PT Indo Tambangraya Megah - 4Q10 weak due to high costs, but operations should start to improve in 2Q11 - JP Morgan

• FY10 results below expectations due to high costs: ITMG reported FY10 net income of US$204MM, down 39% Y/Y. The reported result was significantly below both JPM’s (26% below) and consensus’ (33% below) FY10 forecasts of US$276MM and US$305MM respectively. FY10 production volume of 22MM tons was up 3% Y/Y, while ASP of US$75/ton was up 6% Y/Y. Total cost of US$59/ton rose 19% Y/Y and was the main reason for the weak performance.

• 4Q10 core net income down 71% Q/Q: Subtracting 9M10 results, 4Q10 net income came in at US$18MM, down 74% Y/Y and 65% Q/Q. 4Q10 volume was 5.6MM tons, down 26% Y/Y but up 15% Q/Q. ASP of US$80/ton is up 32% Y/Y but flat Q/Q. The company mentioned mining fuel costs, increase in strip ratio, and demurrage costs caused the 71% Q/Q decline in 4Q10 core net profit.

• Could start to recover in 2Q10: Our channel check with mining contractors indicated that during 4Q10 rains occurred in 10 out of 12 weeks in Kalimantan, but that the weather has improved on a Q/Q basis in QTD 1Q11. ITMG mentioned that because of rain in 4Q10, it was forced to mine in areas that have a high stripping ratio, which increased its cost. We foresee an improvement in operations in 2Q10 as the dry season starts.

• Lower PT to Rp50,000, maintain Neutral: We reduce our FY11 net income forecast by 25% to US$336MM; this is now 39% below consensus as, at the time of writing, the Street has yet to react to the disappointing FY10. Our earnings estimate revision leads us to lower our Dec-11 DCF based PT from Rp60,000 to Rp50,000. The weak result could cause the stock to decline by about 10%, but we believe the worst was in 4Q10 and operations will start to recover in 2Q11. Maintain Neutral. We recommend selling the stock now and reestablishing a position at Rp42,500 or below.

Risks: (1) Rise in coal prices; and (2) lower-than-expected FY11E EPS.