MacQ Bayan Resources (BYAN IJ) (Neutral) - Kepco bought 20% of Bayan for coal offtake

Event

∙         Korea Electric Power announced that it plans to buy a 20% stake in Bayan Resources for about US$515m (implying roughly Rp7,000/share). This represents roughly a 3% discount to yesterday's closing price but a 12% premium to our price target. We think the deal is relatively fair for KEPCO as the deal price implies roughly 7.3x 2011 PER, which is slightly below the sector at 7.8x 

Impact

∙         Security of supply is the key for KEPCO. The acquisition would enable Korea Electric to secure roughly 2mt of coal per year starting from 2012 and 7mt per year starting from 2015.  Further, we believe this will also help KEPCO to hedge its cost of fuel, especially given it does not have a transparent mechanism to pass on fuel price changes. Our channel checks also highlight that KEPCO is looking to nominate 1 member to Bayan's Board of Directors, which currently consists of 8 members. ∙         What does Bayan have to offer? Bayan Resources is Indonesia's 6th largest coal company with current production rate of 14-15mtpa and growing to about 23mt longer-term. The company currently has roughly 477mt of reserves and 1,008mt of resources. We believe that the company is well positioned to benefit from the higher coal price environment especially given its relatively high coal quality (6,500Kcal GAD, well above the Indonesian average of 5,800Kcal).
∙         High cost structure and declining coal quality is the key risk for Bayan. We believe the main risks for the company lies in its high cash production cost of around US$52-54/t (2010-12E) due to a high strip ratio and long transportation distances. Further, whilst the current coal production quality is high at 6,500Kcal GAD, we see this declining towards 6,100-6,200Kcal longer-term.
∙         Deal done  in line with market valuation but premium to our DCF fair value . We think that the deal represents a fair price as the deal price roughly implies 7.3x 2011 PER (vs. the ASEAN peers at 7.8x).  However, it implies a 12% premium to our price target and should this be done across the sector, it would lead to a 30-35% upside to the sector.
∙         Increasing M&A trend. We believe that the deal reiterates our thesis of increasing M&A activity within the Indonesian resources space (either in the form of foreign companies investing in Indonesian greenfield mine or getting minority stakes in major coal producers for potential off-take). We expect this trend to continue evidenced by our recent trip to the Coaltrans coal conference, which saw an increasing number of Indian and Chinese participants. 

Action and recommendation

∙         We believe that the deal highlights the increasing M&A activity within Indonesian resources space and could benefit the ASEAN coal sector. Further, we see the potential for the ASEAN coal sector valuation to re-rate upward from around 8x 2011 PER currently towards its historical mean of around 11.5-12x on a better coal price outlook.Company mentioned:

KEPCO (

015760 KS, KRW31,900, OP, TP:KRW45,000)