Nomura Coal mining Indonesia (Update 6) Bumi Resources

Kickers…on the ball
 Vallar deal is the kicker
We expect the Vallar deal to be share price positive because of: 1) lower balance sheet risk through debt refinancing and/or restructuring, 2) lower share price volatility as a result of pooling of the group’s
ownership in Bumi under Vallar, and 3) potential improvement in corporate governance.

 Deleveraging despite scepticism
Despite market scepticism, BUMI is continuing its deleveraging process; it lowered last year’s debt by some US$500mn. Management has said it intends to lower the debt further by another US$800-1,000mn in 2011, but we have not factored this into our forecasts. Should the plan go ahead, we estimate a post-tax earnings addition of US$28-34mn, representing 11-13% of our 2011F earnings forecast.

 Strong 2010-12F EBITDA growth
We forecast BUMI will post a 77% EBITDA CAGR in 2010-12F on a combination of higher volume (13% CAGR) and better ASP (23% CAGR) in spite of higher production cash costs (5% CAGR).

 26% discount to peers
BUMI’s coal assets are trading at 2011F EV/EBITDA of 6.2x, a 26% discount to the average EV/EBITDA of its domestic peers. We expect the discount to narrow given improvements on the balance sheet side.
Our SOTP-based price target of Rp4,300 offers potential upside of 45.8%, hence we recommend BUY.

Profit and loss
We forecast BUMI to grow earnings from US$147mn in 2010 to US$984mn in 2012 (159% CAGR) on a combination of: 1) higher production (13% CAGR), from 60mn tons in 2010 to 77.2mn tons in 2012, and 2) stronger ASP (23% CAGR), from US$70.1/ton in 2010 to US$105.6/ton in 2012. We forecast EBITDA margin will then rise from 25% to 42% over the same period and net margin will increase from 4% to 13%. The company's net margin is currently still relatively low, and we expect a only a small increase as BUMI will still have to pay high interest charges of over US$500mn pa in 2010-12.

Balance sheet
We have not assumed aggressive debt reduction in our financial model for 2010-12. We assume the debt will decline gradually from US$3.9bn at the end of 2010 to US$3.6bn at the end of 2012. Bear in mind that BUMI plans to reduce debt by another US$800-1,000mn which, if executed, would save a significant amount in interest charges. We forecast gearing (debt/equity) will decline from 2.1x at the end of 2010 to
1.2x at the end of 2012, mainly due to a larger equity base driven by stronger operating cash flows.

Sensitivity analysis
We have performed earnings sensitivity analysis on coal price, volume, and oil price variables.

 Coal price
Our earnings forecasts are very sensitive to changes in our coal price assumption. Our sensitivity analysis suggests that for every 10% change in our 2012F coal price assumption, our 2012F earnings estimates change by 35%.

 Production volume
Our sensitivity analysis suggests that for every 10% change in our 2011-12F production volume assumptions, our 2011-12F earnings estimates change by 29% and 15%, respectively.

 Oil price
For every 10% change in our 2011-12F oil price assumptions, our 2011-12F earnings forecasts change by 18% and 6%, respectively.

Risk factors
Coal price volatility
Most of BUMI’s ASPs are driven by the internal coal price. Beyond supply and demand dynamics, this price can be affected by non-fundamental factors such as trading volatility/sentiment, currency movements and rebalancing of the asset portfolio. Our sensitivity analysis suggests that for every 10% change in our coal price assumption, 2012F earnings change by 35%.

Risk of coal price and oil price decoupling
Coal prices and oil prices have had a strong positive correlation over the past 10-11 years (coefficient correlation = 0.90). We expect the strong positive correlation between the two to continue. However, a decoupling of the two – ie, a higher oil price that is not followed by a higher coal price – would have a significant impact on BUMI’s financials.

Weather
Extreme weather is an external uncontrollable factor that could affect BUMI’s operational performance. We assume that starting in 2011, the weather will improve from that of 2010. Our production assumptions are sensitive to weather conditions and we have conducted an earnings sensitivity analysis on this variable. Our sensitivity analysis suggests that for every 10% change in our 2011-12F production volume assumptions, our 2011-12F earnings estimates will change by 29% and 15%, respectively.

Regulatory risk
Regulatory risk in the mining sector in Indonesia is probably the highest of any other sector, in our view. The risk lies not only in the implementation of mining regulations but also the synchronization of implementation of the regulations among upstream/downstream segments of the mining industry that would in turn affect the
mining sector.

Industry data reliability
It is very difficult to find reliable data on the Indonesian coal industry. Data from one source could be  significantly different from that of other sources. Given Indonesia’s position as the world’s largest coal exporter, miscalculation or error in industry statistics would have a significant impact on the global coal market.

Execution risk
We have assumed that BUMI will able to engage contractors, secure the required equipment, and do other necessary mining activities to ramp up its production.

External mining contractor risk
To diversify operational risks, BUMI has engaged with mining contractors to mine reserves and aims to engage more in the future. Even though this policy is good from the perspectives of efficiency and cash flow management, the flip side is that it also poses additional risk to BUMI should the mining contractors be in trouble.

Balance sheet risk
To lower the balance sheet burden, management intends to continue the deleveraging which it started in 2010. Unsuccessful deleveraging could result in a higher risk premium and cost of debt, which could hurt the company’s financials and share price performance.

Tax dispute risk
Although BUMI has repeatedly mentioned that it has already settled its tax obligations, the Directorate General of Taxation has continued to make mention of BUMI’s unpaid tax obligations.

Share price volatility risk
We assume that following the Vallar transaction, all the group’s ownership in BUMI will be consolidated under Vallar, hence reducing share price volatility in BUMI.

Valuation methodology
Our target price of Rp4,300 implies 2011-12F EV/EBITDA of 8.8-4.0x. We use a sum of the part (SOTP) methodology (multiplied by BUMI’s stake in each of the assets) to value BUMI as follows:
 for the existing mines, KPC and Arutmin, we value the assets using DCF at a 12.36% discount rate. The discount rate is based on cost of equity of 20.7%, net rupiah cost of debt of 8.8% and a debt/equity ratio of 70/30. Our cash flow projections for this DCF value is until 2021F assuming 10% terminal growth;
 for KPC and Arutmin we value the assets at US$0.8/ton;
 for the reserves and resources of BUMI’s two subsidiaries, Fajar Bumi Sakti (FBS) and Pendopo Energi Batubara (PEB), we assign a valuation of US$0.1/ton;
 for BUMI’s stake at Darma Henwa (DEWA IJ) and Bumi Resources Minerals (BRMS IJ), we use the closing prices as of 30 December 2010 of Rp71/share and Rp670/share, respectively.

We then adjust the valuation of our estimate of BUMI’s net debt position (as of 31 December 2011) of US$3.6bn to arrive at BUMI equity value.