Sunday, March 6, 2011

PT. Indo Tambangraya Megah Tbk (ITMG)

by Citi Securities

We came away from a meeting with the company more assured that the surging costs seen in 2H10 are unlikely to transpire in 2011, barring a further surge in the oil price and another major weather disruption.

The company attributed the weak 2010 results to:
1. Heavier than normal rainfall, which: 1) forced a move to a different pit in its Indominco mine and 2) resulted in sizable demurrage costs of US$23m. The former resulted in a substantially higher stripping ratio (SR).
2. Surging fuel prices (average of US$0.72/l in 2010 vs. US$0.52/l in 2009). For 2011, the company has hedged c.80% of its fuel requirement at c. US$90/b.
3. Several one-off items, such as the write-off of an underground project’s deferred exploration and development costs of US$25m and a standby fee to contractors of US$9m as the Jorong mine operation was suspended for several months.
4. Derivative losses. The company booked US$71m losses (realized and unrealized) on its coal swap contracts in 2010.

Post the meeting, we take comfort in our view that the cost pressures are likely to taper off substantially in 2011. First, the company expects the SR of its major Indominco mine would decline to 13.6x in 1Q11 from 14.7x in 4Q10. Demurrage costs are also expected to be substantially lower as the company slows vessel acceptance and expects the waiting period for the vessels to normalize starting March. Finally, we expect the company’s coal swap losses to decline to c. US$30m in 2011E on our benchmark coal price assumption of US$122/t.

The company is upbeat on the coal price outlook and hence has locked in prices for only 40% of its 2011E volume target as at February. The buoyant coal price outlook, normalizing costs and attractive valuations lead us to maintain our Buy call. We view the current share price weakness as an enhanced buying opportunity.

Indo Tambang Raya Megah (ITMG.JK; Rp42,500; 1L)

Our target price for ITM of Rp61,200 is based on 2011E EV/EBITDA of 7.3x. This is based on 1 standard deviation above the stock's mean since its listing. We have opted to use EV/EBITDA as our valuation metric to avoid distortions caused by differences in tax rates between Indonesian companies and their regional peers. The discount to the global average is warranted, in our view, given Indonesia's higher risks.

We rate ITM Low Risk , based on our quantitative risk rating system, which tracks 260-day historical share price volatility. We believe Low Risk is appropriate given the company's sizable cash and relatively high dividend payout. Risks that could prevent the shares from reaching our target price include: a) coal price volatility; b) fluctuating crude oil prices; c) poor weather conditions that might hamper coal production.

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