UBS INDO Indonesian Coal: We downgrade our ratings for most of the Indonesian coal names and turn neutral (from positive) on the sector in the near-term

Moving to neutral on the sector
􀂄 Neutral over the near-term
We downgrade our ratings for most of the Indonesian coal names and turn neutral (from positive) on the sector due to: 1) near-term seasonal weakness; 2) strong 6-month performance; and 3) potentially weak Q410 results. We anticipate a correction in March/April between Chinese domestic and international prices.

􀂄 Chinese arbitrage provides weakness and price support
As China emerged as a thermal coal net importer in 2009, domestic prices aligned with international import prices (Newcastle spot). One month ago, import prices significantly exceeded domestic prices due to winter coal supply disruptions, but as near-term weather improves, we suspect spot prices will correct.

􀂄 Mid-2011 weakness could be buying opportunity
We think the 2012 coal price risk is to the upside on account of growing demand and continuous supply tightness. More specifically, power capacity will continue to grow in order to sustain economic growth in Emerging Asia, while supply remains under pressure from a major railway capacity shortage in China and an only partial recovery of Australian production.

􀂄 Buy Straits Asia and Sell Bukit Asam (PTBA)
Straits Asia is our top Buy pick following the preliminary Sebuku approval, which is likely to result in a re-rating to the top of the sector. The company currently has the greatest earnings upside risk. Bukit Asam is our top Sell pick given low selling prices, our earnings estimates are 17% below consensus, and another three-to-fouryear delay in the Bangko Tengah power plant that is supposed to off-take 20% of Bukit Asam’s volumes.

Neutral over the near-term
We downgrade our ratings for most of the Indonesian coal names and turn neutral (from positive) on the sector in the near-term on three primary reasons:
􀁑 Seasonal weakness. As the winter on the Northern Hemisphere weakens over the next few months, so will thermal coal demand while Australian and Indonesian supply partly recovers from excess rain.

􀁑 Strong 6-month performance. The Indonesian coal sector has rallied over 35% over the past six months along with thermal coal prices, and valuations now reflect current price levels of US$120-130/t.

􀁑 Weak Q4 results. We expect Q4 results to be weak due to: 1) fuel cost inflation; 2) production pressure; and 3) relatively low price execution as the quarter was contracted and priced before the current momentum.