ƒBad weather should keep margins under pressure.
ƒHit also by the strong currency.
ƒStrong demand for mining equipment unlikely to compensate.
ƒLimited upside potential – take profit closer to our TP of IDR19,500.
Weather is still the problem
July’s contract mining data does not alleviate our concern about the impact of the unseasonal heavy rain on both production and production costs (while volume-wise coal volume and overburden removal grew 21.5% and 13.5% y-y, it remained flat m-m). Chairman of the Indonesian Coal Association, Bob Kamandanu, recently announced that the association has reduced its coal production forecast for this year from 320m tonnes to 300m tonnes, while PT Bayan Resources also declared force majeure on shipments from its Kalimantan mines due to heavy rains and flooding.
For United Tractors (UT), we are less concerned about production as it has proven its commitment to customers by delivering production on time, but the higher costs associated with this do concern us. This, plus the pressure on a stronger currency, has resulted in UT’s overall margins contracting by 4.8% in the 1H10, basically offsetting the strong turnaround in the heavy equipment segment.
Demand for heavy equipment remained strong
Despite the fact that total coal production in Indonesia may decline, we expect demand for heavy equipment, especially in the mining sector, to remain strong. On top of the new order for expansion announced by the existing coal companies, we believe demand will be supported by replacements for machineries purchased in 2003-2004. We expect demand growth of 75% in 2010 and 15% in 2011 and 2012. Year to July, heavy machinery posted volume growth of 87% to 3,200 units, accounting for 59% of our FY10 volume estimate.
Valuation
Unusual weather (which has raised operating costs in the contract mining business) and concerns about the impact of the strengthening currency (90% of UT’s earnings are USD-linked) are factors preventing us from being more bullish on the company despite it showing exemplary dedication to customers and good corporate governance. Trading at 13.7x our 2011E earnings, we believe the upside is limited and would
advise investors to take profit closer to our TP of IDR19,500, which is derived based on a DCF using a WACC of 12.6% and terminal growth rate of 4.5%. Investors wanting a commodity play will do better owning coal stocks, in our view. Downside risks to our TP for UT: a strengthening IDR and adverse weather patterns. Upside risks: higher-than-expected coal volumes and prices in the mining operations.
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