creating negative sentiment towards certain sectors and companies. This kind of policymaking generates uncertainty and volatility in the mineral sector. Minimum wages Toward the end of 2012, regional governments approved significant hikes in minimum regional wages. The highest adjustment was made by East Kalimantan, a resource-rich province which approved a minimum wage increase of 49.7% and Jakarta, a services and manufacturing city, which approved a minimum wage hike of 43.9%. Overall, minimum wage increases varied from 6.5% in West Sulawesi to 49.7% in East Kalimantan. The average increase was around 20.2%, a significant figure compared to previous years. There is an ongoing debate as to whether the overall impact of higher minimum wages will benefit or adversely impact the economy. As many factors are involved - demand elasticity, flexibility of the labor market (to hire/fire workers), monopsony power of the employer etc this is not an easy matter. However, we can deduce the following: 1) Higher minimum wages will translate into higher purchasing power. So basic consumer and retail companies could be beneficiaries. 2) High capital intensive companies might have a higher portion of skilled labor. Therefore, they will be less impacted by the new minimum wage. 3) Companies that are engaged in contract manufacturing will be hit the most. Export manufacturers of shoes and garments have no bargaining power to pass on the increasing costs by raising product prices. Higher product prices would lead to lower orders or simply no orders and production may be moved to other countries in the region. 4) Companies that manufacture high-end products might need to raise selling prices. Hence, higher purchasing power will be partly negated by higher prices. 5) Retailers that have limited pricing power may be forced to reduce operational hours as labor is a significant component of operating costs. 6) Higher labor costs will reduce the internal rate of return on investment. Therefore, it might slow down investment in general and create higher unemployment as the economy is not able to create more jobs.

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9 January 2013

In short, consumer companies should benefit and capital intensive companies will be least affected. Other companies potentially face a neutral to slightly negative impact, while contract manufacturers will be negatively impacted. Exhibit 28. Minimum regional wage in each province
FY12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 Aceh Sumatera Utara Sumatera Barat Riau Kepulauan Riau Jambi Sumatera Selatan Kepulauan Bangka Belitung Bengkulu Lampung Jawa Barat Jakarta Banten Jawa Tengah DI Yogyakarta Jawa Timur Bali NTB NTT Kalimantan Barat Kalimantan Selatan Kalimantan Tengah Kalimantan Timur Maluku Maluku Utara Gorontalo Sulawesi Utara Sulawesi Tenggara Sulawesi Tengah Sulawesi Selatan Sulawesi Barat Papua Papua Barat Average 1,400 1,200 1,150 1,238 1,015 1,143 1,195 1,110 930 975 1,492 1,529 1,529 992 893 1,257 968 1,000 925 900 1,225 1,327 1,177 975 960 838 1,250 1,032 885 1,200 1,127 1,585 1,450 FY 13 1,550 1,305 1,350 1,400 1,365 1,300 1,350 1,265 1,200 1,150 2,100 2,200 2,203 1,209 1,065 1,740 1,181 1,100 1,010 1,060 1,338 1,553 1,762 1,275 1,175 1,550 1,125 995 1,440 1,200 1,710 1,720 % 10.7 8.7 17.4 13.1 34.5 13.7 13.0 14.0 29.0 17.9 40.8 43.9 44.1 21.9 19.3 38.4 22.0 10.0 9.2 17.8 9.2 17.0 49.7 30.8 40.2 24.0 9.0 12.4 20.0 6.5 7.9 18.6 21.4

Source: Various News Research

Election year: always something good! We are one year away from the elections in 2014. As of the present time, there is no clear favorite, unlike in 2009 when SBY was hotly tipped to win a second term in office. Since SBY has already been elected twice, his party, Partai Demokrat, will need to nominate a new candidate for the presidency. We think that swing voters will be the deciding factor in this election. Loyalty towards political parties remains low. This was proven in the regional election for the Jakarta Governor. Although the incumbent had support from the major parties, the candidate supported by PDI-P and Gerinda (the opposition) won the election. This owed simply to the charisma and popular appeal of Jokowi and his partner Basuki (Ahok). Against this backdrop, the government is likely to favor populist policies. Hence, subsidized fuel price hikes are unlikely. All in all, the incumbent government will need to make propeople policies, although this may not be easy as the current coalition is still quite shaky. Nonetheless, good things tend to happen in election years. For instance, back in 2004, the JCI soared 44.6%, supported by relatively benign inflation of 6.4% and record high GDP (post 2000) of 7.2%. In 2009, the index surged 87.0%, underpinned by record low inflation of 2.78% and moderate GDP growth of 5.6%.

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9 January 2013

Exhibit 29. Election time in numbers, always something good

Snapshot stats JCI increase, % Inflation, % GDP growth, % Source: Bloomberg 2004 44.6 6.4 7.2 2009 87.0 2.78 5.6

Target Index of 5,040 To reach our target index we apply three valuation methods: 1) bottom up approach, plugging in all our target prices of individual stocks to reach our target index, 2) PER multiple based on EPS market 3) % market capitalization of GDP - a more macro approach since the stock market should also reflect economic growth. Using the simple average of these three approaches, we arrive at our target index of 5,040 for 2013, translating into PER FY13 of 15.9x, offering upside potential of 16.3%. Exhibit 30. Summary of target index
Bottom up Target Index 5,021 Target PER 16x 5,056 % of GDP 46% 5,043 Simple average 5,040

Source: Danareksa estimates, DRI, Bloomberg and BPS

A focus on domestic-oriented sectors Based on our top-down approach, we see consistent performance from domestic-based activities. This simply means that the consumer, manufacturing, property, and trade and services sectors should outperform. Stronger growth is, however, contingent on better infrastructure and the provision of financial services. Unless significant investment is made in infrastructure, growth may be curtailed. Concerns remain on the ability of the government to increase infrastructure development and, more specifically, on the thorny issue of land acquisition. These two issues remain as homework for the government and it is difficult to see any significant acceleration in infrastructure development in the near future. Exhibit 31. % market cap to GDP nominal
GDP Nominal 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1,863.27 2,045.85 2,295.83 2,774.28 3,339.22 3,950.89 4,948.69 5,603.87 6,422.92 7,427.10 8,488.00 9,740.00 % Mkt Cap of GDP 11.7 20.3 29.5 26.9 34.4 48.5 20.7 34.7 48.5 44.8 45.2 46.0 Index 425 692 1,000 1,163 1,806 2,746 1,355 2,534 3,703 3,808 4,317 5,043

Source: DRI, BPS and Bloomberg

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9 January 2013

Exhibit 32. Historical PER 2003-2012

2003-2012 Period PER Avrage High Low Median Source: Bloomberg 15.0 23.7 7.6 15.3

Top Picks In our universe of stocks, our top picks are BBRI, BMRI, GIAA, ICBP, JSMR, KLBF, MAPI, and SMGR. Among the smaller market cap stocks we like BSDE, ASRI, GJTL, HEXA, and WINS. The outlook for commodity stocks hinges on global economic recovery. Our picks are plantations firms BWPT and LSIP. Exhibit 33. Rolling PER of the JCI
x 25 20 15 10 5 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 6.8 12.64 P/E Forward Mean +2st.dev -1st.dev 21.38 +1st.dev -2st.dev

Source: Danareksa estimates

Exhibit 34. Top picks

Share price Rp GIAA ICBP JSMR KLBF SMGR BSDE GJTL HEXA WINS ASRI MAPI Banks BMRI BBRI 650 8,000 5,600 1,040 15,750 1,160 2,225 8,750 450 630 6,550 Mkt cap Rp bn 14,717 46,648 38,080 52,811 93,421 20,297 7,754 7,350 1,624 12,379 10,873 FY13F x 11.5 18.3 30.6 25.5 14.7 15.5 8.0 10.1 6.6 9.8 19.9 FY13F 10.6 10.2 PER FY14F x 8.2 16.6 19.9 20.7 13.8 12.7 7.2 8.8 5.0 7.7 15.9 PER FY14F 9.4 9.4 EV/EBITDA FY13F FY14F x x 4.6 12.3 15.0 19.1 10.3 13.8 5.0 7.2 5.5 5.2 9.7 FY13F 2.3 2.3 3.7 11.2 12.2 15.5 9.6 11.5 4.5 6.2 4.3 4.1 8.0 PBV FY14F 2.0 1.9 TP Rp/share 940 8,900 7,100 1,300 18,650 1,580 3,075 10,000 650 760 7,900 Potential upside % 44.6 11.3 26.8 25.0 18.4 36.2 38.2 14.3 44.4 20.6 20.6

8,250 7,350

190,575 179,505

9,900 8,600

20.0 17.0

Source: Danareksa Sekuritas and Bloomberg (as of January 4, 2013)

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9 January 2013

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