The Pacific Ring of Fire

Today’s powerful earthquake 200 miles off the coast of the Indonesian island of Sumatra reminded the world that the country sits on the edges of the Pacific, Eurasian and Australian tectonic plates known as “the Pacific ring of fire.”

Earthquakes, volcanic eruptions and tsunamis always have been the major unknowns for investors in Indonesia. That said, this nation is shaping up to become the next “I” in the BRIC acronym, joining Brazil, Russia, India, and China as an emerging powerhouse.

Indonesia has a huge population of nearly 240 million, with a median age of 28. The country has the largest economy in Southeast Asia and has enjoyed strong economic growth for almost a decade. For the last five years, gross domestic product (GDP) growth averaged about 6 percent, based mainly on consumption and infrastructure investment (see chart, below).

Source: Bloomberg

Foreign direct investment (FDI) has been a big contributor to GDP in recent years, rising from USD2.6 billion in 2009 to USD20 billion in 2011. Last year, exports surpassed government projections and increased by 29 percent to USD203.6 billion.

The Indonesian stock market has been a relative underperformer this year among its Asian peers. This isn’t surprising, because the market has been a huge outperformer in eight of the past ten years and cheaper markets have been trying to catch up.

Indonesia’s Parliament recently shot down the ruling government’s proposal to raise subsidized fuel prices by a third. A deal was struck whereby the government was given the authority to raise prices if the country’s benchmark oil crude price averages 15 percent above its target of USD105 over six months.

Given that the oil benchmark is very close to this target, the planned price hike only has been postponed for a month or so. When it kicks in, it’s bound to boost inflation and perhaps trigger a stock market pullback.

That said, the government is projecting inflation at only around 6.8 percent for the year, not extremely high given the economy’s growth rate and previous periods when inflation surpassed 10 percent and at times even reached 20 percent. Moreover, the markets have been warned and Indonesia still boasts some of the lowest gasoline prices in the region. Infrastructure spending also is in full swing, providing a cushion for any setbacks.

Long-belated infrastructure investment is an important driver of the Indonesian economy. The latest government budget passed by Parliament pumps an extra USD2.7 billion in spending for roads, bridges and other fixed capital investments in six provinces in eastern Indonesia. The Jakarta administration also is in the process of awarding contracts for the construction of the first Mass Rapid Transit line that will be 111 kilometers long and cost USD1.5 billion.

That’s why any dip in the Indonesian market related to the recent earthquake or inflation fears is a buying opportunity. To be sure, the market isn’t one of the cheapest in the region but its growth potential is strong, with an estimated return on equity of above 20 percent. 

The market hasn’t been helped from the recent weakness of the Indonesian currency, which has lost some ground against the US dollar. Nevertheless, long-term trends favor the rupiah (see chart, below).

Source: Bloomberg

The telecommunications, financial and commodity sectors of the market are trading at reasonable valuations. The latter sector is especially appealing; Indonesian coal companies are trading at the lower end of their historical trading range.

Long-term readers know that PT Telekomunikasi Indonesia (NYSE: TLK) has been a favorite of ours for some time; see today’s Stock Spotlight section. To play the broader market, ETFs are the only liquid option for individual investors.

We recommend the iShares MSCI Indonesia Investable Market Index Fund (NYSE: EIDO), which offers exposure to banks and key industrial, materials and energy companies that otherwise would be almost impossible for investors to buy. A new addition to the model portfolio, this ETF is a buy up to USD35.

 

Stock Talk

Add New Comments

You must be logged in to post to Stock Talk OR create an account