MACQUARIE RESEARCH Adaro Energy (Outperform) - Looking for ar brighter 2012

Event
§                          We reiterate our Outperform recommendation on ADRO and raise our price target from Rp2,500 to Rp3,250, representing 24% upside from the current share price. This is on the back of our global commodities team upgrading their thermal coal price forecast by about 20-38% to US$145/t (JFY11) and US$120/t (JFY12), which we believe is about US$20/t above consensus. This leads us to be 30% above consensus in 2011-12.

Impact
§                          Differentiated thermal coal view. Consensus believes that coal prices have peaked; however, we see the potential for continued supply disruptions, coking coal producers prioritising coking coal vs. thermal coal through the supply chain, and thermal coal being upsold into PCI/Semi-soft markets leading to shortage in 2011. In 2012, we expect the market to remain tight due to strong Indonesian and Indian demand, which, combined with rising Chinese costs, should lead to robust Chinese imports.
§                          2011 production challenges but long-term growth on track. We have downgraded our 2011 production forecast by 6% from 50mt to 47mt (roughly inline with the industry), mainly due to the below target pre-stripping work in 2010 (due to rain). However, we think in the medium term, the company is still well positioned to grow its production by 13% pa CAGR in the next three years.
§                          Limited benefit in 2011 but looking for strong 2012. Whilst we think the company has a limited exposure to the rising coal price in 2011 (as 50% of the company's current year production is sold at previous year's benchmark), we believe it is set to benefit in 2012. This is reflected in the company's increasing ASP assumptions from US$81/t in 2011 to US$90/t in 2012.
§                          Premium-valuation is warranted. We believe that the company's premium valuation of 12x 2011E adjusted PER vs the sector at 11x is warranted. This is especially due to a strong 2012 earnings outlook (as 2012 PER drops to 9.7x), solid governance, production outlook, liquidity and governance.

Further, we have changed our Asean coal valuation methodology from DCF to PER as we now expect the coal market to trade at a premium to the cost curve over the next three years, and therefore that stocks will trade at a premium to DCF. Our price target is based on a 15x PER in 2011E and 12x in 2012E.
 
Earnings and target price revision
§                          We have increased our earnings forecast by 9-29% in 2011-12 due to our higher coal price assumptions, leading us to be 30% ahead of consensus. We raise our price target from Rp2,500 to Rp3,250.
Price catalyst
§                          12-month price target: Rp3,250 based on a PER methodology.
§                          Catalyst: Increasing coal price and production, and production at Maruwai.
Action and recommendation
§                          We reiterate our Outperform recommendation on the company with a revised price target of Rp3,250. We believe consensus upgrades will drive share performance on this large cap and liquid name.