CLSA Adaro Energy (ADRO IJ)

The business Jakarta Comp @ 1,332.67 Indonesia 2 February 2009

Adaro Energy's main business is coal mining‚ which contributes 85% of consolidated earnings. The company bought its mine‚ Adaro Indonesia‚ in two stages - the first 40% in 2002 and the remainder through a leveraged buyout in 2005. The mine is currently the second-largest producer of thermal-coal in Indonesia and operates under a 30-year coal contract of work; commercial operation started in 1992. Adaro owns a mining-contracting unit that presently handles 21% of its own production‚ with plans to increase its portion to 50%. It also has strategic investments in coal-logistics companies and is in the process of acquiring a small coal mine.

The company's total reserves of 928m tonnes and resources of 2.8bn tonnes the third-largest in Indonesia - are key to its plan to double production to 80m tonnes in five years. The coal produced is of moderate calorific value with very low ash and sulphur content‚ which is suitable for blending to meet stricter global environmental requirements. Adaro Energy sells coal to more than 40 customers in 18 countries‚ most of which are major power plants and none accounts for more than 10% of Adaro's total revenue. Domestic sales represent some 30% of total top line and this portion could rise in tandem with increasing domestic power capacity.

There are several issues surrounding Adaro. First, the company has been in a legal battle with Indonesia's pulp and paper tycoon, Sukanto Tanoto, for the legal right of the coal mine. We believe Adaro has the legal right on the coal mine as supported by the Singapore High Court's decision on this case. The legal case, however, is dragging on in both Singapore Supreme Court and Indonesia State Administrative Court. Second, there is an ongoing renegotiation on the 30m tonnes contracted until 2011. Third, as net gearing is hovering at 90%, the company's expansion plan might be delayed, especially with the current global credit crunch. Fourth, valued-added-taxroyalty issue might have a near-term cashflow impact, as reimbursement might take a while.