Indonesian Coal – A double whammy today...is the entry point fast approaching? - UBS

A double whammy of bad news for the Indonesian coal stocks this morning:

1. Adaro (ADRO Neutral PT 2,800) announced a poor result last night
Late last night ADRO reported a 49% decline in net income YoY to US$242m in 2010 on account of a slight drop in selling prices and cost pressure from higher fuel prices. The results was 10% below UBS estimates of U$269m reported net income. Production volumes grew 4% to 42mt, average selling price declined 3% to US$57/t and cash costs rose 17% to US$35/t YoY in 2010, in line with our estimates. We attribute the lower results versus our forecast to weak earnings at associated businesses, such as CoalTrade and SIS.

The result was 17% below consensus estimates, according to Reuters, which is likely to result in share price weakness after market open.

2. Newcastle prices are sliding and are poised to fall through $120
Hot off the press from industry journal Platts this morning - as relayed by the UBS Commodities team:

Thermal coal prices are vulnerable: Demand has ebbed in the Australian thermal coal spot market, with an expectation that FOB Newcastle prices may re-test the $120/mt support level in coming weeks as surplus cargoes to accumulate, market participants said.

Market sources said Australian thermal coal was facing looming oversupply, and stressed it could take considerable time for coal demand in Japan to recover after the recent earthquake. "There is still a surplus of coal available ex-Newcastle in the prompt (Q2), and I think this overhang will persist for a while into Q3 given that Japanese demand will be reduced for longer than many expect – we don’t expect it to recover in 2011," one market participant said. "There is a lot more coal around. Prices have to go lower as no one is buying at these levels," said a second market participant. He added that although buyers could stop buying, miners could not stop producing coal, with some excess thermal coal presently being stockpiled at mine sites.

Participants said there was a limit to how much Australian thermal coal could be absorbed by other Asia buyers. "Japan is not buying, South Korea is full and Taiwan is not taking any," a market participant said. (Platts)

Our read on the sales desk:
The poor ADRO result and the prospect of Newcastle falling through $120 short term is bad news for sentiment and we might see share prices fall back somewhat. However we shouldn't forget that our analyst Andreas Bokkenheuser (and others like him) downgraded their sector view on the basis that poor 4th quarter results and seasonal coal p weakness would weigh on stock prices. The poor 4th quarter results are by and large in the market now. It doesn't take too much imagination to guess that analysts will upgrade their sector view as prices fall to lower levels.

We agree with the call from Peter Hickson, Andreas Bokkenheuser and the rest of the global coal team that we will see very strong prices into the second half of the year. We are concerned, however, that there might once again be production shortfalls in 2011 - if the sun shines this dry season, we think that ''lack of heavy equipment deliveries from Japan" will become an oft-used excuse for production shortfalls.

In other words, we think that 2011 will be all about strong prices and moderate production growth. We'd look to buy on any weakness over the next couple of weeks as Newcastle slides below $120.