BASML INDO COAL: beyond earnings; upgrading Indonesian coal players

Today we upgraded our PO for all coal players in Indonesia after all the POs exceeded in the past one month.We still see value to be unlocked from Indonesia coal companies.

Here are our 10 key arguments:
1. We believe we should value Indonesian coal stocks on asset rather than earnings as i) we are the low end the cycle and ii) M&As are heating up.
2. We think current earnings yet reflect any recovery in coal price. True, Indonesia coal now trades at around 13x PE but that is based on a conservative US$65/t coal price forecast (which is where current coal price is). A 10% increase in coal price could easily see earnings recover by ~30%. This time around, we believe street is slower in upgrading their coal price forecasts.
3. We believe coal price will recover from this low level. Macro environment is supportive for higher coal price. The weakening US$ is supportive for commodities irrespective of fundamentals. Our commodity analyst believes an upturn in economic activity, even if modest, could have a very significant impact on oil demand, which could translate into higher prices given oil supply is semi-fixed in the short run. There is a close correlation between oil and coal prices and between the coal price and coal company shares.
4. Sustainability of China’s big import remains a mystery but at least that creates a floor for coal price we think.
5. By now, we think poor 2009 (i.e. weak demand, contract prices being lowered; weak results post 1Q) are already a known one and been priced in.
6. To look beyond this phase of pronounced volatility, we return to NPV as a value base. In past cycles, cyclical commodity stocks traded at premiums to NPV in anticipation of rising commodity prices. At this stage, we still value Indo coal on a par with NPV.
7. With lower domestic rates and external vulnerabilities, we believe Indonesia deserves a lower RFR and ERP, which translates to lower WACC for Indonesian companies.
8. M&As activities gaining momentum. From local media, we learnt there could potentially be three placements on the table at least. If the deals materializes, they wont look at earnings. Past deals are carried out at between US$7-10/t EV to reserve, which is almost 2-5x the EV to reserve of Indonesia coal companies.
9. Play East vs. West, Pacific vs. Atlantic Basin in coal. Ultimately any recovery in global coal demand will come from the East, with Chinese consumption growth outpacing the increase in demand in Europe and the United States.
10. On the above, we raise our PO for PTBA from Rp8000 to Rp14,900, UNTR from Rp10,000 to Rp12,500, ADRO from Rp860 to Rp1,480, and BYAN from Rp1,855 to Rp4,357.

We still keep BUMI as Underperform though
1. We think the recent share price rally was driven by the return of risk appetite and BUMI played catch-up with Indonesian coal peers.
2. Corporate governance risks, which triggered major downgrades and PO cuts by the street end of last year, have not been addressed, we believe.
3. The participation of strategic investors could change our view, however. The market could once again downplay BUMI’s corporate governance risk.
4. Applying the same RFR and ERP as its Indonesian coal peers, BUMI’s valuation could go as high as Rp3,000.

Action point
1. Buy and buy more on any share price weakness.
2. We are inclined towards firms with lower earnings downside risk that have lagged in the rally.
3. Top pick: PTBA, UNTR, ADRO, and BYAN.
4. PTBA has vast reserve, low cost, net cash with zero debt.