Indo Tambangraya Megah In Need of Some Excitement

Reinstate coverage with Neutral, TP: IDR43,100, potential upside: -11.6%
We reinstate coverage on ITMG with a neutral call as we believe the counter lacks specific catalysts other than taking a ride the generally robust coal sector. We believe the share price already reflects most of the positive factors. Moreover, the company’s relatively minimal volume growth and high production cost are key concerns. Our target price implies a 16.8x-9.7x FY11f-12f earnings.

Rising production cost erode FY10 earnings
Despite an increase in average sales price (ASP) as well as sales volume, ITMG’s FY10 gross profit still fell 5% y-o-y, no thanks to surging production cost (+20% y-o-y). ASP for 2010 stood at USD74.9/tonne (+16% y-o-y) while sales volume came in at 22m tonnes (+3% y-o-y). On top of that, a loss arising from a derivatives transaction shaved off its earnings by 39% y-o-y to USD204m. We believe that as the high production cost will crimp margins, the company may raise ASP in 2011.

Modest growth and coal reserves
With expectations of a relatively humble production growth of 11%-9% for FY11-12f, ITMG’s revenue stream will rely heavily on higher ASP. Accordingly, our estimated earnings growth is 57%-74% for FY11-12f, noting that the significant 2011f growth would be due to the low base in 2010. In addition, ITMG’s modest life of mine of 15 years (with coal reserves 336m tonnes) and high stripping ratio of 13.4x will continue to dog the company compared with its peers.

Strong balance sheet, generous dividend payout the positives
As of December 2010, ITMG’s held total cash of USD295m. The company’s huge payout ratio is one of the stock’s key attractions to investors who prefer cash returns from their investment. ITMG delivered a payout ratio of 70% on its FY09 earnings and an interim payout of 49% on its FY10 earnings.

Risks factors
The key risk to our view is an acquisition of a new coal mine that will boost the company’s production volume.

ITMG operations update for 2011
For 2011, the Indominco and Trubaindo operations will continue to be the largest contributors both in terms of production volume and growth. Additional production would come from the new operations at Tandung Mayang and Bharinto. Indominco’s newly built power plant is already in operation and is supplying power to Bontang port, where the port stockyard area and infrastructure improvements are ongoing.

Better pricing in 2011
In line with recent spurt in the global coal benchmark price, we estimate that ITMG’s ASP will likewise go up in the 2011f-12f period at an annual rate of 13% and 18% respectively. Based on the company’s latest disclosure, 89% of its 2011 coal sales is under contract, out of which the price is fixed for only 40% while 37% will be index-linked and the remaining 23% is yet to be priced. This puts ITMG in a favorable position to command higher overall ASPs for 2011.

High production cost, modest coal reserves remain concerns
Over the years, ITMG’s production cost has gradually moved up, generally due to the company’s deeper coal mining activity, as reflected by its growing stripping ratio. As a result, rising fuel cost has a larger impact on ITMG as a higher stripping ratio means higher overburden removal, which in turn translates into higher coal consumption. Another concern is ITMG’s generally more modest coal reserves, which is currently one of the lowest in our coal universe, especially compared with large coal mining companies like ADRO.

All the positives priced in
ITMG is currently trading at 19x 2011f earnings, which is higher than the industry average, while possesses an average growth profile. Our target price of IDR43,100 implies a 16.8x-9.7x 2011f-12f earnings based on DCF methodology, assuming a WACC of 10.8%. One the counter’s strengths is without doubt its superior dividend yield on account of its huge payout ratio.

We are estimating a dividend yield of 2.7%-4.2% for 2011f-12f (including an interim 2010 dividend paid out in October 2010). Underpinned by its modest growth profile compared to its peers as well as limited upside potential, we have a NEUTRAL call on ITMG.