Coal Industry Overburdened

The Indonesian Coal Sector Report, titled “Overburdened” suggesting another challenging year with more work or earnings pressure for coal producers across the industry.

Interestingly Bumi Plc on the same day, after report dissemination, made another disappointing announcement on the quality of its balance sheet. The new management of Berau Coal Energy (BRAU IJ) has concluded that there is not sufficient evidence to support the capitalization of certain expenditures totaling US$94mn, in particular US$56mn attribute to deferred stripping cost and US$38mn attributed to landowner payment. Therefore, the management likely to expense in FY12 income statement.

Shifts in the global energy mix and in coal industry growth sources in developing economies, create a challenging outlook. We reinitiate our coal sector with an Underweight rating as we expect coal price to linger in 2H13 and further earnings disappointment  in 2013F, leading to unattractive valuations at +1STD or about 15x P/E13F. We have a Neutral rating on PTBA and HRUM; a SELL rating on ADRO, ITMG, BUMI and BRAU.

Tight pricing for 2013, limited signs of recovery. Although the storm may dissipate and the market may see limited downside on coal prices, with 1Q13 at US$91/t (-17%YoY), we see coal price to linger in the coming quarters and we foresee US$90/ton as our 2013 reference price (-21%YoY), or about 5-10% below consensus. Spot price now at US$86.7/t. Indonesia coal export fell 6%YoY or 26%MoM along with slower Chinese coal import at 5%YoY in February 2013 due to continued sluggish power demand which fell 12%YoY, and less restocking activities as inventory remains high at 22 days.

Evolving law: torrent of regulations.  Indonesian government has made a steady progress in mining regulation reform and continues to adjust its mining regulations that, in commercial and practical terms, are more stringent. Plan to seek control on national production or export (quota) are intensely considered. Plans to change from FOB to CIF for Indonesia commodity export trade will likely have negative sentiment to the industry

Where do we turn for 2013? Value plays are very difficult to come by these days especially in the mining universe due to volatile coal prices. While it is intuitive to buy the most geared name for a greater return, but it poses a potential risk of capital raising (BUMI) if coal price recovery do not materialize. Therefore, high quality names with strong balance sheet, growth potential and high cash margin will provide better support (PTBA). Companies that have expensive interest debt, lack of tax shield due to LBO structure will suffer more this year (BUMI, ADRO and BRAU).

Where we differ? Consensus may not adequately incorporate mine-life reserves (adopting an in-perpetuity approach) and potential downside risk from future treatment of actual stripping costs to align with new IFRS. Our FY13 earnings forecast are 22-59% below consensus (ex BUMI). Our adjusted blended valuation incorporates DCF as the core method, blended with earnings multiples, favors PTBA but disfavors HRUM &ITMG given its shorter mine-life reserves.