Regional Market Focus

Indonesia Strategy
DBS Group Research . Equity 02 July 2010
Analysts Sachin Mittal +65 6398 7950 sachin@dbsvickers.com Indonesia Research Team
“Recipients of this report, received from DBS Vickers Research (Singapore) Pte Ltd (“DBSVR”), are to contact DBSVR at +65 6398 7950 in respect of any matters arising from or in connection with this report.”

Opportunity amid volatility
• Benchmark bond yield has plunged to a 13-year low; potential for sovereign ratings upgrade bodes well for equities Stronger Asian currencies due to RMB revaluation should help Asian equities Market may re-rate to 15.5x 2011F PER, > 20% upside potential. Near term weakness is a buying opportunity

• •

Key Indices JCI LQ45 Industry Consumer Rp/US$ Daily Vol (m shrs) Daily Turnover (Rpbn) Daily Turnover (US$m) Current 2,913.7 566.1 312.0 959.0 9,083 3,187.2 3,026.8 333.2 % Chg 0.7% 0.6% 1.1% -0.8% -0.6%

Lower risk-free rate presents a solid case for re-rating. The benchmark 10-year bond yield (proxy for risk-free rate) stands at 8.1%, having declined 40 basis points over the last one-month and 190 basis points YTD. The immediate catalyst was Moody’s revision in the outlook for Indonesia’s sovereign debt to positive from stable on June 21. Government targets further improvement in Indonesia’s sovereign rating, with an objective of securing investment grade rating in 2011, which DBS Group Research believes is a feasible target. Our current discount rates are based on a 9.5% risk-free rate. Incorporating an 8.5% risk free rate, we can justify 15.5x 2011F PER instead of 14x, translating into a target of 4800 for MSCI Indonesia. A 15.5x PER with 8.5% risk-free rate is conservative compared to the 2007 peak of 15.6x PER with a 10% risk-free rate. Stronger Asian currencies are associated with market outperformance. While the pace of RMB appreciation is uncertain, China’s focus to shift reliance from exports to domestic consumption is quite certain. A weaker USD or stronger Asian currencies were also associated with Asian market outperformance in the past. During the RMB managed float regime in 2005-08, Indonesia (JCI +90%) outperformed (STI +30%, KLCI +20%) Moreover, the Indonesian economy is largely insulated from the European crisis, with domestic demand accounting for 90% of real GDP. Ride on the domestic demand theme. Banks have outperformed in the last one-month driven by expectations of loan growth exceeding 20%. Bank Mandiri is our top pick in the sector. We like Indofood in the consumer sector and XL among telcos. We prefer Adaro as a proxy to the Indonesian coal sector. Key risk to our view. A rise of over 200bp in the 10-year bond yield precedes major market correction historically. Bond yield above 10% could indicate potential market correction.

Source: BEI

Market Key Data (%) 2009A 2010F 2011F (x) 2009F 2010F 2011F

EPS Gth 27.6 16.7 17.7 PE 17.3 13.4 11.4

Div Yield 2.3 2.9 3.3 EV/EBITDA 6.6 5.5 4.7

Source: DBSVI
Stock Picks – Large Cap

Source: BEI, DBSVI
Stock Picks – Small Cap

Bank Mandiri Bank Rakyat Indo Perusahaan Gas Adaro Energy Indofood Sukses XL Axiata

Price (Rp) 29-Jun 5,900 9,150 3,825 1,970 4,050 4,050

Target Price 7,000 11,100 4,800 2,500 4,750 5,200

Sampoerna Agro

Price (Rp) 29-Jun 2,300

Target Price 3,275

Source: BEI, DBSVI

“In Singapore, this research report or research analyses may only be distributed to Institutional Investors, Expert Investors or Accredited Investors as defined in the Securities and Futures Act, Chapter 289 of Singapore.” www.dbsvickers.com Refer to important disclosures at the end of this report ed: JS / sa : TW

Regional Market Focus Indonesia Strategy

10-year bond yield as a leading indicator As seen in Chart 1, the equities market corrections in Indonesia in 2005 and 2008 were well preceded by significant rise (over 200 basis points) in the 10-year bond yield, reaffirming our belief that 10-year bond-yield is a reliable leading indicator. Similarly the PER re-rating in the past has been preceded by declining bond yields. Mathematically, we found a high correlation of -0.78x between PER and 10-year bond yields since 2005. Indonesia is amidst a sovereign ratings upgrade cycle, which should help lower yields and lead to higher PERs in our view. More rating upgrades waiting in the queue. Last week, Moody Investor Service raised the outlook on Indonesia’s local and foreign-currency debt to positive from stable, driving 10-year bond yields to a record low of 8%. In Chart 1: 10-year bond yields as a leading indicator of PER re-rating

September 2009, Moody had raised the country's sovereign rating to Ba2 with a stable outlook, which is now revised to Ba2 with a positive outlook. Ba2 is two notches below investment grade. The Moody's move comes after Standard & Poor's Ratings Services in March 2010 raised Indonesia's ratings by one notch to BB with a positive outlook. A BB rating is two notches below investment grade. Separately, Fitch Ratings in January 2010 had raised the country's creditworthiness by one notch to BB+ with a stable outlook, putting it only one step below investment grade. Given Indonesian government’s intent to secure investment grade rating in 2011, we expect continuity in the fiscal and monetary policies. We believe that Indonesia is on track to achieve investment grade rating and the key question is whether Indonesia can secure the rating in 2011 or 2012.

PER (x) 15
12.7x PER 31 May 07

15.6x PER 31 Dec 07

Yield % 30
12.8x PER 30 Jun 10

25
9.6x PER 30 Jan 05 9.1x PER 30 Sep 05

10

20
14.8% yield 30 Sep 05

15

5
10% yield 31 Jan 05 10.0% yield 31 Dec 07

10
8.0% yield 30 Jun 10

8.8% yield 31 May 07

0 2003

2004

2005

2006

2007

2008

2009

5 2010

MSCI Indo PE (LHS)
Source: Datastream, DBS Vickers

10 yr govt bond (RHS)

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Indonesia Market Focus Market Strategy

Implications of a lower risk-free rate As seen in chart 1, the benchmark 10-year bond yield (proxy for risk-free rate) stands at an all-time low of 8%, having declined 50 basis points over the last one-month and 200 basis points year-to-date. Sovereign ratings upgrades have started to gather momentum as Indonesia has been upgraded by Moody’s, Fitch and S&P over the last six months. We believe that Indonesia could return to investment grade (for the first time since 1997) over a one-to-two year timeframe. Our current discount rates are based on a 9.5% risk-free rate. Incorporating an 8.5% risk-free rate, we can justify 10-12%

higher valuation of 15.5x 2011 PER for MSCI Indonesia, instead of 14x. A 15.5x PER with 8.5% risk-free rate would still be conservative compared to the 2007 peak of 15.6x 12 month PER with a 10% risk-free rate. Historical correlation between PER and 10-year bond yields We saw high correlation of –0.78 between 12-month PER versus 10-year bond yields since 2005. Below is the scatter graph between the variables. This helped us to arrive at an approximate relationship between the two variables.

Chart 2: Historical relationship between PER and bond yield

18 16 12-month PER 14 12 10 8 6 4 2 0 0
Source: DBS Vickers

Source: DBS Vickers

y = -0.9753x + 22.612 2 R = 0.6119

5

10 10-year Bond Yield

15

20

Table 1: Sensitivity based on historical relationship
10-year Bond Yield 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0%
Source: DBS Vickers

12-month PER 16.4x 15.8x 15.3x 14.8x 14.2x 13.7x 13.1x

During 2008-2009, equity premiums had gone up substantially due to the global financial crisis, leading to much lower PER than suggested by the 10-year bond yields. We do not expect any major change in risk premium in 2010. On a bottom-up basis, lowering the risk-free rate to 8.5% from 9.5%, we estimate 12% higher valuation of 15.5x PER than 14x as suggested earlier by us. We would turn cautious on the market only if bond yields rise above 10%, indicating liquidity issues.

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Regional Market Focus Indonesia Strategy

Implications of RMB revaluation China surprised markets last week with its announcement that that it may be about to end its two-year-old peg to the dollar to allow greater currency flexibility. While the pace of RMB appreciation is uncertain, China’s focus to shift reliance from exports to domestic consumption is quite certain, in our view. We expect three key outcomes. (a) Back in 2005 when the RMB revaluation first took place, RMB appreciated 19% in three years (about 6.0% a year). Based on past experience, market expects RMB to rise by 3.0% by end of 2010, implying an annualized rise of 6.0%. Our economist believes that RMB appreciation may be slower, at less than 2% by end of 2010, as China could be cautious due to weak European demand. (b) A weaker USD or stronger Asian currencies are typically associated with Asian stock markets’ outperformance. During the RMB managed float regime in 2005-08, ASEAN stock markets delivered strong returns, with Indonesia (JCI +90%) outperforming (STI +30%, KLCI +20%)

(c) A stronger RMB means higher Chinese purchasing power, which may lead to higher imports of commodities. This could be beneficial for the Indonesian coal sector, with China as a key consumer, although the magnitude of RMB appreciation is a key uncertainty here. Rupiah expected to strengthen gradually DBS forecasts the USD/Rupiah exchange rate to be range bound between 9000-9300 in 2010 before appreciating to 8700 by end -2011 and 8300 by end-2012.

Key risk to our view is foreign funds outflow Going by the past experience in 2005 and 2008, equity markets may not see a substantial correction, unless 10-year bond yields rise by over 200 basis points, signaling major risk aversion. Attractive interest rates spread between IDR and USD bonds and bills make Indonesia an attractive destination for carry trades. It also suggests that Indonesia equity market could be subjected to external foreign factors such as Euro zone crisis.

Chart 3:USD/IDR exchange rate over the last two years
13000 12000 11000 10000 9000 8000 Oct-08 A ug-08 Jun-08

D ec-08

D ec-09

Feb-09

A pr-09

Oct-09

Feb-10

Source: Bloomberg

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A ug-09

A pr-10

Jun-09

Indonesia Market Focus Market Strategy

Domestic consumption continues to be strong Real GDP expanded 5.7% y-o-y in 1Q10, accelerating from 5.4% in 4Q09. Household consumption, the pillar of the country's economy, rose 3.9% y-o-y in 1Q10; investment gained 7.9% and exports gained 19.6%. An 8.8% decline in government spending, however, weighed on growth. Central bank expects GDP growth in 2Q10 and 3Q10 to expand at a faster pace as investment and consumption gain momentum. The Ministry of Finance (MoF) projected in May that Indonesia’s budget deficit in 2011 may be 1.7% of GDP, down from an expected 2.1% in 2010. MoF expects real Chart 4: Quarterly GDP (YoY) on rising trend
7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 Mar07 Jun- Sep- Dec- Mar07 07 07 08 Jun- Sep- Dec- Mar08 08 08 09 Jun- Sep- Dec- Mar09 09 09 10 6.1 6.7 6.7 6.2 5.8 5.3 4.5 4.1 4.2 5.4 6.3 6.2 5.7

GDP growth of 5.5%-6.0% in 2010 and 6.2%-6.4% in 2011 with 5.3% inflation in 2010 and 4.9%-5.3% in 2011. All this is reasonable and not significantly different from DBS Group Research’s projections for 2010 (deficit: 0.9%of GDP, average real GDP: 5.5%YoY, average inflation: 4.7%YoY). Moreover, the Indonesian economy is largely domestically driven, with domestic demand accounting for 90% of real GDP. Lastly, we continue to see the monetary policy outlook as bond friendly. Bank Indonesia’s Deputy Governor Hartadi Sarwono said in May 2010 that there is no urgency to raise interest rates if the inflation rate hovers around 5-6%.

Source: CEIC, DBS Group Research

Chart 5: High consumer confidence index of 110 in May 2010

120 110 100 90 80 70 60
Ju l-0 9 Se p09 No v09 Ju l-0 8 Se p08 N ov -0 8 Ja n09 Ja n10 ar -0 9 ar -1 0 M ay -0 8 ay -0 9 ay -1 0 M

M

M

Source: CEIC, DBS Group Research

M

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Regional Market Focus Indonesia Strategy

Chart 6: Motorcycle sales continues to be strong (Astra)
700000 650000 600000 550000 500000 450000 400000 My 9 a -0 Sp 8 e -0 Sp 9 e -0 My 0 a -1 350000 M r-0 a 9 Nv 8 o -0 J l-0 u 8 Jn 9 a -0 Nv 9 o -0 M r-1 a 0 J l-0 u 9 Jn 0 a -1

Source: CEIC, DBS Group Research

Chart 7: Car sales continue to be healthy (Astra)
70000 60000 50000 40000 30000 My0 a- 9 My1 a- 0 N v0 o- 8 Mr 0 a- 9 N v0 o- 9 Mr 1 a- 0 20000

J l- 8 u0

S p0 e- 8

J n0 a- 9

J l- 9 u0

S p0 e- 9

Source: CEIC, DBS Group Research

Chart 8: Foreign reserves continue to increase (US$ bn) except for a blip in May 2010
80 70 70 70 61 60 50 40 M ay-09 S ep-08 S ep-09 M ay-10 M ar-09 N ov-08 N ov-09 M ar-10 Jan-09 Jan-10 Jul-08 Jul-09 62 58 57 51 50 52 51 51 55 57 58 58 57 58 65 66 66 72 79 75

Source: CEIC, DBS Group Research

Foreign reserves declined by about US$4bn in May, mainly due to investors selling off short term debt instruments (SBIs).At the end of 1Q10, there was US$6.9bn worth of SBIs

in the market, which should be less than US$3bn now after the recent sell off.

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J n1 a- 0

Indonesia Market Focus Market Strategy

Regional Comparisons
Table 2- Indonesia is cheaper than India, Hong Kong and Singapore on FY11F PER basis

Regional Earnings CAGR Versus PER
Sector MSCI Korea MSCI Hong Kong MSCI Taiwan MSCI Singapore MSCI India MSCI China Earnings CAGR 09-12F 20.1 13.8 32.0 13.1 22.4 19.0 PER FY10F 9.4 15.9 13.1 14.2 17.0 13.6 FY11F 8.8 14.6 11.6 12.9 14.0 11.6

MSCI Indonesia
MSCI Thailand MSCI AC Asia-ex-Japan
Source: Datastream, DBS Vickers

17.6
17.1 20.2

14.7
11.7 12.9

12.3
9.9 11.5

Table 3 – Indonesian earnings less likely to decline in case of weakness in exports due to Euro zone crisis

Sector MSCI Korea MSCI Hong Kong MSCI Taiwan MSCI Singapore MSCI India MSCI China MSCI Indonesia MSCI Thailand MSCI AC Asia-ex-Japan
Source: Datastream, DBS Vickers

1m -0.2 -0.7 -1.0 -1.0 -0.6 -1.2 -0.5 0.5 2.1

EPS chg % 2010 3m 7.7 0.2 8.0 1.4 0.3 0.1 1.0 1.8 2.6

6m 12.6 6.5 19.2 5.7 0.9 -0.6 3.8 4.5 7.9

1m -0.2 -0.9 -0.7 -0.8 -0.5 -0.8 0.1 0.4 2.2

EPS chg % 2011 3m 4.4 -1.6 2.2 1.9 1.2 -0.1 2.4 2.6 0.9

6m 7.8 0.5 7.7 5.8 2.7 -0.1 5.0 5.1 5.0

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Regional Market Focus Indonesia Strategy

Table 4 – DBSVI coverage sector performance
Price Company (RP) 30-Jun-10 1M Change (%) 3M 6M 12M

Consumer Indofood Sukses Bank Bank Central Asia Bank Mandiri Bank Danamon Bank Rakyat Indo Sector Plantation Astra Agro Lestari Sampoerna Agro London Sumatra Sector Basic Materials Aneka Tambang INCO Timah Sector Oil, Gas and Energy Bukit Asam United Tractors Adaro Energy Indo Tambangraya Perusahaan Gas Sector Telecommunications Indosat XL Axiata Telekomunikasi Indonesia Sector DBSVI Universe

4,150

16 16 12 19 9 11 13 1 7 5 2 2 (3) 1 (1) 2 6 4 9 5 5 (2) 19 1 3 7.7

8 8 7 9 (1) 13 8 (20) (14) (16) (19) (17) (19) (10) (17) 0 0 4 (5) (7) (2) (12) 16 (5) (3) (0.2)

17 17 23 28 19 22 23 (15) (16) (1) (12) (12) 3 8 (1) 0 21 15 17 (1) 9 5 111 (19) (7) 8.8

120 120 69 89 12 48 59 15 39 38 22 (4) (10) 6 (6) 49 88 66 86 23 53 (1) 226 3 15 40.5

5,950 6,000 5,400 9,300

19,350 2,275 8,300

1,940 3,750 2,150

17,250 18,750 1,990 37,150 3,875

4,950 4,075 7,700

Source: DBS Vickers

Page 8

Indonesia Market Focus Market Strategy

Sector growth and valuation
Chart 9: FY10F PER versus FY09-12F earnings CAGR for various sectors in Indonesia

20 18

Expensive Energy

16 14 12 10 8 6 0% 5% 10% 15% 20% 25% 30% Cheap Reasonable

Materials Cons Discr Cons Staples Financials Telecom Utilities

Source: DBS Vickers

Table 5 - 2009-12F earnings CAGR versus PER
Sector

Energy Materials* Cons Discr* Cons Staples* Financials Utilities* Telecom Indonesia*

FY09-12F EPS CAGR

FY10F PER

FY11F PER

12%

15.5 15.6 15.0 19.8 15.1 14.6 14.8 14.5

12.4 13.3 13.4 17.4 12.8 12.5 13.3 12.3

20% 16% 13% 22% 11% 7% 18%

Mandiri is our top pick for recovery of written off assets, leading to earnings upside. The sector outperformed the market in the last one-month and three months, with our top picks Mandiri and Rakyat being the biggest gainers. We expect the outperformance to continue. (ii) Energy sector offers decent growth, need to watch for Chinese imports. Based on DBSV forecasts, FY0912F earnings CAGR of 12% is fairly priced in at 12.4x FY11F earnings. The sector underperformed in the last one-month and three months. We expect the sector to perform in line with the market as a stronger RMB or weaker USD may lead to higher demand from China. We like Adaro as a proxy to the sector and for solid track record of production growth. Consumer staples are rich in valuation due to premium enjoyed by large cap stocks. Consumer stocks have always traded at a premium, as most of the stocks are large cap with higher liquidity. Unilever and Indofood are major stocks in the sector.

Source: Datastream, DBS Vickers *MSCI consensus forecasts (not DBSV forecasts)

Financials and consumers offer higher growth prospects. (i) Financials offer highest earnings growth potential. Based on DBSV forecasts, financials offer FY09-12F earnings CAGR of 22%, which is the highest among all sectors. This is driven by strong annual loan growth of over 20% as Indonesia has very low credit penetration, with a loan to GDP ratio of 26% compared to 50% in India and 120% in China. Bank

(iii)

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Regional Market Focus Indonesia Strategy

We like Indofood for higher rubber and sugar prices and a recovering noodle division. Out top pick Indosat has been a consistent outperformer in the last one month and three months and we expect the outperformance to continue. (iv) Telcos offer lower growth except for XL. Based on DBSV forecasts, FY09-12F earnings CAGR of 7% is the lowest among all sectors due to slower growth at PT Telkom. We like XL for much higher growth than the sector average.

(v)

Materials sector offer second highest growth. While the materials sector offers 20% FY09-12F earnings CAGR, the sector’s earnings are more volatile as they are subject to spot prices. Consumer discretionary offers third highest earnings growth. The sector offers 16% FY09-12F earnings CAGR with Astra International as the major stock in the sector. The sector looks fairly valued in relation to the growth prospects. However, the sector could benefit from earnings upgrades given strong consumer confidence index and loan growth.

(vi)

Sector and stock recommendations

SECTOR Banks Overweight

COMMENTS

STOCK SELECTION

Strong loan growth – may exceed original target of 20% in 2010 Bank Mandiri, Bank Rakyat Robust outlook for the next 3-4 years, as loan to GDP ratio of only 26% presents high growth potential, without diluting ROE Central bank expect GDP to to expand at the upper end of the its 5.5-6.0% forecast range in 2010 (4.5% in 2009). High consumer confidence index of 110 registered in May 2010 Unilever announced plans to double its Indon business in 4 years

Consumer staple Overweight

Indofood Seksus

Energy Neutral

Strong demand growth from domestic power plants Weaker USD may lead to higher imports from China & India Sector not cheap after massive out performance in 1Q2010 • Incumbent Telkomsel’s 60% revenue share too high to sustain. • Mobile internet is the key catalyst for smaller players.

Adaro and Pgas

Telecoms Underweight

XL Axiata

Source: DBS Vickers

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Indonesia Market Focus Market Strategy

DBSV recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends
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Regional Market Focus Indonesia Strategy

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