Indonesia Retail, Confident And Connected Retail Consumers

With the economy growing >5% annually and its people increasingly connected via social media (evidenced in 2014’s presidential election), we see a new generation of confident and informed consumers on the rise. Vibrant, younger Indonesians in the sizeable middle class want to satisfy their secondary needs.

They are optimists, entrepreneurial, technology-dependent and express their opinions and ideas freely on social networks. In this report we analyse which companies under our coverage are best positioned to capture these new consumer behaviour trends. Our Top Picks are Matahari Department Store and Matahari Putra Prima for their focused strategies and minimal USD exposure.

Consumer purchasing power to recover
Considering the deflation in Jan and Feb 2015, oil price hovering around USD50/barrel, Indonesia’s central bank’s decision to strengthen measures to stabilize the weakened IDR, and the slower pace of the expected US Fed Rate increase, we foresee a recovery in the Indonesian consumer purchasing power.

Strong consumer confidence
The consumer optimism is reflected in the Consumer Confidence Index (CCI), in Mar 2015, at 116.9, just slightly below the 120.6 level from Oct 2014, the month in which Jokowi was inaugurated as the President of Indonesia.

Changing lifestyle
Trendier and more brand conscious, Indonesian urbanites are keen to try out new brands and concepts. Based on a Euromonitor survey, 56% of people in Indonesia say that it is important for them to maintain or exceed the standard of living of their peers, compared to less than 25% in Brazil, Columbia, or Mexico. This attention to relative standard of living sets up a potential arms race in the coming years, which is positive for consumer retailers in Indonesia.

Informed, connected retail consumers ready for E-Commerce
Indonesians are very connected with some of the highest level media engagement in the world. The falling price of smartphones is likely to facilitate increased connectivity and social media engagement in the near future. Retailers with solid e-commerce plans will probably reap huge benefits within the next two to three years.

Retailers with good core strategies will excel. Competition is heated in Jakarta, with more entries during 2014 of global brands (eg H&M, Uniqlo, American Eagle), regional department stores (eg Aeon, Central, Parkson), and big-box retailers (eg Courts, IKEA). The UAE-based Lulu is also targeting to open two hypermarts in 2015. Our top picks are Matahari Department Store (MDS) and Matahari Putra Prima (MPPA) for their focused strategies and minimal exposure to the USD.

Key risks include: increased competition from foreign competitors, regulation changes, competition from minimarkets, currency fluctuation, inflation and erosion of consumers’ purchasing power.

Executive Summary
Retail sales growth will probably exceed again the GDP growth. Retail sales growth in Indonesia, with the exception of 2009, has always surpassed the GDP growth on average by 124% from 2005-2014. Thus, we can expect a minimum of 12.3% for this year’s retail sales growth in Indonesia with a GDP growth assumption of 5.5%.

Consumer purchasing power to recover. Considering the 0.24% and 0.36% deflation in Jan and Feb 2015, oil price hovering around USD50/barrel, Indonesia’s central bank decision to beef up measures in stabilizing the weakening rupiah, and slower pace of the expected US Fed Rate increase, we do foresee a recovery in the Indonesian consumer purchasing power in the coming months. Despite the 0.17% inflation last month in Mar, the central bank is confident that the full-year inflation in FY15 will be within its range of 4% +/- 1%.

Strong consumer confidence
The consumer optimism is reflected in the Consumer Confidence Index (CCI), in Mar 2015, at 116.9, just slightly below the 120.6 level in Oct 2014, the month in which Jokowi was inaugurated as the President of Indonesia. Furthermore, the global consumer confidence report from Nielsen showed that, in 4Q14, Indonesian consumers were the second most confident, trailing only India, in the Asia-Pacific.

Low modern trade penetration
Using the penetration of modern grocery stores as a proxy of overall modern store penetration rate in Indonesia, at only 12% in 2012 and 16% market penetration rate in 2013, the potential for modern retail sales in Indonesia is still huge despite increasing competition from both local and new foreign players. Continued rising income and improving living standard will further solidify the customer shifting to the more efficient, quality modern trade channels.

Increased minimum wage
Workers in Indonesia had a c.13% increase in minimum wage on average across the provinces in early 2015, which has increased income levels of the people across the country and their purchasing power.

Based on a 2013 Euromonitor survey, 56% of Indonesian surveyed consumers think it is important to maintain or exceed the standard of living of their peers, compared to less than 25% in Brazil, Columbia, or Mexico. This attention to relative standard of living sets up a potential arms race in the coming years, which is positive for consumer retailers.

Increased urbanization
Based on a 2013 report, McKinsey forecasts that Indonesia’s urban population could reach 71% (209 million people) in 2030 from 55% (138 million) in 2013. The contribution from Indonesia’s urbanites is expected to grow from 74% in 2010 to 86 percent in 2030
Huge potential of E-commerce in Indonesia. E-commerce is one of South-East Asia’s hottest emerging tech sectors.

Compared to many other emerging market regions, South-East Asia’s e-commerce market remains relatively undeveloped. More specifically, international investors (like Alibaba, Softbank, Sequioa, Naspers, OLX) and local players (like Lippo Group) have clearly seen the big potential of Indonesia’s E-commerce sector.

Valuation & Recommendation

We value our retail stocks under coverage using a DCF valuation, with consistent terminal growth of 5.0%, market risk premium of 5.0%, and risk free rate of 7.5%. All other parameters are based on each company’s unique circumstances.

Matahari Department Store (MDS) and Matahari Putra Prima (MPPA) are our top picks as they have the highest ROE, no debts and very minimal exposure to the USD. As we further explain in this report, they both are pursuing the right business strategy (see Figures 8 and 9) due to their asset-light policy and increasingly private label brands acceptance in Indonesia. For all those right reasons, we believe they demand premium valuations compared to their peers.

Investment Thesis
Retail sales growth usually surpasses GDP growth
Over the past 10 years, from 2005 to 2014, retail sales growth in Indonesia, with the exception of 2009, always surpassed the GDP growth on average by 124%. Thus, we can expect a minimum of 12.1% for this year’s retail sales growth in Indonesia based on a GDP growth assumption of 5.5%.

Consumer purchasing power to recover
Considering the 0.24% and 0.36% deflation in Jan and Feb 2015, oil price hovering around USD50/barrel, Indonesia’s central bank decision to beef up measures in stabilizing the weakening IDR, and slower pace of the expected US Fed Rate increase, we do foresee a recovery in the Indonesian consumer purchasing power in the coming months. Despite the 0.17% inflation last month in Mar, the central bank is confident that the full-year inflation in FY15 will be within its range of 4% +/- 1%.

Responsible actions from the Central Bank
Last February, BI stunned the market by cutting its benchmark interest rate by 25 bps to 7.5% due to controlled core inflation, lower international oil prices and better food security. It also expects capital inflows to emerging market countries, including Indonesia, as the European Central Bank embarked on its EUR60bn/month bond buying program, the quantitative easing.

In the most recent BI Board of Governors’ meeting in March, in addition to holding its benchmark rate constant at 7.5%, BI also stated it would beef up measures to stabilize the IDR via intervention in the foreign-exchange market and government bonds purchases in the secondary market. It is a welcomed move as continued weakening and uncertainty of the IDR would jeopardize expansion plans of lots of companies here and put a serious dent in consumers’ spending patterns.

Choose retailers with strong local brand acceptance
We believe retailers with strong local brands and minimal exposure to US Dollar, such as Matahari Department Store (MDS) and Matahari Putra Prima (MPPA) will continue to gain traction with the Indonesian customers this year. While Mitra Adiperkasa (MAPI) does target mid to high-end segment, its profit margins could be under pressure as it may not fully pass on the required price increase on its imported brands given the competition among fashion retailers is already intense.

Good Retail Sales Index (RSI) growth in Jan 2015
Although the Retail Sales Index (RSI) in Jan 2015 dipped to 171.9 from 176.4 in Dec 2014, it actually grew 10.4% YoY compared to 3.3% YoY growth in Dec 2014. On a closer look into the RSI components, telecommunication equipment recorded c.30% growth YoY, followed by food and beverages (F&B) and tobacco at 15.1% growth YoY. In Indonesia, smartphone sales are rapidly increasing as they are considered a true modern lifestyle, further propelled by their falling average selling price (ASP).

Strong consumer confidence
The consumer optimism is reflected in the Consumer Confidence Index (CCI), in Mar 2015, at 116.9, just slightly below the 120.6 level in Oct 2014, the month in which Jokowi was inaugurated as the President of Indonesia. Furthermore, the global consumer confidence report from Nielsen (Figure 6) shows that, in 4Q14, Indonesian consumers were the second most confident, trailing only the consumers in India, in the entire Asia-Pacific region.

Indonesia retail landscape
As shown in Figure 8 below, ideally an Indonesian retailer would want to position itself in the most profitable Quadrant (namely Quadrant #4 with high margins, high turnover), as Matahari Department Store (MDS) does. If reaching Quadrant 4 is not doable, a retailer must choose to focus in the volume-driven business (Quadrant 1) or high margins business (Quadrant 3). Every retailer should avoid being trapped or moving backward into Quadrant 2, which usually means the business may require restructuring.

Although Matahari Putra Prima (MPPA) was in Quadrant 2 in FY14, it is currently moving upward towards Quadrant 4 as its asset turnover increased from 1.2x in FY11 to 2.2x in FY14, indicating its volume-driven business strategy is well executed. Likewise, its EBIT margin increased from 1.1% in FY11 to 4.8% in FY14. Based on this analysis we consider MPPA and MDS as our top picks.

Low modern trade penetration
Using the penetration of modern grocery stores as a proxy of overall modern store penetration rate in Indonesia, at only 12% in 2012 and 16% market penetration rate in 2013, the potential for modern retail sales in Indonesia is still huge despite increasing competition from both local and new foreign players. Continued rising income and improving living standard will further solidify the customer shifting to the more efficient, quality modern trade channels.

Increased minimum wage
Workers in Indonesia had a c.13% increase in minimum wage on average across the provinces in early 2015, which has increased income levels of the people across the country and their purchasing power. However, Ramayana (RALS) will likely continue to experience cost pressure from the minimum wage hike as: a) its low-end customers are very price sensitive and b) it cannot increase freely its product prices due to competition from the chronic cheap clothing imports entering Indonesia.

Based on a Euromonitor study, 56% of Indonesian surveyed consumers think it is important to maintain or exceed the standard of living of their peers, compared to less than 25% in Brazil, Columbia, or Mexico. This attention to relative standard of living sets up a potential arms race in coming years, which is positive for consumer retailers.

More foreign players attracted to Indonesia
Competition is increasing in Jakarta with the entry of global reputable brands like H&M, Uniqlo, and Forever 21. The influx of foreign players, lured by Indonesia’s middle class potentials, will definitely cap existing retailers’ pricing power, possibly leading to margin pressure for retailers that do not have focused core strategies or clear competitive advantages.

Tight retail space in Jakarta
The retail space market in Jakarta will experience limited future supply due to the moratorium policy for new mall development. Last year, only c.142,000 sq m of new retail space was added to the retail space market, the majority of which came from the new Lippo Mall Puri with 129,200 sq m addition.

Some of the anchor tenants for the new mall are Parkson, Matahari Department Store (owned by MDS), and Hypermart (owned by MPPA). Only two shopping centres are expected to begin operation in 2015, namely Pantai Indah Kapuk Mall (c.30,000 sq m) and Shopping Mall @ Pancoran (c.8,000 sq m). In short, rising rental costs in Jakarta are eating into retailers’ profits.

According to Savills PCI Research, retail space occupancy rate will gradually increase to around 95%-96% by 2018 from 92% in 2014, due to robust expansion of both foreign and local retailers, including F&B and lifestyle brand retailers. As the main business area of Jakarta, the central business district (CBD) area has the most upper-class shopping centres, having significant gaps in rental rates compared to those outside the CBD area.

Expansion outside Jakarta and Java
As retail space in Jakarta has become scarce, international retailers will look to tap other fast growing cities like Bandung, Yogyakarta, Surabaya and Medan to expand their businesses in Indonesia. Last month, H&M already opened its 6th and 7th stores in Medan and it plans to open one in Surabaya. Other retailers will most likely follow suit, such as Valiram Group from Malaysia, whose brands include Bath and Body Works and Victoria Secret.

In the case of Mitra Adiperkasa (MAPI), its bargaining power on rental space is weakening as there is more foreign competition entering Indonesia through Jakarta and malls are becoming very selective of its tenant mix. Furthermore, as the competitive Java region contributes 85% of its total revenues, MAPI has been experiencing EBIT margin compression.

Informed, connected generation
Indonesia’s 2014 presidential election witnessed the increased use of digital technology, at a level never seen in prior elections. Facebook estimated c.200 million Indonesia election-related interactions (ie posts, comments, shares, and likes) on its platform between March and July 9, the Presidential Election Day. Those interactions were mostly generated by users under the age of 35. Mark Zuckerberg himself traveled to the Facebook-crazy Indonesia and met with President Jokowi last Oct 2014.

Twitter estimated c.95 million election-related tweets were transmitted from the start of 2014. When it comes to retail purchases, more than 60% of Indonesian digital consumers, surveyed by Nielsen, profess to the influence of social media, far greater than developed markets like Australia, Japan or New Zealand.

Low penetration of smartphones
Based on eMarketer’s research, in Dec 2014 Indonesia was ranked 7th with c.38 million of total smartphone users (around 2% global market share, a 16% local penetration rate). In 2018, smartphone users in Indonesia will probably more than double, reaching c.100 million users (around 4% global market share), making them the 4th-largest smartphone users in the world. On a global basis, International Data Corporation (IDC) expects the average selling price (ASP) of smartphones to reach USD241 in 2018, down from USD297 in 2014.

A Balanced View On E-Commerce

Huge potential of E-commerce in Indonesia
E-commerce is one of South-East Asia’s hottest emerging tech sectors. Compared to many other emerging market regions, South-East Asia’s e-commerce market remains relatively undeveloped. We noticed the increased interest for Indonesia’s E-commerce sector from international investors (like Alibaba, Softbank, Sequioa, Naspers, OLX) and local players (like Lippo Group).

Current challenges of E-commerce in Indonesia
Lack of security in using credit cards has been the main reason preventing Indonesian consumers from shopping online. Offline payments are also crucial because Indonesia has 250 million people, but only around 8 million people have credit cards. Credit card growth is declining because of a new regulation preventing people from using cards if their income level falls below a certain amount, which we will explain further on the next page.

Restriction on credit card issuance
Consumer protection has been a concern of Bank Indonesia since 2012 with the promulgation of Bank Indonesia Regulation (PBI) No. 14/2/PBI/2012 as well as Circular No. 14/17/DASP concerning the Implementation of Card-Based Payment Instruments.

Indonesians still love shopping at malls, but do research products online
Indonesians love going to the store shopping physically, which is the number one activity during weekends – a great time for hanging out or catching up with families and friends. With few public parks available, Indonesian families do enjoy their free time in shopping malls. That explains why online sales were only less than 1% of total retail sales in 2014. People do research their products online, but then purchase offline due to the obstacles previously mentioned.

Based on Jana’s Online Shopping in Emerging Asia Jul 2013 survey, cash on delivery (COD) is the preferred method used in purchases by Indonesians, trailing only the Vietnam online consumers.

Offline retailers are also adopting E-commerce
In conclusion, we don’t foresee any demise of brick-and-mortar retailers any time soon. Given that the informed, social media active Indonesians do their review and research products online, the vigilant retailers, like ERAA, MAPI, and MPPA, have revamped and bulked-up their websites. Both MPPA and MDS will also be able to provide their offerings in MatahariMall.com, developed by the Lippo Group.

Regulatory Environment
Current relevant regulations for retailers in Indonesia. As the Indonesian retail sector keeps expanding, the Indonesian Government has introduced newer regulations since 2013 to prevent monopoly and spread the opportunity to smaller enterprising companies for them to grow in concert with their international counterparts.

The main key rules for both modern stores and franchise operations are related to: i) maximum outlets, ii) minimum local content, iii) maximum supporting goods, iv) maximum private labels, and v) restrictions on foreign investment and franchisee appointment matters.

Valuation & Recommendation

We value our retail stocks using DCF valuation with consistent terminal growth of 5.0%, market risk premium of 5.0%, and risk free rate of 7.5%. All other parameters are based on each company’s unique circumstances.

Matahari Department Store (MDS) and Matahari Putra Prima (MPPA) are our top picks as they have highest ROE, no debt, and very minimal exposure to the USD. As we have explained in this report, they both are moving into the right business strategy Quadrant 3 (as shown in Figure 38 and 40) due to their asset light strategy and increasingly private label brands acceptance in Indonesia. For all those right reasons, we believe they demand a premium valuation compared to their peers.

Matahari Department Store (MDS)
Due its asset light strategy and very well accepted private label brands (contributing 27% of its total gross sales), it has managed to maintain high margins and higher asset turnover each year. It won the prestigious Marketing Magazine’s Top 2014 Brand in the Department Store category.

Matahari Putra Prima (MPPA)
Like Matahari Department Store, MPPA also employs an asset light strategy and plans to push higher its private label brands’ sales contributions from the current 4% to 10% in the near future. It also plans to refine further its efficient centralized distribution centres to achieve 65% throughput from the current 60% level. To generate more traffic, MPPA is building 12 new stores and converting ten existing Hypermart stores to its most recent quality G7 format store.

Erajaya Swasembada (ERAA)
ERAA has been required by Samsung to order six to eight weeks of inventory when it places an order with Samsung as Samsung wants to defend its market share in Indonesia from the newcomers, such as Xiaomi, Asus, and Lenovo. It is renegotiating with Samsung and also plans to sell more accessories with higher margins. As such, we are NEUTRAL on ERAA.

Ramayana Lestari Sentosa (RALS)
RALS has been facing competition from the local regional retailers and cheap chronic clothing imports. On the cost side, it also has been facing rising wages. However, it has good operating cash flow generation complemented with a clean balance sheet. Its current focus on SPAR supermarket development might succeed, but it also may also divert its attention from protecting its still profitable department store division. As such, we are NEUTRAL on RALS.

Mitra Adiperkasa (MAPI)
MAPI has been suffering from the heated competition in Jakarta due to more foreign retailers and department stores expanding into Jakarta (Note: 69% of MAPI’s revenues are from Jakarta). It has also been trying hard to reduce its excess inventory with aggressive discounting/promotion. The weak IDR against USD might also dampen its customers’ appetites for pricier imported goods (Note: MAPI imports 60% of its goods). As such, we have a NEUTRAL on MAPI.