Macquarie Indika Energy Like the company, not the price

Event

We reiterate our Underperform recommendation on Indika but increase our target price to Rp1,900 from Rp1,225, representing 33% downside to the current share price. The revised target price reflects our slightly higher coal price assumption and lower cost. However, we think that the current share price is justifying a significantly higher coal price.

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

Impact

Improving thermal coal outlook but reflected in forward coal market. We see medium-term supply demand balance tightening; however, 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 current levels.

Lack of 2009 earnings visibility. The company as of now has merely priced in 60% of its 2009 sales volume at roughly US$60/t. Therefore, given we see risk on coal price in the near term plus the company’s low CV coal; we think the company’s 2009 earnings could be at risk.

EPC business highly dependant on Chevron. The majority of its EPC business comes from the Chevron contract (over 50% of EPC revenue) which currently is under negotiations for renewal. Therefore, should the company fail to win the contract renewal, its earnings could be negatively affected. However, the company has been able to renew its contract over the past 15 years.

Recent acquisitions appear sensible. We think that the company’s recent acquisitions (Petrosea [PTRO IJ, Rp9,600, NR] and 13 KP in West Kalimantan) appear strategically sensible and in line with the company’s strategy to become an integrated coal producer and contracting and IPP company.

Valuation is rich as it trades on our 2010 number at 22x PER, 1.2% dividend yield and 4% FCF yield. We think the stock is pricing in US$90/t by backing out 12x PER, which we see has a low probability of happening.

Election upside = market re-rating. We see the potential for a further re-rating in the market should SBY achieve a landslide victory.

Earnings and target price revision
We have raised our earnings for 2009−11 by 17%, 32%, and 48% respectively mainly due to slightly higher coal prices in 2010 and lower production costs.

Price catalyst
12-month price target: Rp1,900 based on a Sum of Parts methodology.
Catalyst: Increasing production and coal price and potential acquisitions

Action and recommendation
We therefore reiterate our Underperform recommendation on the stock with Rp1,900 target price due to expensive valuation.