Investing in Indonesia's Favorite Pastime

The Daily Reckoning PRESENTS: The Profit Hunter’s Sala Kannan, traveled to Indonesia to investigate the country’s thriving cigarette industry – and arrived on World Anti-Tobacco Day. She quickly realized that Anti-Tobacco Day means nothing there…


I arrived in Indonesia’s capital, Jakarta, on World Anti-Tobacco Day. Ironically, I’m here to research the country’s thriving cigarette industry. It is the second largest employer in Indonesia. And the country’s three biggest cigarette makers are also among the largest taxpayers in the country. The industry contributes 12% of Indonesia’s tax revenue.

Smoking is a passionate pastime. The thick, spicy smell of Indonesia’s clove-based kretek cigarettes is everywhere. Street peddlers sell kreteks at traffic stops like hot dogs at a baseball game. Children as young as 15 smoke on street corners. And it seems like every wall in Jakarta is plastered with kretek advertisements.

Kreteks are made from a mixture of cloves and tobacco, giving them a characteristic spicy flavor. 92% of all cigarettes sold in Indonesia are kreteks. It is said that an Indonesian called Nitisemito invented kreteks. Claiming that cigarettes relieved his asthma, he mixed tobacco with crushed cloves and rolled it in corn leaves. He began selling these cigarettes in 1906. When one smoked Nitisemito’s corn husk-rolled cigarettes, the burning husk made a “kretek-kretek” sound. Hence the name of the cigarette.

I met economist Kahlil Rowter to talk about Indonesia’s consumption trends. Kahlil is a knowledgeable and jolly man; he brought along Rani Sofjan, head of equity research at Mandiri Securities. We met in Jakarta’s Auto Mall – a mall cum auto exhibition. On the first floor there were Isuzu, Harley-Davidson, Suzuki and Nissan vehicles on display. On the second floor was a line of shops and eateries.

We sat down in a cafe and chatted over cappuccino and chamomile tea. “Do you mind if I smoke?” Kahlil asked, pulling out a pack of Sampoerna A Mild kretek cigarettes. Around us, everyone in the cafe was lighting up. A thick cloud of smoke hung over every table.

Over 50% of Indonesians smoke. The evidence is everywhere – in malls, on the roadside, after work, during lunch – Indonesians are addicted to smoking. And they start young. The Indonesian health department estimates that 22.9% of urban 10-year-olds and 24.8% of rural 10-year-olds smoke.

“It’s a rite of passage,” Kahlil explained. “In the U.S., a child is grown up when he gets a driver’s license. Here it is when he starts smoking,” he joked. Blowing out a puff of clove smoke, Kahlil reminisced. “As a teenager, my father used to say I could start smoking when I had my own money to buy a kretek.”

I asked if there have been any nonsmoking regulations. “Look at how full this cafe is,” Rani Sofjan said, pointing with her Marlboro Light. “A few months ago, the cafe tried to implement a no-smoking rule. Its sales fell by half. Nobody wanted to come here anymore if they couldn’t smoke. Then it lifted the ban and now business is good.”

“Guess why Indonesians smoke so much?” Rani asked. “We are a Muslim country. We’re not allowed to drink. So we turn to the other vice – smoking,” she laughed. And although it is a health hazard, most smokers seem to ignore the negative effects of smoking.

“Nobody is worried about dying from smoking when there is the bird flu, earthquakes, volcanoes and tsunamis,” said Rani.

Such complacence on the consumer’s part has only helped the cigarette makers. Sampoerna is Indonesia’s fastest-growing kretek maker. Its market share has grown from 4% in 1992 to 25% today. The stock trades for just 12 times earnings. In fact, Sampoerna’s growth and performance were so attractive that tobacco giant Altria (MO:NYSE) bought out the company last year.

The other significant players in the kretek market are Gudang Garam and Djarum. But Sampoerna’s A Mild brand is the most popular. Gudang Garam and Djarum attempted to compete with Sampoerna in the mild segment, but failed. And the failure isn’t surprising. Sampoerna has such great brand loyalty that other brands face a tremendous barrier to entry. That also means that Sampoerna can raise prices and easily pass them on to the customer.

“Cigarettes are a good play on domestic consumption,” said Kennyarso Soejatman, portfolio manager at First State Investments Indonesia. And with the downward trend in interest rates, consumption growth is expected to pick up in Indonesia. Already, Indonesian households spend more on tobacco than they do on clothing and meat.

J.P. Morgan head of equity research Rizal Prasetijo told me, “The commodity boom has also put more money in people’s hands. Purchasing power is on the rise.” Indonesia is a significant producer of oil and gas, coal, copper and coffee. Record-breaking price increases in all these commodities have improved revenues for corporations and purchasing power for individuals. Already, demand for kreteks is so high that Indonesia has gone from a net exporter of cloves to a net importer.

Rizal also gave me an important investing tip: “Buy stocks in the nontradable sector.” Nontradables are those goods that cannot be dumped in a foreign market when there is excess production domestically. Rizal explained, “For example, if Malaysia built excess telephone lines, it couldn’t bring them and sell them here in Indonesia. So telecom is a nontradable sector.

“If China built excess roads, it couldn’t export the excess, so infrastructure is a nontradable sector. So are banking and real estate. The nontradables are buffered from foreign competition.

“Interestingly, kreteks are nontradable. If a foreign country produced excess cigarettes, it’d never be able to export them to Indonesia, because Indonesians don’t smoke regular cigarettes. So our cigarette industry is buffered from foreign competition.”

Kreteks in Indonesia are a classic case of emerging market consumerism. Mark Mobius of Templeton Funds says, “Commodities play a key role in an emerging-market investment strategy. But just as important are the consumer-oriented stocks.”

Mobius notes that spending power among citizens in developing countries is rising rapidly, and consumer-product companies are benefiting. His favorite picks include telecommunications giant China Mobile Ltd. and South Korea’s Samsung Electronics Co. Ltd.

As populations expand and incomes grow, people tend to consume more and more of certain goods. Often, such consumption patterns are culturally defined. Like cigarettes in Indonesia, tortillas in Mexico or Tata cars in India, looking for what an entire population buys is a great starting point for scouting investment opportunities.


Sala Kannan
for The Daily Reckoning
June 15, 2006

Editor’s Note: Sala has been quite busy lately. In addition to making the trek to Indonesia, she has been working tirelessly on a new special report on a “designer fuel” that could save us from $7 gasoline. Find out what this secret fuel is here:

How to Beat OPEC…and Make a Fortune Trying

Sala Kannan, a native of India and a graduate of the University of Cambridge, boasts connections with economists and industry insiders worldwide. An expert on global economic trends, she’s especially well versed in developing nations, such as India, Brazil, Argentina and China.

Sala is the author of the Agora Financial Special Reckoning Report series, which is an in-depth view of emerging markets and investment strategies.

Wearing baubles, bangles and beads.
I’ll glitter and gleam so,
Make somebody dream so,
That someday he may buy me,
A ring, ring-aling-a,
I’ve heard that’s where it leads,
Wearing baubles and bangles and beads.

– Kismet

This week’s big drop in the gold market slapped us like a jealous mistress. We were sure we needed to do something in return, but we weren’t sure what. Is this the end of our fling with gold? Or is it merely the beginning of something even more wonderful? We thought about it and came to a familiar conclusion. To make a long story short: if you wanted to buy some jewelry for your Indian girlfriend, this is probably a good moment to do it. You might want to pick up a few shares of Tata Motor Company, too, but that discussion will have to wait.

There are some things in which we here at The Daily Reckoning, as skeptical and cynical as we are, have an abiding and almost unquestioning faith.

When a politician says he is doing something for our sake, we are sure he is lying. When a central bank issues paper money, we are sure it will one day be near worthless. And when the great mass of investors goes running off in one direction…we are sure it is wise to go in the other.

The “flight from risk” was fully booked early this week; even the wait list was overflowing.

On Tuesday, the Nikkei went down by 4.14 percent with 222 out of a total of 225 stocks lost in the session. India’s Sensex index fell by 5.53 percent for the session, bringing it down by almost 30% since the early part of May. Emerging markets have lost all the gains they made in 2006.

Commodities and metals followed the rest of the market sheep to the shearing.

July copper closed down 21.8 cents, or 6.8%, at a little over $3 an ounce. July contracts for silver dropped by $1.44, or 13% touching $9.60 an ounce, a level it hasn’t seen since Feb. 23, 2006.

But it was the flight from gold that caught our eye. According to MarketWatch, “Gold futures closed lower Wednesday – failing to hold earlier gains despite weakness in the U.S. dollar, to tally a seven-session loss of more than $82 an ounce.” And we also learn from MarketWatch that “Gold has now fallen about 22% from its May peak above $730, pulling other metals with it.”

But wait. How can anyone still believe that gold is safer than dollars? Has it not lost $150 in the last three weeks? Is it not lower by more than 20%? What kind of a safe haven it that?

Well, we know we should be delighted. And somewhere remote in our frontal lobe, we suppose we are almost beside ourself with joy. Now, we know can buy more of the stuff for less money, we tell ourself. We would buy some gold bangles for our Indian girlfriend, if we had a girlfriend. And if she was from India. We would get more bangles for the buck.

But we are flesh and blood; yes, we are human, too. At least, we are Irish.

Which means we have poetry in our hearts as well as calculation in our heads. And yesterday, our heart bleated out a refrain of fear along with nearly everyone else’s. “What if we’re wrong…what if gold just keeps going down, down, down until it finally gets to Hell…or China?”

Then, for once – fortunately – we ignored the poet and turned to the accountant. “Gold is an even better deal today,” he informed us, and we came to our senses.

This week’s “flight from risk,” you see, is crowded with refugees from the Dubai Stock Exchange…with runaways from the Indian stock market, too. They are escapees from copper, and even deserters from gold itself. When gold crashed through $600, it seemed to have de-clenched some automatic program selling, or at least some knee-jerk selling. How else can you describe it? Who but a jerk with weak knees would sell gold at $600 when he deemed it a bargain only a month ago at $700?

But the jerky knees were everywhere. And there were the advisors, the experts, and the pundits…those who were in a fever to buy gold when it was a $100 more expensive. And now, they are in a delirium to drop it. There were the prophets of a new golden age in a panic that the “bubble in gold” had popped.

How do you account for such behavior? Along cometh Matt Stichnoth with what may not be an explanation, but at least it rounds out our observations:

“In Expert Political Judgment, Philip Tetlock…ran a systematic, multi-year study of forecasts made by political experts, then tallied the results. In particular, from 1987 through 2003 Tetlock asked 284 individuals, all of whom make their living analyzing and pontificating about politics…and added up their scores once the outcomes of the events were known…And what Tetlock found when he was done was the same thing that a regular viewer of those cable shows might already suspect: the forecasts made by political experts often end up being glaringly wrong.

“In fact, Tetlock’s work shows that the forecasts of experts aren’t much better (and are occasionally worse) than that of mere well-informed amateurs. And in just about every case, on every issue, over every measurable time frame, human prognosticators don’t do as well as mechanistic forecasting approaches…when subjects were asked to assign a likelihood to a series of hypothetical future events by rating their chances of happening from zero (impossible) to 1.0 (inevitable), the events that had been rated impossible or virtually impossible (0 or 0.1) by experts ended up happening fully 15% of the time. Sure things or near-sure things failed to occur a whopping 27% of the time. This is hardly the sign of a discerning knowledge of what the future holds.

“In all, it was a mess.

“One area that does show some significance correlation with accuracy, meanwhile, is the frequency of an expert’s contact with the media. Unfortunately, that correlation is negative. You read that right: experts that tend to appear regularly on TV tend to make forecasts that are even less accurate, on average, than their camera-shy peers. Someone please call the cable news networks.”

And don’t forget to tell investors: if they’re paying any attention to market forecasters – especially those on TV – they’re probably making a big mistake.

Here at The Daily Reckoning, we remind readers, we have no forecast, just faith. We have faith in Ben Bernanke, Hank Paulson, George W. Bush, Jean-Claude Trichet, Mervyn King, and all the great officials and experts of finance. They have unplugged the dikes, the sluices, the floodgates and the taps.

A tide of liquidity – mostly in dollars – has swamped the globe. Since the dollar was cut loose from gold, the great ones have destroyed 80% of its value. They will get the rest of it soon. They will not let us down.

More news from our team at The Rude Awakening…


Eric Fry, reporting from New York:

“We have no idea if these water stocks are worth their premium pricing. But we have some idea that business will be booming for a very long time in the U.S. water infrastructure industry.”

For the rest of this story, and for market insights, see today’s issue of The Rude Awakening.


We found Bill in Germany. Here are more of his thoughts…

*** These days the one thing that intrigues us as much as gold itself is Goldman Sachs, which is first an investment bank, but today, also the world’s biggest and most successful hedge fund. It has profits of 200%, leaving Enron at 100% in the dust. What it does, it must do well, it seems. But what does it do?

Luke Johnson in the Sunday Telegraph has an explanation. He says, “Hedge funds make their managers huge profits, so they can afford to bribe private bankers and others to push their products…Of course, the City [London’s answer to Wall Street] loves hedge funds. They deal ferociously and pay big commissions. They only manage a fraction of the total funds invested in U.K. equities, but pay a significant minority of fees.

“Consequently, brokers and investment bankers have promoted their ascent. And many of the cleverest investors have left the classical investment houses to work at their own hedge fund boutiques where, with a little luck, they can earn five times as much.”

More to come…

*** Sala Kannan, reporting from Indonesia:

“I arrived in Jakarta, Indonesia, early Wednesday morning and an air-conditioned Toyota SUV took me to the guesthouse I was to stay in. The guesthouse, I soon found out, was really a palatial 15,000-square-foot mansion in Jakarta’s posh Menteng area. A household of staff of about 15 greeted us and showed me my room. Everywhere I turned there was beautiful Indonesian furniture, large paintings of dancing girls and lavishly upholstered raw silk sofas.

“The mansion is a stately U-shaped structure wrapped around a shallow blue swimming pool. Swallows played around the pool every evening, diving down to touch the water, making the surface dance in concentric ripples.

“I counted at least 17 air conditioners in the house. And they ran all day and all night. Even if I switched off the air conditioner when I left my room, I always returned to find it switched back on. Sometimes lights were left on all night.

“You see, the mansion belongs to the Bank of Indonesia. Nobody actually lives in the house, yet the 17 air conditioners run 24 hours a day. And even when nobody is in the house, there are 15 household employees who simply watch TV and smoke all day. A classic case of underemployment.

“Underemployment is a common occurrence in rural farmland. A plot of land, for example, might require just one farmer, but there might be four people employed on that land, making them all underemployed. And that’s exactly what’s happening at the mansion.

“The official unemployment rate in Indonesia is 11%. But about 80 million of Indonesia’s 220 million people are employed in the agricultural sector and many are underemployed.”

*** Yesterday was the kind of day that made us think twice about our career as an international homme d’affairs. The affaires were pleasant enough, but getting to and from them was tiring. We rushed to the airport on Tuesday night, but got held up in traffic and missed our plane. We found another one, but it was delayed by thundershowers.

Britain and Germany are both still in the running for the World Cup soccer tournament, which is playing itself out now in Germany. From what our sources tell us, soccer hooligans on both sides of the channel have spent the last few weeks on the Internet organizing a rumble. So, the airport police are on the alert. Why they suspected your editor of being a soccer hooligan, we don’t know. We’ve never even watched a soccer match and have no idea what is going on when we notice one on the screen at the pub. Still, after we passed through the metal detector the guard decided it was time for the hands-on approach. We have never been so thoroughly patted down. When it was over, we didn’t know whether to leave a complaint or a tip.

When we finally got to Dusseldorf, it was after midnight. But the real trouble was, we weren’t going to Dusseldorf, we were going to Bonn. So, we had to jump in a cab for another hour or so. Fortunately, the cab driver was an Indy 500 racecar driver manqué who flew down the highway as if the polizei were after him. He must have lost the cops at Koln, because there were no sirens screaming of lights flashing when we got to our hotel on the Rhine.

“Did you know what hotel this is?” asked the driver.

“No…” we replied.

“This is where Adolph Hitler chewed the rug. He stayed here, and he was so annoyed at something, he got down on his knees and bit the carpet. I guess we Germans should have known there was something abnormal about him.”

The Daily Reckoning