JPM BRAU Initiate with OW, June-11 PT of Rp530

Initiate with OW, June-11 PT of Rp530: Berau is the fifth-largest coal producer in Indonesia (FY09 production: 14MM tons) and controls Indonesia’s sixth-largest reserve (46MM tons). Within the Indonesian coal space, we expect Berau to generate higher-than-industry volume growth during FY10-12, and it stands out for its low-cost advantages and strong cash flow generation. In FY11, we expect revenue and core net income to rise by 29% and 74%, respectively.

• Positive investment themes: 1) Volume to rise by 16% CAGR over the
next five years, outpacing industry growth of c 14%. 2) Low production costs (FY11E US$44.2 cash cost per ton, in the bottom quartile of JPM’s universe) due to the strategic location of the mines near coastal areas, thus reducing hauling and barging costs. 3) Operating leverage. 4) Refinancing at lower interest rates.

• Upcoming catalysts: We believe that Berau's stock performance is held back by uncertainty over resolution of parent level gearing. One key development to monitor is the parent Bukit Mutiara’s (BM’s) deleveraging plans, which we believe could include a stake sale of Berau. Currently BM is holding an auction to sell up to 30% of BRAU; which at the current market value of US$1.8 billion translates to potential US$540MM proceeds. If the process resulted in the entry of a strategic investor, it could underpin valuations, clear the overhang, and potentially unlock upside beyond our PT.

• Valuation, price target, risks: Our PT of Rp530 is based on a blend of 3 standard metrics for coal companies (P/E, EV/EBITDA, and EV/reserves) combined with DCF, less a 15% discount to account for the overhang of the potential stake sale from the parent company. If the overhang were removed, our blended valuation method puts fair for BRAU at Rp620. Our Rp530 PT equates to 16.3x FY11E P/E and 6.3x FY11E EV/EBITDA. Additional risks to our PT and view include: 1) ASPs coming under forecast (as a function of variance in coal quality), 2) Execution risks – e.g. volume shortfalls, project delays, and 3) Any possible change in future accounting treatment of deferred exploration costs.