Our view on Indonesia coal companies - Merril Lynch

ITMG: our top pick
Despite higher cost and coal price expectation, we end up keeping our earnings estimate and our price objective for the company unchanged.
Driven by a higher oil price, we raise our cost estimates by 12% for 2011 and 2012. But at the same time, we raise our JFY price settlement for 2011 to US$125/t and for 2012 to US$129/t from US$110/t, previously.
Our 2010 earning estimates are now 10% below consensus but 8% above consensus for 2011. Our 2012 expectation is in line with consensus.



Why buy ITMG?
„It is the preference of investors who are bullish on thermal coal given its export coal exposure, relatively good execution/corporate governance, and strong balance sheet.
Potential reserve upgrade.



ADRO: our second pick
Earnings lowered
„On lower volume expectations primarily and lower cost, we ended up lowering our earning estimate by 9% in 2010 to Rp2.4tn, by 7% in 2011 to Rp5.1tn, and by 18% in 2012 to Rp6.8tn. We also lowered our price objective for the company from Rp2700 to Rp2600. Key drivers behind the change in our estimates:
We cut our volume estimates by 8% to 46mn t and by 27% to 51mn t, while keeping our 2010 volume estimates unchanged.
We raised our JFY price settlement for 2011 to US$125/t and for 2012 to US$129/t from US$110/t previously. We understand ADRO’s prices can normally be broken down into: 25% index linked; 50% based on previous-year JFY; and 25% based on current-year JFY.
On higher oil price and longer distance to dump overburden, we raised our cost expectations by 5% in 2010, 19% for 2011, and 10% for 2012. We understand ADRO hasn’t hedged any of its oil requirements for the year.
Our 2010, 2011, and 2012 earnings estimate is now 15%, 7%, and 3% lower than consensus.


Why buy ADRO?
„ It is still Indonesia’s thermal coal sector proxy given the size of its market cap and liquidity, coal capacity, and better perception on corporate governance.
„Potential reserve upgrade. Besides optimization (ie, a higher coal price), our recent visit to ADRO’s coal mine revealed a potential reserve upgrade in the North Tutupan resulting from more drillings.
Its exposure to coking coal market through its 25% stake in BHP’s Maruwai coking coal project. Our trip to BORN coking coal mine found 1) water level problem could still be addressed by putting over capacity for
barges, at least for smaller-scale mining projects; 2) BHP’s lend use permit for its hauling road cut across BORN’s concession; and 3) BHP’s concession is up to 50km in terms of road distance from BORN’s mine while its port is only five minutes away from BORN’s. That said, there is limited disclosure from BHP about the overall plan and we are increasingly concerned about the land acquisition and the commitment of BHP to go with a smaller-scale project. We still assign zero value for this investment in BHP.
Potential for more acquisition and bringing in strategic partners to help faster monetize its coal reserve.


PTBA: Neutral
Despite higher coal price expectations, we have left our earnings estimate for PTBA unchanged. In light of the DMO requirement, we have factored in a US$15/t discount for domestic coal sales.
We are Neutral on PTBA. On valuation terms, we think it is relatively expensive: we believe contributions from existing railway plans and some value from new railway projects (still being engineered) are fully priced in. It looks expensive compared to historical P/E. Unless the land bill is passed, we think land acquisition for its railway project could prove to be challenging.


BUMI: Neutral
Despite lower volume expectations, we end up leaving our earnings estimates and our price objective for BUMI unchanged. Given past disappointment, we have taken a more conservative approach in our volume for the firm. We lower our 2012 volume estimate from 100mn t to 70mn t, but we raise our JFY price
settlement for 2011 to US$125/t and for 2012 to US$129/t from US$110/t previously. Our 2011 and 2012 earnings estimate is now in line with consensus.
We are Neutral on BUMI. We believe Vallar’s shareholding in the company could be a positive for BUMI’s share price, based on our understanding that Nathaniel Rothschild’s stake is not likely to be diluted, thanks to it being the founder’s shares. We believe the founder could in fact benefit either from Vallar buying more assets, increasing the value of its assets (ramping up BUMI’s share price or restructuring the firm), or raising its BUMI stake (a swap of Vallar with BUMI shares planned for April 2011). Still, we are in no hurry to buy BUMI. We think 4Q10 earnings could surprise on the downside again. We also see near-term weakness in the coal price. Moreover, it is yet to be seen whether this structure will bring about a change in internal
management (cash flow, balance sheet) and day-to-day operations.
In 4Q10 results to be released in March, we expect to see total debt lowered. We take a more cautious approach as we have been negatively surprised by BUMI’s debt level in the last several earnings seasons. Our recent discussion with the company found it in the process of reducing its debt. As of September 2010, BUMI had total debt of US$4.16bn, but by end-2010, total debt was reduced to US$3.8bn. In 4Q10, it raised US$700mn through bond refinancing and paid US$1bn in debt. It plans to reduce by another
US$300mn in 1Q11. BUMI said it will receive US$190mn in cash from Mitra Perkasa sales, which it will use to repay its Deutsche loan. It also plans to repay US$600mn of the first tranche of the CIC loan as the lock-up expires in October 2011.