ADRO : Welcoming E-4000 - Mandiri

Amid much negativity on ADRO, there is an opportunity to be contrarian. We expect ADRO to deliver better supply chain and logistics management this year learning from last year problem. Despite of its high valuation in the industry, ADRO remains a coal proxy in market due to its high liquidity and still attractive PEG of 0.4 - 0.5x for EPS11F-12F growth, relatively to industry’s average. 15%-20% increase of selling price was expected to be used to base the March 2011 coal reference price (HBA), Envirocoal-5000 has reached US$84/ton, 17% increase from December 2010. Ample room for leverage would support future expansion especially inorganically and move to downward integration to power plant business.

Weak FY10 was expected. ADRO reported FY10 net profit of Rp2,207bn (-49.5% yoy, -6.0% qoq), approximately 4.8% below our and 14.0% below consensus estimates. In term of US$, FY10 net profit declined 42.2% yoy to US$243mn. The weak results mainly were due to higher cash cost which increased 17.3%yoy to US$35.3/ton, followed by rising strip ratio to 5.5x and demurrage costs of US$63mn. ADRO failed to benefit from higher global coal prices as heavy rainfall restricted coal production in Tutupan mine. To compensate this, coal production from Wara mine was boosted. But due to lower quality and higher moisture, consequently average selling price (ASP) was slightly lower at US$57.2/ton.

Robust demand on low-rank coal. 2010 was the first year of commencement of the Envirocal-4000 (E-4000). Despite of its lower caloric value and higher moisture, demand for such coal remain robust from the Asian market especially from China, India and South Korea. ADRO has sold 2.05Mt E-4000 coal in FY10 and expected to increase to 5Mt this year. Wara would be the growth driver for ADRO in the future. So far ADRO is grateful with Wara since it could sell it at a good price, without blending it with Tutupan coal. And it has similar margin with Tutupan since it has much lower strip ratio of around 2.1x vs 6.4x in Tutupan. Wara is aimed to contribute up to 20-30Mt coal in 2014 – 2015, around 40% - 50% CAGR.

OPCC contract signed. ADRO has just signed Out Pit Overburden Crushing and Conveyor (OPCC) project with WIKA and FLSmidth valued at US$175mn. The lower capex mainly is due to difference on scope of project field and design, which previously was expected to have double line with capacity of 66mmbcm and now only have single line with capacity of 40mmbcm. This project is aimed at ramping up coal production in Tutupan pit and save some fuel costs.

Maintain Buy. Adaro now is traded fairly at 14.0x PER11F. We did not make any major changes in our assumptions, and we maintain our TP at Rp2,800 per share implying 17.8xPER11F. We maintain our Buy rating on ADRO.