RHB Indonesia Morning Cuppa - 29 December 2016 - (Consumer)

Good morning,

Consumer: Spending To Be Boosted

Consumer spending is expected to improve, driven by higher minimum wage, which would increase faster than inflation, as well as higher coal and CPO prices – the main sources of income outside Java. In addition, accelerated government spending on infrastructure projects would likely create more jobs. The weaker IDR is a key risk since it would likely increase production costs. We see this to be manageable as consumer companies have room to increase selling prices. Our Top Picks are Indofood Sukses (INDF IJ, BUY, TP: IDR10,300) and Nippon Indosari (ROTI IJ, BUY, TP: IDR1,870).

¨ Higher wages to increase consumer spending in Java. We see consumer spending increasing, driven by higher minimum wage – average increase of 8.9% – much faster than our estimated inflation rate, at an average of 3.8% (after including higher electricity tariff). Higher minimum wage would increase consumer spending in the manufacturing and services sectors in cities such as Java and Bali, in our view.

¨ Higher commodity prices boosting disposable income outside Java. Outside Java, disposable incomes should be boosted by higher commodity prices – for coal and CPO. Our channel checks at United Tractors, the largest Indonesian heavy equipment distributor, suggest coal contractors have ordered more heavy equipment to increase production capacity, thereby creating more jobs. In addition, higher CPO prices would boost disposable incomes outside Java, in our opinion.

¨ Higher government spending likely to create more jobs. The House of Representatives approved the country’s investment budget for 2017, with infrastructure spending increasing by c.20% YoY (to IDR390trn). The area with fastest growth is general infrastructure for villages. The higher government spending on infrastructure should create more jobs, especially in rural areas. Next year, the Government is targeting to build 815km of roads, 550km of railway, 9km of bridges, 13 airports, and 55 seaports.

¨ Inflation likely to remain soft. We expect inflation to pick up slightly to an average rate of 3.8% in 2017, on account of planned electricity tariff hike and a modest increase in volatile food prices. Although inflation is estimated to accelerate, it is still at the lowest level. As a comparison, the inflation rate averaged at 5.4% over the last five years. Hence, we believe inflation should not significantly impact consumer spending.

¨ Weakened IDR a major threat. The IDR has been become more volatile since mid-November. Our economist sees that IDR/USD weakening to IDR13,700 by end-2017 (from IDR13,400/USD in 4Q16). This is likely to increase Indonesian consumer companies’ production costs since the majority of input costs are denominated in foreign currencies. However, given stronger projected consumer spending, we believe consumer companies have room to pass-on higher costs by increasing selling prices.

¨ On the positive side, lower commodity prices – especially wheat – are likely to partially offset the weakened IDR. Average wheat price has declined by 13% YoY to USD440 per tonne in 11M16 (FY15: USD507 per tonne). Wheat price is highly correlated with flour prices, the main raw material in the production of noodles, breads, and biscuits.

¨ Overweight. Given the better outlook for consumer spending, we are maintaining our Overweight stance on the Indonesian consumer sector. Our Top Picks are consumer companies with input costs related to wheat prices, such as Indofood Sukses and Nippon Indosari. Main risk to our call is a weaker IDR, although it would be partially cushioned by lower commodity prices, especially wheat, in our view. (Andrey Wijaya)

Link to Daily report: Indonesia Morning Cuppa - 291216