Indonesian banks' growth relies on rate cuts and infrastructure

Its banks will benefit from infrastructure spending.

It has been noted that despite the 42% price appreciation last year (vs 22% for the JCI), Indonesian banks will re-rate further on interest rate cuts and progress in the execution of infrastructure projects.

According to a research note from Nomura, it believes this will mark the return to higher growth, possibly to levels seen during previous episodes of high growth when the sector traded at 2.8x book, implying 17% upside from current levels.

The policy rate was reduced recently by 25bps and we expect an additional 50bp cut in the coming months. In 2006 and 2008, Indonesian bank stocks responded to the 250bp rate cuts within six months by appreciating by an average of 34% and 131%, respectively.

Indonesia appears to be on the verge of significant infrastructure expansion and the banks are in a strong position to finance these projects. Nomura estimates that 70% of the projected USD500bn investments will be via the private sector, and the incremental increase per year will be 7pp for loan growth and 11% for earnings.

Nomura also believes that Bank Mandiri and Bank Negara (BNI) stand to be the prime beneficiaries, given their close links to state-owned enterprises.

Here's more from Nomura:

Key risks - We see the return of tight liquidity and a potential ceiling on lending rates as the key risks. A 50bp increase in rates would cut our earnings by 7% and price targets by 16%.

A ceiling on lending rates in micro finance would be negative for Bank Rakyat (BRI) and Bank Danamon because this business accounts for 31% and 14% of their loans, respectively. We estimate a 1pp reduction in the lending rate could erase earnings by 4.4% for BRI and 3.6% for Danamon.

All banks benefit from interest rate cuts - BRI is our top pick as we expect it to benefit from falling interest rates via stronger net interest margins and lower credit costs.

We like Mandiri because we believe it can deliver a strong financial performance and it is positioned to benefit from infrastructure spending. We like Danamon because at 1.2x 12-month forward book, it is inexpensive considering it will likely be a prime beneficiary of interest rate cuts.

We rate BNI a Buy as we think it can leverage on its strong capital position and cheap deposits to deliver sustained growth. While BCA has an impressive franchise, at 3.7x FY15F book value of IDR3,771, we think it is fully appreciated.