Adaro Energy Giving The Benefit of The Doubt

Maintain BUY with TP of IDR2,550
We remain optimistic of ADRO’s performance going forward as the company is positioned to ride on a strong wave of coal demand, as is being reflected in the red-hot coal price. Indeed, although missing its production target and surging costs in 2010 are of concern, we believe that the recent correction in its share price has priced in those fears.

Our TP is revised down to IDR2,550, which implies a 20.7x-14.5x FY11f-12f earnings. The premium valuation attached to ADRO is justified given its huge exposure in the coal industry, sound corporate governance as well as proven track record.

Bad weather in 2010 negated the company’s performance
As a result of a lower than expected production target, ADRO has to bear with demurrage charges as well as lower ASP for 2010. However, production costs continued to surge as a function of a higher strip ratio as well as additional weather related costs (e.g. pit dewatering efforts, construction of pipelines, repair & maintenance of hauling road). These in combination caused a 49% y-o-y decline in 2010 profit to IDR2.2trn, although this also includes the negative impact of currency conversion.

Looking ahead
ADRO offers an exciting profile in terms of growth potential and its solid position in Indonesia’s coal industry. We envisage a coal production growth of 12%-15% and ASP growth of 8%-17% for FY2011f-12f respectively. Also worth noting it’s the company’s continuing expansion as well as its involvement in IndoMet Coal Project (ICP), in which ADRO holds a 25% stake and BHP Billiton, with 75%. The ICP comprises seven JVs with each being signatory to a Coal Cooperation Agreement (CCA) across Central/East Kalimantan. Although this is naturally a long-term venture, one cannot deny its potential as ADRO has poured c.IDR3.2trn into this project.

Valuation and target price
We revise our TP slightly lower to IDR2,550 after adjusting our assumptions on coal price and production cost. At present, the counter is trading at 18.5x-11.8x 2011f-12f earnings, which is definitely a premium over the industry average of 15.6x-12.4x. We deem this premium justified given ADRO’s robust future outlook, solid track record and sound corporate governance.

Risk factors
The key risks to our call are: i) prolonged extreme weather, and ii) higher than expected production costs.