We upgrade the coal sector to Overweight from Neutral. First, we believe coal prices are bottoming out. We are raising our benchmark coal-price assumptions for FY09-11 by 9-15% to US$78-100/tonne and by 21% to US$70/tonne for the long term. Second, the sector should be a beneficiary of consolidation. Third, there is a growing demand for Indonesia's low-rank coal. Our higher coal and oil-price assumptions raise our EPS estimates by 14-38% for FY10-11 and our target prices by up to 60%. Indonesian coal stocks remain at discounts to Chinese peers. Adaro is our top pick for its operational superiority and moderate corporate-governance risks. We upgrade Bumi and Bukit Asam to Outperform from Trading Buy and Neutral respectively while Indo Tambang has been upgraded to Neutral from Trading Sell.
Valuation and recommendation
Upgrade to Overweight from Neutral. There have been a number of positives emerging for the Indonesian coal sector. First, higher coal demand and international coal prices could last into FY11, in our view. Coal prices could have bottomed out, benefiting Indonesian exporters particularly. Second, the sector would also be beneficiary of consolidation. Third, there is a growing demand for Indonesia’s low-rank coal. Indonesian coal stocks remain at discounts to their peers overseas, despite potentially greater returns.
Adaro is our top pick. We continue to like Adaro for its fundamental strength. It is also a possible M&A target (remaining 13% stake from foreign institutional shareholders) and is a large low-rank coal player. We believe it should be trading at premium P/Es to peers on account of its operational superiority and moderate corporate-governance risks. We raise Adaro’s DCF-based target price to Rp2,000 from Rp1,270 following EPS revisions and lower WACC assumptions from 16% to 13%.
Upgrade Bumi to Outperform from Trading Buy. Bumi is increasingly attractive given its strongest earnings sensitivity to coal-price movements. We raise Bumi’s DCF-based target price to Rp3,500 from Rp2,600, following our EPS revisions and lower WACC assumptions from 18% to 16%.
Upgrade Indo Tambang to Neutral from Trading Sell. We upgrade Indo Tambang to Neutral from Trading Sell, seeing its dividends could still be appealing. We raise our DCF-based target price to Rp24,000 from Rp15,000 following our EPS revisions and lower WACC assumptions to 13% from 16%.
Upgrade Bukit Asam to Outperform from Neutral. We upgrade Bukit Asam to Outperform from Neutral as a higher coal-price outlook would reduce concerns of deteriorating earnings into FY10. We raise our DCF-based target price to Rp17,000 from Rp11,300 following our EPS revisions and lower WACC assumptions to 13% from 15%.
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