Goldman: Buy Adaro, Sell Bumi

Stock GS Rating Current Px 12 Month Target Px
Bumi Resources (BUMI.IJ) Sell Idr 2,850 Idr2,300

Adaro (ADRO.IJ) Buy Idr 1,510 Idr2,800

Key Summary Points:-

Rising oil prices are positive for coal equities
Historically, thermal coal prices have been highly correlated to oil prices (88% over the past 10 years), and so have coal stock prices (87% correlated since 2003). We are positive on the outlook for oil, and last month we raised our 2010E and 2011E oil price forecasts to US$90/bbl and US$110/bbl, respectively, on stronger demand projections (our report from September 24, 2009, “Global: Energy: Oil—Recovery and relapse, v2”).

No major supply destruction, some projects nearing completion
Despite the downturn, there has not been any major reduction in thermal coal capex and in fact several projects are nearing completion. Australia’s new third coal port terminal (NCIG) is expected to ship first coal in early 2010E, with a full ramp-up by 2011 (representing a 30% expansion in export capacity). Meanwhile, we estimate that Indonesian coal producers may increase capacity by 40% by year-end 2010E. Our global thermal coal supply-demand estimates indicate that the supply surplus in 2009E is likely to narrow in 2010E due to stronger demand, but it is still in surplus.

Coal price upcycle may lag oil, initiate with neutral stance
Given our positive view on oil prices, we are forecasting higher thermal coal prices over 2009E-2011E. However, with a stronger supply availability of coal, we believe that the coal price cycle may lag oil. Currently thermal coal prices are 20% of oil on an energy-equivalent basis, which is below the historical average of 26% (the historical range is 14%-51%). On an annual average basis we see coal as a percentage of oil declining from 25% in 2009E to 17% in 2011E. We are initiating coverage on the sector with a neutral stance.

Stock selective approach; Buy Adaro, Sell Bumi
Adaro is our top pick, given attractive valuations and a strong earnings growth trend as its low-priced legacy contracts expire. Meanwhile, we rate Bumi Resources as Sell due to rising capital costs, its increasing debt load and declining ROIC. We initiate on Straits Asia and Bukit Asam at Neutral.

Risks
Upside risks to our views and price targets include a disruption in the global coal supply chain (e.g., from bad weather, port congestion) causing coal prices to spike or China coal demand being stronger than we expect; downside risks include China’s small mines restarting operations.