Indonesia Coal: Buy Bumi and Adaro, to Become Largest Global Exporters - Citigroup

 Huge earnings upgrades; PTBA and Bumi are new Buys — Citi’s Global
Commodities team has raised its thermal coal price forecasts by 13% and 36%, respectively, to average US$139/t and US$148/t for 2012-13. We raise our earnings forecasts by 10-23% for 2012 and by 43-108% for 2013. The sector is attractively valued at 2012E P/E of 9.4x (7.7x in 2013E) vs 38% earnings CAGR in 2012-13E.
 Preferences — Our top pick remains Adaro for its robust medium- to long-term growth potential and its high earnings leverage to the seaborne coal-price up-cycle. Adaro also screens well in global valuation relative to volume production growth to 2015 metrics.
 Indonesian companies: main beneficiaries of seaborne coal-price up-cycle — With one of the strongest volume growth outlooks in the world, we believe the Indonesian coal sector is the best way to play earnings leverage to tight thermal coal markets. By 2015, Bumi and Adaro are expected to be two of the top three exporting companies globally. Growing acceptance of Indonesia’s lower-rank coal should also allow a narrowing in the price discount to the benchmark grades.
 Valuations at Mean Multiple — The sector trades at a mean 12-month forward P/E and EV/EBITDA multiple despite the current coal price up-cycle. In comparison, in the previous up-cycles the sector’s valuations overshot to +2 std. Indonesian coal stocks are attractively valued compared with their global peers. The sector’s 2012E P/E and EV/EBITDA are at 25% and 23%, respective discounts to global peers’.
 New pricing paradigm for coal — The demand for coal from the energy sector appears to be unrelenting, with too few producers expected to meet the strong demand from developing economies. This will leave the coal market exposed to sudden price spikes and a new premium on supply as disruptions become common-place.
 Catalysts — We expect robust Y-Y earnings growth on higher production and better ASP to prop up earnings in 2Q-4Q11. We also expect the substantially higher spot-coal prices in 2H11 on increased Chinese buying should improve sentiment on the sector.