RX indonesian coal - we are warming up again

Event

· Following the recent 20–30% underperfomance in the sector and signs that fundamentals are starting to bottom out, we are warming to the Indonesian coal names again on a medium-term view.

· Improving fundamentals include: 1) inventories to start declining on a 12-month basis; 2) China to potentially maintain a higher-than-expected level of imports in 2010; 3) Indonesian domestic demand to accelerate in 2011; 4) Indian demand to accelerate in 2011/12.

Impact
· When to buy a coal stock? We believe that best time to buy a coal stock is when: 1) prices are trading at or below the cost curve; 2) supply/demand balance is tightening; 3) stocks are trading below fair value.

· Inventories to start declining? Inventory levels are exceptionally high, particularly in Europe, however on a 12-month view we see the potential for inventory levels to decline gradually, particularly as we enter the Northern hemisphere winter, and the arbitrage between the global and Chinese spot price comes back into play.

· China to maintain high imports ? We maintain our view that China is not short of coal, but we do see the potential for the the cost curve to increase as a result of higher taxes, cost pressures and Renminbi appreciation. This higher cost curve (particularly in US dollar terms), could lead to the import arbitrage opening up again, resulting in higher-than-expected net imports.

· Indonesian domestic demand to accelerate. We believe that roughly 6–7GW worth of power generation will be fired up in 2011, which will result in roughly 20mt worth of additional demand (which should limit exports).

· Indian demand set to rocket. We believe that Indian demand will increase from roughly 50mt to 75mt by 2012. We see a a large proportion of power plants coming on in 2012, which combined with a change in policy mindset at Coal India, who will now actively import, to achieve our forecasts.

· Coal contractors vs coal producers? While we are warming up to the coal producers on a 12-month view, we still see potential for earnings downgrades in 2010 (as consensus is expecting US$80–90/t prices versus our US$70/t forecast in 2010). Although we see the potential for consensus downgrades at the coal producers, we see upside risk to earnings at the coal contractors (ie UNTR). We think that UNTR (UNTR IJ, Rp15,000, N, Rp14,500) is a great defensive volume play in the coal sector.

Action and recommendation
· We are warming to the sector again on a 12-month view. Our top picks remain ITMG (ITMG IJ, Rp23,600, OP, Rp26,600), Banpu (BANPU TB, Bt438, OP, Bt500), and SAR (SAR SP, S$1.86, OP, S$3.1), but we see upside risks to earnings at UNTR.