Adaro Energy: Hold; Rp2,550; TP Rp2,450; ADRO IJ Key takeaways from site visit - DBS

• Vertical integration into power plant to secure coal demand.
• Good weather supports coal production in 2Q. Expect 1H production to be within our estimates.
• Maintain Hold, Rp2,450 TP.

We joined the analyst meeting and site visits at Tutupan and Wara mines in South Kalimantan . Some takeaways are as follows:
2x1GW Power Plant Deal is a long-term project; not much expected in near term. Adaro (34% stake) recently announced a project with J Power (34%) and Itochu (32%) for a coal-fired plant with 2x1GW capacity in Central Java . The purchase agreement with PLN will be for 25 years after the completion of the project. Although this IPP project represents a strategic move by Adaro to move downstream and to secure demand for its coal (up to 7m tons per year), we believe the project should not have any material impact in the near term. While the project could offer interesting prospects given its size and coal consumption potential, we think it is still too early to judge as the project will not start its operation until 2017. Assuming US$1m per MW and 80:20 debt/equity ratio, its 34% stake or US$136m will be financed internally and net gearing will increase to 0.7x but the debt at project level will not be consolidated into the book. We expect IRR of mid-teen for the power plant project.

Better weather supports coal production in 2Q. Our discussion with the operation personnel revealed that the weather was favourable in April and June with exception in May. But overall it was drier than last year. Combined coal production at Tutupan and Wara could reach 120-130k tons/day in 2Q. This should translate into up to 12m tons of output in 2Q or 22.4m tons in 1H or inline with our estimates as we expect 47m tons of production in FY11F. Given current weather conditions, we believe 48m tons of output for 2011 is possible.

Kelanis terminal expansion and power plant. A new set of barge loaders with capacity of 30m tons will be build at south Kelanis near the existing facility in order to expand capacity to 80mtpa (from 55mtpa) with estimated completion in 2Q12. ADRO also plans to build 2x30MW power plants to supply power for its overburdened crushing and conveying and other parts of the mining operations as well as to reduce dependency on fuel oil.

Bio diesel fuel project. Jetrova-based Bio diesel fuel (BDF) refinery plant with capacity of 1.2 tons per day has been built in March. ADRO estimates around 8k tons of BDF will be used annually and reduces 20k tons of CO2 emission. ADRO currently use its BDF production as a fuel for its Komatsu HD785 dump truck.

Maintain Hold, Rp2,450 TP. We like ADRO for long-term growth prospects with the power plants generating stable cash flow and creating demand for its coal. However, we foresee short-term earnings risk due to its slower growth in ASP compared to peers. Maintain Hold, Rp2,450 TP.