Asia Coal Volumes take centre stage - UBS

􀂄 Event: Xstrata signs high
Xstrata has signed a US$127.50/t thermal coal contract with Japanese utilities company, TEPCO, with delivery from October 2011. The settlement is high at 30% above last year’s levels and 6% above the current spot price. It underlines the tightness of the thermal coal market, as the price is only US$2.50 below the April contract, which was characterised by supply pressure from flooding in Australia.
􀂄 Impact: raising coal prices but so what?
We raise our thermal coal estimates for 2012 and 2013 by 13% and 10% to US$125/t and US$110/t, respectively, while our 2011 forecast of US$130/t is unchanged. Indonesian coal earnings will thus be significantly more dependent on production growth next year, contrary to previous years’ dependency on price growth.
􀂄 Action: buy volume growth
As in previous years, we expect several Indonesian coal miners to miss their production targets again this year given insufficient asset investment. We continue to favour miners who have consistently invested in infrastructure and production capacity through the cycle. With relatively high operating leverage, we expect those producers to outperform the sector and the general index.
􀂄 Straits Asia remains top pick
Straits Asia remains our top pick given its 60% volume upside to current nameplate infrastructure capacity. We likewise maintain our Buy ratings on Adaro, Banpu and Indo Tambangraya Megah (ITM), while upgrading Bukit Asam and Bumi Resources to Buy. We have created a UBS Custom Index available on Bloomberg at ticker UBSASCOL Index.

􀁑 Adaro Energy Investment Case
We remain bullish on Adaro as the Wara pit starts ramping up production at low cost (low stripping ratio). We expect volume growth to remain in line with the 5-7% sector-average in 2011, but below management's 10% target. Near-term earnings should benefit from realised price growth to above US$70/t next year, while cost growth should remain in the low end of the sector as the company ramps up the lower cost Wara pit.
􀁑 Bukit Asam (PTBA) Investment Case
Volume growth could exceed that of its peers this year and the next as PTBA takes delivery of additional railway wagons and engines to be incorporated within its existing rail network. Management's target to grow production fourfold from 13mt currently remains a distant target, in our view, unlikely to materialise any sooner than 2017.
􀁑 Bumi Resources Investment Case
We are more confident of the company's ability to refinance and unlock reserves. More specifically, we expect Bumi to pay down its US$1.9bn CIC debt before end-2012 following the sale of Bumi Resource Minerals. Although we disagree with management's 100mt annualised production target from Arutmin and KPC by Q412, we think 80mt is feasible given the completion of additional conveyor belts and port loading capacity. If completed, this would make Bumi one of the fastest growing coal miners in Indonesia over the next 36 months, although production growth risk remains to the downside over the next 12 months. As such, we estimate 62mt of production in 2011 versus management's 67mt.
􀁑 Indo Tambangraya Megah (ITM) Investment Case
We downgrade our production volume from 25mt to 24mt for 2011 as management warns of excess rains in Indonesia, which may put downward pressure on output. We continue to look for management's ability to price its coal above the market given its higher quality at 6,200kcal. With a reserve life of 13 years, we think investors may push back on a valuation above 12x Asia Coal 12 July 2011 UBS 18 earnings multiple, but we highlight that the Bharinto, IndoMinco and Trubaindo mines probably have another 4-6 years left at least.