Sunday, March 24, 2013

Adaro Energy Low Operating Margin

Adaro Energy: Weak 4Q12 results, Hit new record low margin- FY12 result 83%consensus
(Rp1,400/share, Under review)

Weak 4Q12 results. ADRO’s FY12 net profit was US$383mn (-30%YoY) and operating profit US$869mn (-32%YoY), 15% below consensus. Despite excellence 4Q12 operational performance with production up 7%YoY and 22%QoQ at 13.3Mt, bottom line only US$35mn (-80%YoY, -76%QoQ) as company expensed its deferred stripping cost of US$117mn from the US$160mn deferred stripping cost on the balance sheet as of 9M12, led 4Q12 COGS up 23%YoY and 32%QoQ to US$787mn. This is in line with our expectation, as we had highlighted such earnings risk following significant lower actual SR in 4Q12 at 5.8x (-32%QoQ) (see exhibit 1 and our previous email or report).

Hit new record low operating margin. ADRO has hit new record low 4Q12 operating margin of 12.8% since its listing  in 2008 (see exhibit 2). We have been highlighting Tutupan’s mine characteristic has showed peak cycle, resulting costly mine operations due to overhauling and challenging OB issues. ADRO’s 4Q12 ASP was US$65/ton (-18%YoY, -5%QoQ) while total cash cost remain high at US$52/ton (+9%YoY,+9%QoQ). Coal cash cost (ex royalty) in FY12 was reported up 9%YoY at US$39/t vs ASP down by 4%YoY at US$70/t. Higher total cash cost in ADRO also part of higher contribution from expanding SIS’s business, which relatively has lower profitability. Lower utilization rate on fleets at this juncture and significant higher labor cost increased which up 114%YoY to US$49mn.

2013 Outlook remain challenging. ADRO’s aiming FY13F EBITDA of US$850mn- 1.0bn, or about 23% lower for the low end. Company is also seeking to lower SR to’s 5.8x and lowering coal cash cost (ex royalty) of US$35-38/t. OPCC and mine mouth power plant are expected to commission in May/June 2013.  Company plans to reduce capex spending and slow big spending on the development of its new coal acquisitions to preserve cash. But with higher debt which up 16%YoY to US$2,445mn, effective higher salary wage for labors in 2013 will increase the fixed cost portion and may tweak margins further. FY13 earnings also still expose to remaining US$43mn deferred stripping cost on the balance sheet.

Our take: Bottom line matters, not EBITDA - Albeit Company highlighted it has hit the low end EBITDA target of US$1.1bn, what matters for Investors is the earnings or bottom line delivery as it affects the dividend income or yield for shareholders. Ironically ADRO known as the low cost producer reported lower operating margin vs high cost producers such as ITMG which recorded 4Q12 operating margin of 16%.

In our view, vertically integrated into mining contracting business (SIS) not necessarily value accretive to shareholders especially in a structural shift and bearish market, in fact as it’s highly capital and labor intensive with higher fixed cost portion, it has double impact to bottom line. ADRO’s mining services cost % to revenue has surged significantly up to 7% of total revenue, the highest in the last 4 years (see exh. 4). In addition, with the new minimum wage 40-50% increase effective in 2013, it should give additional burden to SIS’s operational costs, eventually affect ADRO.

We believe that change in mine plan by lowering planned SR from 6.4x to 5.75x likely to affect its minelife reserves in our view. With Newcastle spot rate below US$90/ton, ADRO’s FY13 contract pricing sounds tight and earnings outlook remain challenging. Assuming EBITDA-net profit sensitivity ratio in  FY12 at 1.2x maintained, then we may see potential downside of 27-28% lower bottom line in FY13 based on Company’s low end EBITDA guidance or at about US$300mn, implying 15.4x FY13 P/E vs Consensus at 12.0x.  We still see SELLING PRESSURE on the stock as earnings downgrade from street may continue for FY13F. Currently we’re still in a process reviewing our coal sector coverage including ADRO.

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