Asian Metals and Mining - Coal; Rising costs compound squeeze from lower coal prices; Cautious - Goldman Sachs

Coal prices to correct further on rising supply, weakening demand
Newcastle coal prices have corrected 7% over last 2 months. However, our checks with traders indicate that demand from China and India continues to slow in the seaborne market due to high coal prices, while supply out of Indonesia has been improving recently, consistent with the widening gap between Indonesia’s sub-bituminous and Newcastle coal prices. Despite the shutdown of 12.4GW nuclear plants in Japan, we believe that coal consumption may slow due to potential demand disruption on shut-down of 7GW coal power plants (5.5GW may take at least 6 months to re-start of which 2GW is almost completely damaged), high utilization rates of coal fired plants (75%-85%), port damages and power outages.

Rising costs to keep a lid on margins; remain cautious
Fuel costs (~30% of cash production costs) and inflation pressures are accelerating with added pressure of higher strip ratios which may lead to average 12% higher cash costs in 2011E (despite high 2010 base due to one-off demurrage expenses) and may surprise the market on upside. On higher cost estimates, we revise our 2011E-13E net profit by -19% to +1% and 12-m Director’s Cut TPs by -21% to +1%. Stocks under our coverage have fallen by average 7% over the last 2 months, but valuations are still above mid-cycles (both on EV/EBITDA and EV/GCI), keeping us cautious.

Downgrade Adaro, SAR to Sell; maintain Sell on Bumi (Conv List)
We downgrade Adaro to Sell from Neutral, given our belief that cash production costs may rise by 20% in 2011E posing earnings risk. We also downgrade SAR to Sell from Neutral on earnings reduction and our new 2011E-12E earnings forecasts are 31-37% below Bloomberg consensus. We maintain Conviction Sell on Bumi given its rich valuations, 4th quartile CROCI profile and earnings risks. Our Sell-ideas offer average downside of about 19%.

Raise ITMG to Buy; PTBA to Neutral post recent underperformance
We upgrade ITMG to Buy from Neutral given attractive valuations (2011E EV/EBITDA is at 9% discount to sector average), superior CROCI profile (>60% in 11E-13E) and high dividend yields (6.3% in 2011E). We also upgrade PTBA to Neutral from Sell given the stock’s under-performance relative to peers.

Key risks
Disruption in the global coal supply chain causing coal prices to spike.