Buy INDY on market confusion - JP Morgan

* Sales Call – accumulate Indika Energy (INDY): The company is holding an EGM on 8 June to approve its non pre-emptive (PE) rights issue plan.

My take: the news came as a surprise to the market, potentially creating some confusion. Use of proceed is unclear at this stage. I am inclined to view any share price weakness on INDY as buying opportunity, for these reasons:

(1) Non PE rights issue tends to have positive share price impact. By Bapepam-LK regulation, non PE rights issue is capped at 10% of outstanding shares; action and pricing must be approved in an EGM. In the case of Bumi Resources, its EGM on 24 June 2010 approved non PE rights issue at Rp2,366 versus closing price at the time of Rp1,890 (25% premium). The other non PE case precedent is Media Citra Nusantara (MNCN) and Global Mediacom (BMTR) when Singapore’s Mediacorp took a strategic stake, also at a premium to market price.

(2) INDY is a solid candidate for inclusion into MSCI Indonesia. Sue Lee, JPMorgan’s equity derivative and index analyst, pointed out that MSCI will announce the result of its semi annual index review on 16 May, to be made effective on 31 May. For MSCI Indonesia, she noted two potential index inclusion: INDY and DSSA. Personally, I think INDY’s chance is looking decent, in-light of potential free float reduction on coal peer Bumi Resources.

(3) Good track record on acquisition. At this stage, investors will need to have faith on INDY management using the non PE rights issue proceed wisely. The last two acquisitions by INDY were good ones, namely Petrosea and Mitra Bahtera Segara Sejati. The company has proven to be conservative when it turned away from Berau Coal acquisition, although the competitive bidder ended up making money from the deal despite the aggresssive pricing at the time.

INDY is the most attractively coal stock (beside Bumi Resources) in Indonesia with a consensus P/E estimate of 10.9x and 8.9x for FY11-12. Arguably, the stock could have been artificially depressed due to corporate actions.