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 Kretek. Claiming that cigarettes relieved his asthma, he mixed tobacco with crushed cloves and rolled the mixture 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.

The Kretek industry is the second largest employer in Indonesia. And the country’s three largest Kretek makers are also among the largest taxpayers in the country.  The cigarette industry contributes 12% of Indonesia’s tax revenue.

I met economist Kahlil Rowter to talk about Indonesia’s consumption trends. Kahlil is a knowledgeable and jolly man and he brought along Rani Sofjan, head of equity research at Mandiri Securities. We met in Jakarta’s Auto Mall. 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 café and chatted over cappuccino and chamomile tea. “Do you mind if I smoke?” Kahlil asked pulling out a pack of A Mild Sampoerna Kretek cigarettes. Around us, everyone in the café was lighting up. A thick cloud of smoke hung over every table.

More than 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 ten-year-olds and 24.8% of rural ten-year-olds smoke.

“It’s a rite of passage,” Kahlil explained. “In the US a child is grown up when he gets a drivers license. Here it is when he starts smoking.”  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 non-smoking regulations. “Look at how full this café is,” Rani Sanjo pointed with her Marlboro light. “A few months ago the café tried to implement a no smoking rule. Their sales fell by half. Nobody wanted to come here anymore if they couldn’t smoke. Then they 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 joked. 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 and tsunamis,” said Rani.

Such complacence has only helped the cigarette makers. PT 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 competing 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 it on to the customer.

“Cigarettes are a good play on domestic consumption” says 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.

Head of equity research at JP Morgan, Rizal Prasatejo 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 has improved revenues for corporations and better purchasing power for individuals.

Rizal also gave me an important investing tip: “Buy stocks in the non-tradable sector.” Non-tradables 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, they can’t bring them and sell them here in Indonesia. So Telecom is a non-tradable sector.

“If China built excess roads, they cannot export the excess, so infrastructure is a non-tradable sector. So are banking and real estate. The non-tradables are buffered from foreign competition.

“Interestingly, Kreteks are non-tradable.  If a foreign country produced excess cigarettes, they’ll 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. As populations get larger and incomes grow, people tend to consume more and more of certain goods. A profit hunter is sure to do well tracking down such investments.

More Notes from Indonesia…

An Empty $3 million Mansion

I arrived in Jakarta, Indonesia early Wednesday morning and an air-conditioned Toyota SUV took me to the guest house I was to stay in. The guest house, 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 richly upholstered raw silk sofas.  Here is a picture of me in one of the mansion’s three living rooms:

The mansion is a stately ‘U’ shaped structure wrapping 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 conditioning 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 — an institution notorious for its wasteful spending. Nobody actually lives in the house, yet the 17 air conditioners run 24 hours a day. And even when nobody is in the house they have 15 household employees that 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 under employed. 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.

Prada for $20

Jakarta’s Mangga Dua (“Two Mangoes”) Mall is a fake goods haven. Prada, Gucci, Burberry and Louis Vuitton goods are stacked from floor to ceiling. “There are three grades of fakes,” a shopkeeper explained. As a tourist, she insisted I learn the science of fake goods. “Grade 1 is the best quality, made in Korea…good quality,” she said eagerly. Then her voice turned sour, “Grade 2 and 3 reproductions are cheaper but quality no good. That’s because it’s all from China.”

An Indivisible Currency

1 US dollar equals 9,100 Rupiah. The Rupiah is expected to reach 9,300 by year-end. However, Indonesia experienced a mini currency crisis in 2005 mainly due to oil price shock. Its worth noting that, although Indonesia’s oil and gas production accounts for over 30% of GDP, it is a net importer of oil.

The smallest Rupiah denomination is Rp. 20 and the largest is Rp. 100,000.

Regards,

Sala
June 02, 2006

Travel Notes From Indonesia was originally featured in the Penny Sleuth.