JP Morgan - Adaro Energy - Management call update - further risks to forecasts. Switch to ITMG

Management call feedback – 3Q10 weather is still wet, risk to FY10E EPS:
Following a dismal performance in 2Q10 due to record rain, the weather indication at the mines has still been wet during 3Q10. With this, the weakerthan-expected performance could continue into 3Q10, leading to a potentially weaker FY10. The reduction in earnings forecast began on 2 Sept 10, when we last highlighted this issue, until now; the gap between our and consensus estimates for FY10E net income has narrowed from 16.9% then to 12.6% currently, while for FY11E, it has narrowed from 32.2% then to 30.1% currently. Using the latest estimates, we view that the FY11E implied consensus operating profit of US$26.8/ton is still too high, as historically this level of profit has never been achieved.

• Replacing overland hauling conveyer: Adaro also disclosed that it is replacing the planned overland hauling conveyer, which faced constraints on material handling, with an OPCC conveyer system that will carry the mine materials to disposal. The expected cost of the new mine-site conveyer system will be about US$250-300 million, compared with the US$240 million cost for overland conveyer. This mine-site conveyer should maintain the expected reduction in annual operating cost of US$1-2/ton.

• Premium attached to our valuation: Currently, Adaro is trading at 16.3x our FY11E earnings, compared with the industry average of 13.1x. Also, our PT of Rp1,700 implies 14.4x FY11E P/E, which is at a premium to the industry. Currently, Adaro’s share price is trading at a 26% premium to the sector P/E vs. the historical 15% premium. Despite our belief that the P/E premium is less based on the Street’s forecast, as Street forecasts decline, we see downside to valuations.

• Maintain UW and PT of Rp1,700; switch to ITMG: We recommend investors switch from Adaro to ITMG on the back of: (1) potential re-rating of ITMG's share price; (2) higher FY11E and 5-year earnings growth of ITMG; (3) attractive valuation of ITMG at 10.9x FY11E P/E vs. Adaro’s 16.3x; and (4) higher dividend yield on ITMG. At this point, we are not changing our earnings forecasts, and view that the recent 4.89% outperformance since 2 Sept-10 should reverse. Maintain UW and PT of Rp1,700.