Equity market strategy: The baby & the bathwater

Harry SU Head of Equities & Head Research Bahana Securities (The Jakarta Post today)

With the index having formed a new recent 2013 low two days ago at 4,174 and dipping below 2012’s year-end level, the propensity is for investors to panic and sell everything under the sun.  However, we believe that it is important that stock market players keep calm and not throw out the baby with the bathwater, in other words, preventing an avoidable error in which good counters are eliminated when attempting to get rid of bad stocks. 

The market is currently confronted by triple troubles from: 1. IDR weakness from funds outflows and 2Q13 current account deficit of 4.4% of GDP; 2. Lower growth due to higher interest rates and BI’s attempt to prevent rising NPLs by lowering LDR requirements; and 3. Scaled-back QE possibly starting in September. 
These concerns have caused nearly 20% market pullback since recent peak at 5,215, allowing for buying opportunities. 

We are of the view that investors must attempt to look forward when it comes to the current account deficit, as looking at 2Q13 level will provide a distorted view given that the impact of the fuel price hike is still absent during the period. 

On the local currency front, we believe the IDR will strengthen over the medium term on three factors: 1. Increased interest rates; 2. Higher exports; 3. Continued FDI into Indonesia.

On the latter, we think that Indonesia will continue to benefit from demand displacement from China.  With labor shortage and wages in the coastal areas at USD600 per month, companies are relocating from China to Southeast Asia, and in particular Indonesia given the country’s young and plentiful population base, ensuring a sufficient work force. 

In the export front, if the US and Euro zone are experiencing improved economic condition, Indonesia’s exports will eventually improve over the medium term in our view.  This, coupled with higher interest rate (we believe the central bank will hike at least another 25bp), will help shore up confidence in the local currency going forward.
 
Other market support will stem from the plan of the Financial Services Authority (OJK) to allow share buybacks without the need for EGMs to help support the market.  Meanwhile, the government has also instructed state-owned companies to implement share buybacks. 

Hence, we believe it is time for investors to begin bottom fishing, accumulating stocks with solid fundamentals.  Exhibit 1 below shows our top 10 picks which comprised of stocks which have the capability to withstand current short-term market shocks. 
Sector wise, we like companies in defensive industries such as consumer and telco.  We think that values in TLKM (-10% drop since its recent peak), GGRM (-35%), KLBF (-13%), ICBP (-22%), EXCL (-19%), and TELE (-29%) have emerged. 

On banks, our top pick is BMRI (-27%) which benefits from a rising interest rate environment as it holds the most variable government bonds.  PGAS (-20%) is another defensive name we like with one of the highest ROEs while SRIL is a new listing with a captive domestic market in military uniforms and resilient exports due to demand displacement from China and Bangladesh.

In conclusion, before you throw out the bathwater, it would be advisable to ensure that your baby (read: stocks) is well worth keeping. 

Exhibit 1. Top 10 picks, 2014F valuation

Mkt cap.
Price
TP
Upside
EPS gwt.
PE
P/BV
Yield
ROE

(USDm)
(IDR)
(IDR)
(%)
(%)
(x)
(x)
(%)
(%)
TLKM
22,928
10,950
14,500
32
7.6
13.5
2.9
3.8
22.3
BMRI
18,419
7,600
10,300
36
13.1
9.2
1.8
2.7
20.9
PGAS
12,715
5,050
6,800
35
2.1
13.7
4.6
4.1
38.2
GGRM
7,494
37,500
55,000
47
16.5
13.8
2.2
2.2
16.5
KLBF
7,067
1,340
1,580
18
14.0
28.8
7.1
1.7
26.3
ICBP
5,996
9,900
14,700
48
12.9
20.7
3.5
1.0
18.2
JSMR
4,167
5,900
7,300
24
18.3
20.1
3.6
2.0
19.0
EXCL
3,723
4,200
5,375
28
4.2
10.2
1.8
4.9
18.2
SRIL
492
255
360
41
18.9
23.1
1.3
0.0
12.3
TELE
278
495
900
82
20.8
7.8
1.7
4.0
23.0
Source:  Bloomberg, Bahana estimates