Macquarie Bayan Resources Improving execution is in the price

Event

We downgraded our recommendation on Bayan to Underperform from Neutral but raise our target price from Rp1,340 to Rp2,250, implying a 58% downside to the current share price.

Our global commodities team has marginally increased its 2010 thermal coal price forecast from US$65/t to US$70/t

Impact

Improving thermal coal outlook: We see our medium-term supply/demand balance tightening. However, we think this is more than reflected in the current forward curve, with coal trading at US$90–100/t in 2011. Further, we are cautious on the coal price near term, as we do not believe the Chinese import arbitrage economics work at the current levels.

Improving execution: We believe the company has improved its operations significantly, evidenced by the 1Q09 production that was ahead of our expectation (2.4mt vs. budget of 1.8mt). The company is on track to achieve our forecast of 12mt coal production in 2009 and 12.5mt coal sales volumes.

High leverage to price: We believe the company is one of the most leveraged coal companies to the coal price, given its 100% export exposure and relatively high CV producer (at an average of 6,500 Kcal vs Indonesian average of 5,800Kcal). Further, the company is also starting to price in its 2010 contract at the current high forward curve price. As of now, the company has locked in roughly 13% of 2010 production volume at over US$80/t price.

…however, this is already in the price: We think the current share price has factored in the current 2010 forward curve of US$80-85/t coal price vs our US$70/t assumptions. While we think this is a reasonable upside scenario, we it is already factored into the share price.

Valuation is not cheap: On a relative basis, the stock appears expensive as it trades on 25x PER, 13.1 EV/EBITDA, and 2.4% dividend yield in 2010. This compares unfavourably with the Indonesian average of 20x PER. Earnings and target price revision We downgrade 2009 net profit by 36% to reflect higher production cash cost,
but upgraded 2010 by 45% to reflect higher price and production. We raise our price target from Rp1,340 to Rp2,250.

Price catalyst
12-month price target: Rp2,250 based on a DCF methodology.
Catalyst: Increasing coal price and production.

Action and recommendation
We downgrade our recommendation from Neutral to Underperform with a new price target of Rp2,250 on the back of expensive valuation (the current share price has already priced in the US$85–90/t coal price).