JP Morgan - Adaro Energy: Initiating coverage

Abstract: We estimate the fair value for the new Adaro 2019s at around 7.75-8% ytm. With the bonds trading marginally tighter (7.5% offer ytm) than our fair value estimate, we are initiating coverage with a Neutral rating.

We like the bonds as a carry play, but do not expect them to outperform the markets in the near term. At the same time, we do not expect the Adaro bonds to under perform either, given the strong technicals in the markets. A strong local bid should also provide some support as Adaro 2019s are offering around 100bp higher yield than the PLN 2019s and about 225bp higher yield than the Indonesia 2018s. In addition, we believe the Adaro bonds look slightly cheap when compared to similar credits in the US, which could create support from offshore investors as well. The bonds are unsecured and will be issued by the group's mining subsidiary, PT Adaro Indonesia.

They will be guaranteed by the ultimate holding company, PT Adaro Energy, but not
by any of Adaro Energy's non-mining subsidiaries. The bonds are callable before October 2014 at a fixed spread over US Treasury, and after that at scheduled call prices.

Adaro also has the option of redeeming up to 35% of the bonds before October 2014 at the specified price from proceeds of equity offerings. Fundamentally, we are comfortable with the credit and remain constructive on the near to medium term outlook for the Indonesian coal sector. However, we are slightly cautious on the longer term outlook given aggressive growth plans of almost all the players, including Adaro. For Adaro itself though, we believe the operating cash flows should be sufficient to fund the announced capex, keeping free cash flows positive and leading to a gradual decline in leverage. Hence, we do not have a convincing explanation for the use of proceeds from the recent fund raisings, including the USD bonds.

We will not be surprised to see Adaro become more aggressive with its acquisition strategy and that it might also increase its dividend payout within the limits of its covenants. We do not expect this credit to be upgraded to Investment Grade in the near to medium term.