Nomura Coal mining Indonesia (Update 4) Indo Tambangraya Megah

A diversified and defensive miner
 A diversified miner with seaborne exposure
As the fourth-largest coal miner in Indonesia, ITMG has diversified mine operations lowering operational risk and providing potential upside from coal blending. It has a wide range of customers with very strong exposure to promising and growing seaborne markets.

 Possibility of higher dividends
In our view, post the acquisition of Centennial Coal, Banpu could ask for higher dividends from ITMG. We believe that ITMG has the capacity to meet such demands due to its solid balance sheet and strong operating cash flow to fund both organic and non-organic expansion. We now assume a 60% payout, but think ITMG could easily increase it to 100% – almost a 5% yield, which would be the highest in the sector.

 Reserve valuation to mitigate mine life risk
The reserve revaluation to be done in 1Q11 is positive as it can enlarge the reserve base. The larger reserve figure should mitigate investor concerns over the company’s relatively short mine life (13.7 years vs peers’ 22-172 years).

 Attractive valuation
The current valuation at 7.7x 2011F EV/EBITDA is attractive as it is: 1) in the mid-cycle valuation of 4-9x (excluding 2008 crisis valuation), 2) 1x standard deviation, and 3) in line with domestic peers.

 Risks to our investment view
Risks include: 1) coal price volatility, 2) disconnection between coal and oil prices, 3) weather, 4) regulatory regime, 5) capacity upgrade execution, 6) mining contractors’ performance, and 7) disappointing dividend policy.

Valuation methodology
We set our target price at Rp73,000/share which implies 11.2x 2011F EV/EBITDA and 17.8x 2011F earnings. We set our target price based on average of 11.8x 2011F EV/EBITDA and 16.9x 2011F earnings. We use regression analysis which measures casual relationship between EV/EBITDA and PER as the dependent variables and coal price as the independent variable to set our target EV/EBITDA and PER multiples. We use data weekly data starting beginning of April 2009 when global equity and commodity markets started to recover. Based on our US$140/ton coal price assumption for 2011, the implied EV/EBITDA and PER multiples are 11.8x and 16.9x, respectively. Our target price is higher than our DCF valuation of ITMG’s reserves and resources of Rp27,900/share. The main reason that our DCF valuation is much lower than our target price lies mainly on ITMG’s short mining life.

Sensitivity analysis
We have conducted earnings sensitivity analysis on several input variables: ASP, production/sales volume and oil price.

 Average selling price
Changes in ASP can have a significant financial impact on ITMG. Our sensitivity analysis suggests that for every 10% change in our 2011-12F coal price assumptions, our 2011-12F core earnings forecasts would change by 26% and 20%, respectively.

 Production/sales volume
Our sensitivity analysis suggests that for every 10% change in our 2011-12F production/sales volume assumptions, our 2011-12F earnings forecasts would change by 13% and 12%, respectively.

 Oil price
Volatility in oil price should not have a significant impact to our earnings forecasts as fuel costs represent some 13% of ITMG’s total costs in 2011-12. Our sensitivity analysis suggests that for every 10% change in our 2011-12F oil price assumptions, our 2011-12F earnings estimates would change by 2% and 2%, respectively.