Market volatility creates buying opportunity - BoAML

No longer see much downside risk in coal price
At the current price level of US$123/t, we no longer see much downside risk in the coal price. China has come back to the market more aggressively in the last two weeks – the price rise in China domestic coal came earlier than expected. We expect coal prices to trend higher, especially in 4Q (with likely some volatility in 3Q) and we see the risk of our 2012 JFY estimate of US$129/t to the upside.

China buying seems to provide support for the market
We understand from our recent channel checks that: 1) China has been aggressively buying coal from Indonesia, with last week’s offer at US$92-96/t for 5000kcal NAR coal (or roughly 5300kcal GAR), or around US$115/t on index basis, but the ash content is likely higher at ~20%, vs. Japanese quality of <12%. This offer was higher by US$7-10/t than the prices in early April. Perhaps it was driven by speculation by traders, who dominate the China import market ahead of a hot summer. In any case, the momentum seems to be just starting; and 2) There is still about a US$10/t gap between Australia coal and Chinese domestic coal pricing, but the gap continues to narrow, with Chinese coal prices continuing to rise. This should provide near-term support for coal prices.

Japan pricing to Indo coal quoted around US$130-136/t
After Australian coal was priced at US$129/t, the pricing quoted for Indo coal for JFY2011 should be about US$130-136/t, factoring in advantage from lower freight rates and ash content. It seems some of the coal mines have been over-committed for delivery ahead of the Japan tsunami, softening the blow of price correction, our contacts say. Since one coal owner can own more than one mine, he/she is able to arrange the coal allocation strategically to one buyer from different coal mines.

Potential pricing volatility in 3Q
The good news is there is talk/hope that two of the four JPUs (Joban and Tepco) that were affected by the Japan tsunami could resume operations by July/August. But demand from China may come down on de-stocking or perhaps over-speculation by traders during 2Q. Also, coal supply tends to be the highest in 3Q (except in 2010). Safe to buy now, in our view; share prices still below NPV To look beyond the current phase of pronounced volatility to seek long-term growth that a multi-decade super cycle event offers, we have used DCF up to the end of contract life or reserve life (whichever is faster) to value all Indo coal companies, with the exception of BUMI. Our pecking order: SAR, ITMG and ADRO are trading at 5%, 12% and 8% discounts to NPV, respectively. Share prices tend to overshoot NPV when coal prices rise, so we reiterate our Buy ratings on those names.

Consolidation first or big dividends could be on the cards
Most Indo coal firms, barring BUMI, are now sitting on huge cash piles (see table in page 2). Even for ADRO, we estimate it can raise up to US$2.5bn in loans if it needs cash for expansion. We learnt there is one relatively sizeable mine up for sale now.

Buy BORN (premium HCC producer) for met coal exposure
While we see more downside in the coking price near term than in thermal coal, as the Queensland effect fades and with slowing demand from Japan due to the infrastructure bottleneck, we still recommend clients buy BORN. We believe premium HCC will be prioritized over semi-soft/PCI, as buyers in such tight capacity will allow zero tolerance of operation failure. Indeed premium HCC price still stands firm at US$320/t.