ITMG:Awakening the animal spirit - Mandiri Sekuritas

With reserves of 335.6Mt and production of 25.0Mt with estimated peak production volume of 29.0Mt, and dividend payout of 70%, ITMG is an income stock (under strong coal price environment). We play down the recent derivative loss, as ITMG has been prudent in using derivatives to smoothen earnings volatility and not for speculative intentions. Despite cost shock in 4Q10, it is a singular event, and we still have confidence in ITMG cost control. Our concern is on their lack of progress in acquisitions. With sterling reputation in the eyes of investors, ITMG might be unwilling to take risks while in coal concessions prices offered will be related to risks inherited.

Costly 4Q10. Mining cost despite qoq production increase of 0.6Mt to 5.6Mt has nearly doubled (+73.6% qoq). Two reasons cited: (1) fuel price increase to US$0.76/ltr from 3Q of US$0.71/ltr, and (2) higher stripping ratio (SR) in Indominco (20 from 3Q of 13.5) due to adjustment in mining plan to tackle weather related problem. ITMG stated that SR will be reverting to normal of 14 plus in 2011. Aside from US$54.1mn derivative losses, the expensing of US$20.1mn writeoff from the cancelled underground mining attempt also eroded the profit.

It is not the derivative that we concern. ITMG makes regular swap transactions on fuels, and also on coal. The losses were partly unrealized due to ‘mark to market’ coal contract at US$125/ton benchmark price, while ITMG recorded gains in its fuel swap transactions. As ITMG has been practicing hedge transactions since its IPO, we have no reservations on its continuance despite the losses that was made.

But lack of inorganic growth initiatives. ITMG has the lowest incidents of negative earning surprise, hence, the investor appreciations. However we hope it is not turning into an obsession. Inorganic growth will involve risk taking and in a bullish sentiment for coal industry, it is difficult to find bargain basement price.

Upgrade to Buy, upgrade target price. We upgraded our earnings forecast as we increased our benchmark coal price projection from US$105/ton to US$115/ton. Our DCF valuation improved to Rp55,800, hence we raised our recommendation from Neutral to Buy. Our views on their lack of risk taking initiatives may be run against investors who prefer stability, and hence ITMG still has its supporters and preferred choice for Indonesian coal exposure.