At the end of the third quarter earnings season, overall net profit rose steadily by 13.4 percent year-on-year (yoy), an improvement from 11.7 percent in the second quarter of this year and 12.4 percent in the third quarter of last year.

The Jakarta Composite Index (JCI), the main gauge of the Indonesia Stock Exchange (IDX), was up 14 percent year-to-date (ytd) through Nov. 3 in both local currency and US dollar terms, making it one of the best-performing stock markets regionally, and crossed the psychological level of 6,000 in the past week.

Through the remaining months of this year, we foresee a limited upside to our end-of-2017 target of 6,300 and also a stock-picker’s market near
term, but a decent upside next year.

As we roll over our valuation to the earnings per share (EPS) for next year at Rp 389 (3 US cents) (up 12 percent yoy) and apply an unchanged target of price to earning ratio (PER) of 18x (plus 1 standard deviation over past-five-year mean), we obtain our end-of-2018 JCI target of 7,000 (up 16 percent in upside potential).

The JCI now trades at a 2018 PER of 15.6x, with 12 percent growth of EPS and 18 percent of return on equity (ROE) on our forecasts.

Exhibit 1 shows sectors that booked above-market growth yoy in their third quarter net profit, namely infrastructure (up 133 percent), coal (up 87 percent), property (up 28 percent) and metals (up 22 percent).

Earnings of the infrastructure sector were driven by faster-than-expected revenue recognition from strong project pipelines and better margin delivery, while earnings of coal and metal were largely driven by a surge in average selling prices (ASPs) amid flat production volumes.

Property earnings picked up highly due to one-off land plot sales, namely PT Alam Sutra Realty’s land sales to China developers.

Transportation earnings, meanwhile, saw strong growth largely from Garuda’s improved efficiency.

Sectors whose earnings came inline yoy are telecommunication (up 25 percent), staples (up 13 percent), autos (up 13 percent) and banks (12 percent).

Earnings in the telecommunication sector were fueled by robust data consumption in line with deeper smartphone penetration. We put the telecommunication sector as inline as its operating profit growth was below the market, but its net profit after tax was above the market.

Earnings of staple producers made a decent growth on the back of more working days due to the impact of the seasonality of Idul Fitri as well as lower advertising expenditure.

Automotive producer, largely PT Astra International (ASII), was driven by better motorcycle sales because of lesser competition despite a margin dilution in car sales because of greater discount and large volumes of heavy equipment sales.

Lastly, banks continue to post solid growth not only due to high pre-provision operating profit (PPOP), but also largely a credit-cost recovery.

Weak earnings were recorded by cement manufacturers (down 57 percent yoy), retailers (down 49 percent), poultry firms (down 53 percent), plantation firms (down 16 percent) and media (down 12 percent).

Cement was the biggest drag because of subdued volume growth and ASP dilution as a result of competition although we believe that 2017 will be the bottom.

Poultry was down due to lower chicken prices, higher prices of corn relative maturity input and Idul Fitri seasonality impact.

Retail was hit by the Idul Fitri time shift (with a high base seen in the thidr quarter of 2016) and soft purchasing power.

Crude palm oil (CPO) saw a negative ASP growth despite stable production growth. Meanwhile, media were dragged by lower advertising spending as fast-moving consumer goods (FMCG) companies reduced their ad budgets.

Our new top 10 picks are (in) PT Bank Negara Indonesia (BBNI), PT Ramayana Lestari Sentosa (RALS), PT Indofood CBP Sukses Makmur (ICBP) and (out) PT Bank Rakyat Indonesia (BBRI), PT Mitra Adi Perkasa (MAPI) and PT Surya Citra Media (SCMA).

We replaced BBRI, which is a solid bank, but may see its net interest margin (NIM) fall after the recent cut of micro credit (KUR), with recently upgraded BBNI, a proxy for 2018 infrastructure lending.

We also replaced MAPI at full valuation with RALS, the best proxy for low-mid end purchasing power recovery and SCMA, which was recently downgraded after poor thir quarter result, with ICBP, a favoured FMCG play with attractive valuation.

Our favorite sectors and stocks in 2018 are banks (BMRI, BBNI), infrastructure (PT Jasa Marga (JSMR), PT Semen Indonesia (SMGR), coal (PT United Tractors (UNTR), consumer (PT Gudang Garam (GGRM), ICBP and RALS, and selected rate-sensitive names (ASII, PT Ciputra Development (CTRA).

Events to watch out for next year include regional elections (Pilkada) in June, annual Idul Fitri festivity in June, the Asian Games 2018 in Jakarta and Palembang in August and the start of the general election campaign period in the fourth quarter for presidential election in April 2019.
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The writer is the acting headof equity research at PT Bahana Sekuritas.