Deutsche Bank Indonesia Coal Sector : Rising thermal coal prices

Indonesia key beneficiary of rising coal prices amidst supply disruptions Indonesian coal is set to benefit from the price outlook amid the persistent weather issues, which are likely to severely impact Australia likely through 1Q11F. Indonesia remains the world’s largest thermal coal exporter, accounting for nearly half of Asia-Pacific’s seaborne supply; it should grow by some 10% over the next two years. Our preferred names are those with the largest exposures to coal prices (HRUM, INDY and ADRO).

Adaro has relatively been a laggard due to volume shortfalls but this has already been priced-in, in our view.
Strong coal price outlook in the next two years The current spot of about US$126/t already exceeds our above-consensus 2011F forecast of US$115/t. We recently forecast prices to reach US$135/t in 2012F and US$120/t in 2013F, reiterating our bullish stance on coal for the next two-three years. Companies to benefit the most are those with greater spot exposure, and higher operating and financial leverage. These include HRUM, INDY and ADRO (have only priced around 23-25% of their 2011F volumes) and Bumi (financial leverage), whose earnings would change 1.8-2.5% for every 1% change in the spot benchmark price.

Revised EPS implies at least 78% and 58% growth in 2011F and 2012F The price upgrades moderated 2011F earnings cuts of 5-25% due to lower volumes (weather) and higher costs (fuel price and mining contractors’
rates). Hence, for 2012F, we raise EPS by up to 7%. This still allows for the above-mentioned strong earnings growth rates in the next two years.

Sector target price PER of 19.4x and 11.8x in FY11 and FY12 NPV is based on life-of-mine DCF, while the revised target prices are set relative to the NPV. The revised target prices would imply a sector target 2012F PER of 11.8x, in line with the sector’s mid-cycle PER of 12x. Meanwhile, the target 2011F PER of 19.4x compares to the historical peak PER of 20-28x, which coincided with the previous coal price up-cycle in 2007-2008. The sector currently trades at an average of 14.5x 2011F PER at our US$115/t base case coal price forecast, or 11.7x 2011F PER at the US$130/t near-spot. We initiate Harum with Buy; maintain Buys for Adaro, Indika, PTBA, ITMG, and Hold for Bumi. 

Key risks: commodity price fluctuations and production disruption.