EEMA - EIDO ETF: Going Against The Tide

2023-11-02 15:20:42 ET

Summary

• iShares MSCI Indonesia ETF has underperformed EM-Asia in the past year, but we think it could be due for a comeback.
• We appreciate Indonesia's consistency when it comes to growth and next year it will be one of the few regions that will likely deliver improved GDP growth.
• EIDO is heavily exposed to the banking sector and that sector will benefit from a number of tailwinds.
• We feel the price action looks overextended to the downside and the valuations are not prohibitive.

Introduction

The iShares MSCI Indonesia ETF ( EIDO ) is a 13-year-old ETF that focuses on 85 Indonesia equities. Over the past year, EIDO has proven to be a disappointment of sorts; whilst a diversified portfolio of Emerging market Asian stocks have delivered steady returns of 12%, EIDO has lost ground by -12%.

EIDO may not be lighting up the sky, but we feel it could be poised to make a comeback, and we think the opportunity could be rather apt for opening yourself up to a region that will likely displace Brazil and Russia and become one of the to p five la rgest EMs over the next few decades. Nonetheless, here’s why we’re optimistic about Indonesia in the short-to-medium term.

Macro Considerations

If one considers the OECS’s latest economic outlook , most notable regions across the world, are poised to deliver a lower cadence of GDP growth in FY24 relative to FY23. However, Indonesia is one of the rare exceptions which will see its GDP growth pick up from 4.9% this year to 5.2% next year.

If one is prepared to overlook the pandemic phase, you’d find that Indonesia is one of those rare economies that offers you consistent GDP growth of ~5% year in and year out. It did this for five straight years before FY20, and is now poised to do it yet again in FY23 and FY24.

For a landscape that generates such consistent economic growth, we feel it would pay to garner additional exposure to banks as the beta of loan growth relative to GDP growth typically tends to be around 2x (S&P Global certainly believes that could well be the case, with loan growth expected to come in at 10-12% for the year. EIDO is very well-positioned in that regard, as over half its holdings are in banks.

If one scrutinizes the Indonesian central bank’s recent banking survey , it looks like Indonesian banks could continue to flourish with loan growth across all loan types poised to witness further traction (working capital loans will likely lead). All in all, the weighted net balance, a proxy that measures new loan disbursements is poised to improve from levels of 95.4% to 96.4% in Q4.

There’s something to be said about the appetite for credit growth in Indonesia, when you consider that the central bank has already lifted rates by 250bps since August 2022. Some of this is driven by the fact you currently have down-payment policies on products such mortgages and auto loans, something that will likely linger all the way to the end of FY24. These rate hiking initiatives should also reflect well on the net interest margin position of some of Indonesia’s largest banks. Note that some of EIDO’s top holdings PT Bank Rakyat Indonesia and PT Bank Mandiri are poised to deliver relatively high NIMs even in FY24.

One other positive surprise we’ve seen of late is the central bank’s surprise decision to lift rates again, when many experts thought policy rates would be left unchanged . The central bank has received some criticism from some quarters for resorting to this outcome, particularly when inflation appears to be within their target range , but we think this is a welcome development as it could likely trigger greater flows to Indonesian assets away from Indian assets (India appears to have put rates on hold and will likely trim them next year) in an environment where the carry trade standards are going to be even more discerning. Note that the spread between the 10-year benchmark relative to India’s corresponding instrument was quite wide at well over 75bps three months back, but lately it has narrowed quite considerably.

One potential wildcard to also watch is Indonesia’s thrust in leveraging its nickel expertise and how favorably this could reflect on the country’s trade balance over time. The economy is believed to have the world’s largest nickel reserves at 21m metric tonnes and is currently exploring options to lock down a limited free trade deal with the US.

Closing Thoughts- Technical and Valuation Considerations

On the charts, it appears that the momentum is currently with the bears, but there’s reason to believe that things may change soon enough.

On EIDO’s weekly chart we can see that since October 2021, the ETF had chopped around within a certain range (as demarcated by the two black lines). Currently the price is intriguingly poised at around the lower boundary of this range. We’d like to think that EIDO could be a due a bounce or could flatten out from here on account of a few reasons.

Firstly, we think the selling momentum has been overdone; we’ve now seen seven straight candles where the close of the week has been lower than the open. Secondly note that the 14-period RSI has hit oversold levels and is now at its lowest point since the pandemic lows of March 2020. Finally note the yellow highlighted area which captures the price action from June to August 2021. We’ve seen this terrain work previously as a congestion zone, and even if EIDO may not quite make a smart bounce, we think the probability of flattening out here should not be dismissed.

The buy case for EIDO is further supplemented by the fact that the EIDO does not look overbought vs its peers from the EM-Asian terrain. The image below shows that EIDO’s RS ratio, versus the EEMA ETF is around 22% off the mid-point of its life-long range, offering up some scope of mean-reversion.

Finally also consider that EIDO is currently priced at a P/E multiple of 11.94 , which translates to a 3% discount to EEMA’s corresponding multiple . Meanwhile both portfolios are also poised to deliver a similar threshold of long-term earnings growth of 10% or thereabouts.

For further details see: