Adaro Energy; Rising cost pressure; Hold (downgrade from Buy); Rp2,200; TP Rp2,450 prev Rp2,850; ADRO IJ - DBS Vickers

• 1Q11 earnings below expectation on higher production cost.
• Less leveraged to spot price due to lower CV coal compared to peers
• Cut FY11-13F earnings by 2-7%. Downgrade to HOLD, TP revised to Rp2,450.

Higher than expected production cost. Adaro (ADRO) 1Q11 net profit of Rp965bn (+12%y-o-y) came in below our estimates (19% of FY11F) mainly on higher than expected production cost. Coal sales volume fell by 5%y-o-y to 10.9m tons (23% of FY11F of 47m tons) but this largely offset by 16% higher ASP to US$63.8/ton. However, production cost/ton increased by 21%y-o-y to US$41/ton (incl royalties) mainly on higher mining cost. Note that Tutupan stripping ratio increased to 6.4x in 1Q11 from 5x in 1Q10. Looking ahead, we expect coal production to accelerate in 2Q onwards combined with higher ASP in line with higher market price.

Less leveraged to spot price. We believe that ADRO is less leveraged to rising coal price as it produces lower CV coal (5,000-5,500 kcal/kg) compared to peers (5,500-6,500 kcal/kg). Its expansion plan will be supported by its low-rank coal asset in Wara which we believe to have even lower margins. Wara is estimated to contribute around 25% of target production of 80m tons in 2014-15.

Downgrade to Hold, cut TP to Rp2,450. We have downgraded our recommendation to Hold as we see downside risk to earnings from rising production cost. We have also cut our FY11-13F earnings by 2-7% after imputing higher production cost. Accordingly, our TP is lowered to Rp2,450 based on blended valuation of 12x FY12F and 3x PBV as we roll over to FY12.