Borneo Lumbung Energy Strong thematic appeal; new Buy, Rp1750 PO - BoA Merrill Lynch

Rare investment proposition; 22% upside potential to PO
BORN, our new Buy, with a PO of Rp1,750 (22% upside potential), is Indonesia’s only hard coking coal (HCC) producer. It offers a rare investment proposition not only in Indonesia, but also globally. We believe HCC supply in the world, especially premium quality, is limited, amid growing demand as the average blast furnace size increases throughout emerging markets. BORN’s product is considered premium HCC with a 60% CSR, 7% ash, & 26.5% VM. The asset’s uniqueness reminds us of BAYAN, in which KEPCO took 20% stake at a premium.

Sales volume set to triple between 2010E and 2012E
We initially doubted BORN’s ability to ramp-up volume due to the erratic river water levels, but our recent trip to the mine showed the problem can be solved by putting in extra capacity (at least up to 5mn t, in our view). In our view, 60% volume growth to 5mn t over 2010-12E is still feasible. It has up to 7mn t barging capacity (our est.), which should offer a three-month buffer when water level is abnormal. It should have mining capacity of up to 5mn t by end-2011, assuming six hours of rainfall. That said, we think the Street could be too conservative in its volume est.

Positive outlook on coking coal near-term and long-term
As a house, we are bullish on the coking coal price. Following severe outages, met coal supply adjustment could take some time, and while supply improves from Australia, Russia and Mongolia by Q3, underlying demand should remain robust and apparent demand will be supported by restocking, as such tightness could linger throughout the year. In the long term, we see emerging market cost inflation as a major positive supporting met coal prices over the next three years.

Share-price catalyst: Strong FY10 results; risks to our view
We set our PO on a par with its DCF up to the end of its mine contract (2039) based on the existing reserves of 69mn t in Kohong and potential reserve upgrade of up to 20% of JORC-certified resources. We use a WACC of 12% to arrive at the cost of equity of 17%. Catalyst: strong FY10 results. Risks: 1) weather; 2) shareholder’s commitment in BORN; 3) oil/HCC price volatility; and 4) delays in getting permits.