CLSA coal downgrade, stick to quality, ITMG top pick

Research Today: coal downgrade, stick to quality, ITMG top pick

Our mining analyst Olie lowers his earnings forecasts for Indonesian coal companies by 3-39% in 2009 and 2010, following our downward revisions on thermal coal price assumptions (10% this year and 6% next year).

The interesting point is that change from the previous coal price assumptions is only 6% for 2010 (when coal contracts have expired). But the impact on earnings is bigger for some companies. Olie cut Bumi (BUMI IJ) and Indika (INDY IJ) earnings by 39% in 2010. In addition to lower coal price assumptions, both the operating and financial leverages will not help BUMI’s numbers in 2010. For INDY, rising contractor fees contribute to the earnings forecast cut.

We agree with our coal analyst’s view to stick with quality and most defensive characteristics. Stock picking is the key here. Indo Tambang (ITMG IJ) is our only BUY call in the sector. Dividend yield, we expect to be around 17% this year, will provide some cushion. Balance sheet is strong (US$220mn cash balance as of Dec 08), and robust cash flows. Good CG is another reason to like ITMG.

Key points from the report:
Lowering our earnings forecasts for Indonesian coal companies by 3% to 39% in 2009 and 2010, on 6% to 12% lower thermal coal price assumptions.
Indo Tambang (ITMG IJ): the least adjustment due to its contracted tonnage while BUMI has had the sharpest revision in earnings.
Stay with defensive coal names, those with cash rich balance sheet and good earnings visibility.

ITMG is still our preferred play given its defensive characteristics. The stock trades at 15% to 25% discounts to peers and dividend yields of 17%.

Maintain Outperform rating on Bukit Asam (PTBA IJ), on strong balance sheet, contracted tonnage, and above average production growth. However, a lot seem to be priced in as it trades at 15% to 40% premium to peers.

Downgrade Adaro (ADRO IJ) to UPF. The company remains an intriguing prospect given its size and long-term growth potential. However, recent plan to acquire related-party companies raised an issue, particularly as investment in an asset management firm remains unclear.

Downgrade Indika (INDY IJ) to UPF. While we like the coal assets, visibility on other businesses is limited. The recent acquisitions fit the long-term strategy but offers limited near-term upside.

We cut our rating on Bumi (BUMI IJ) to a SELL. Investment risk is high as the announced acquisitions look excessively valued and do not fit strategically.