Resource Alam Indonesia, Excitement Aplenty
Supported by ample coal reserves and in-place coal processing and handling infrastructure, Resource Alam Indonesia (KKGI) is set to continuously ramp up coal production in the coming years. The company has internal estimated coal reserves of 73m tonnes, which translate into a life-of-mine of 20 years. Production for 2011 is slated to reach 3.5m tonnes (+58% y-o-y) and that for 2012 to 4.5m tonnes (+26% y-o-y), backed by its in-place infrastructure of coal crushing and loading capacity of 7.7m tonnes and 12m tonnes per annum each respectively.
Big leaps in production growth
Since commencing full-scale production in 2007, KKGI has been chalking up superior growth in production volume of a CAGR of 132% from 2007 to 2010. For 2011 and 2012, we estimate that KKGI would be able to produce 3.5m tonnes (+58% y-o-y) and 4.5m tonnes (+26% y-o-y) of coal respectively, driven by ever-rising coal demand as well as adequate capacity to cater to such volume.
Demand for coal will come from both the global and domestic markets as the latter will be driven by recently developed coal-fired power plants to provide more electricity to support Indonesia’s economic growth. The state electricity company (PLN) estimated that domestic power plants will consume a total coal of 58.6m tonnes (+60% y-o-y) in 2011 and 75.3m tonnes (+28% y-o-y) in 2012. KKGI itself has signed a contract with PLN to deliver 500,000 tonnes of coal for 2011.
Adequate coal reserves to support expansion
KKGI has estimated coal reserves of 73m tonnes and coal resources of 126m tonnes. We note that this figure has yet to be verified by industry norm third party reviewers such as JORC (Joint Ore Reserve Committee). Taking the figures into account, KKGI’s life-of-mine will stretch up to 20 years, assuming an annual production of 3.5m tonnes, which is more than sufficient to support its long term operation. Of KKGI’s entire mine concession area of 24,477ha, only 23% is already in production. On top of that, being located close to the port, with only a c.13km hauling distance, it is able to enjoy operation efficiency.
Healthy balance sheet and strong cash flow
At the end of 2010, the company’s unaudited balance sheet reflected a net cash position of IDR132bn. This year, the company is budgeting for total capex of IDR30bn to support its expansion, which will simply be funded by internal cash. Having said that, the, possibility of an earnings distribution as dividend is also imminent.
Initiate with a BUY
We set our target price for KKGI at IDR4,625, implying 11.3x-7.9x 2011-12F PER based on a 25% discount to the industry’s weighted average 2011F PER of 15.1x. The undemanding multiples and exciting growth profile of KKGI underpins our positive stance on the counter.
CHANGING FOR THE BETTER
Shifting focus to coal mining
KKGI was initially established in 1981 under the name PT. Kurnia Kapuas Utama Glue Industries, which was engaged in the glue industry and focused on wood adhesive production via a vertically and horizontally integrated business model. In 1997, the company acquired a coal mine concession in East Kalimantan under a CCoW generation III licence for an area totaling 24,477 ha. A key advantage of this type of licence is its more tax-friendly features compared to the previous generation.
Steadily ramping up production
Since commencing full-scale production in 2007, KKGI has been delivering superior production volume growth at a CAGR of 132% from 2007 to 2010, supported by KKGI’s well-planned infrastructure development. Yearly production growth in 2010 experienced astounding growth, jumping 58% y-o-y from the preceding year, and hitting the initial annual target of 2.2m tonnes. In order to boost production, the company will open more sites in its concession area and engage with its contractors to deliver more coal.
Resource-rich mine and strategic location
KKGI has estimated coal reserves of 73m tonnes and coal resources of 127m tonnes in Kalimantan. Note that this figure has yet to be verified by third party reviewers such as JORC (Joint Ore Reserve Committee) as the management does not consider this necessary at the moment. The average calorific value is 5,355 kcal/kg, which is a sub-bituminous coal type.
KKGI’s life-of-mine will stretch up to 20 years, assuming an annual output of 3.5m tonnes (2011 target), which is more than sufficient to support its long term operation.
Of KKGI’s mine concession covers 24,477 ha, only 23% is already in production
The coal, which is mostly exported, contributed 95.2% of total sales volume as at 9M10. Having a mine concession in East Kalimantan is a key advantage for KKGI as it is close to large thermal coal markets in Asia such as China (58% of total coal sales). Furthermore, the mine concession is located close to a port (with a 13km average hauling distance, which translates into efficient operation cost). Adding to this is the company’s relative resilience to bad weather conditions due to its strategic location and having mining sites that are adjacent to each other.
As a result of bigger economies of scale, the higher production volume has led to KKGI’s production cash cost declining on a historical basis. Although we don’t expect this trend to continue as costs will steadily rise as more coal is extracted, we believe the growth will be relatively modest due to factors such as: 1) the company’s use of mining contractors that offer more competitive fees compared to the big names such as Pamapersada or Bukit Makmur, 2) short average hauling distance of only 13km from pit to port, and 3) average stripping ratio of 8x, with an average CV of 5,355 kcal. Thus, with ASPs expected to increase, the company stands to generate better margins.
Beneficiary of rising coal demand
The recent surge in global coal price has been largely due to stronger coal demand from countries undergoing strong economic expansion such as China and India as well as the recent floods in Australia, which have disrupted sea-borne coal supply. McCkloskey Newcastle Index coal price has surged to USD132.5 per ton, up 67% since January 2009.
On-going demand for coal will emerge from the global and domestic markets as the latter will be driven by recently developed coal-fired power plants in order to provide more electricity to fuel Indonesia’s economic growth. The state electricity company (PLN) estimated that domestic power plants will consume a total coal of 58.6m tonnes (+60% y-o-y) in 2011 and 75.3m tonnes (+28% y-o-y) in 2012. KKGI has signed a contract with PLN to deliver 500,000 tonnes of coal for 2011, which would give KKGI a more balanced proportion of sales as it current production is mostly exported.
On expansion mode
We expect coal production to reach 3.5m tonnes (+58% y-o-y) in 2011 before reaching 4.5m tonnes (+26% y-o-y) in 2012 on the back of higher production and ASPs. As a large concession area is still not fully exploited, growing coal extraction is imminent given the installed coal crushing capacity of 7.7m tonnes p.a and loading capacity of 12m tonnes p.a. KKGI will operate a total of 6 blocks in its mine area for 2011, in order to ramp up production.
Profitability set to rise further
Regardless of its relatively modest capex of IDR30bn in 2011, we believe that production growth would be robust within the 2011-2012 period given that the infrastructure is already in place, as well as the huge demand for coal. This would boost 2011 revenue to IDR1,854bn (+ 91% y-o-y), driven by a 58% (3.5m tonnes) increase in sales volume as well as ASP that will be 17% higher (USD56/ton).
Consequently, net profit will soar by 136% to IDR408bn in 2011. For 2012, we are estimating a sales volume growth of 26% (4.5m tonnes), with ASP growth of 7% (USD60/ton), which translates into a revenue and net profit y-o-y growth of 35% and 44% respectively.
As of Dec 2010, KKGI was in a net cash position with a cash balance of IDR132bn, accounting for 25% of total assets. Thus the planned capex will simply be funded by internal cash. The company’s strong cash flow generation and a solid balance sheet suggest a potential reward in the form of dividend distribution. Assuming a 40% dividend payout ratio, the dividend yield for 2011-12F is about 1.9% – 4.6%.
Brief overview of 9M10 results
KKGI recorded stellar growth of 116.2% and 265.5% y-o-y in its top and bottom-lines for its 9M10 due to strong production volume. It also managed to increase its cost efficiency given that its 9M10 gross margin surged to 50.0% compared to 37.4% in 9M09. This results in a net margin expansion to 18.0% for 9M10 from 10.6% in 9M09.
Valuation
Our target price for KKGI at IDR4,625 is based on a targeted 2011F PE ratio of 11.3x, which implies a 25% discount on the industry average. We assign the discount to reflect KKGI’s lack of size and long-term track record compared to its larger peers. At present, the counter is still trading at an undemanding multiple of 8.7x even though it is chalking up robust volume growth momentum.
As such, we believe KKGI presents an interesting alternative exposure to Indonesia’s robust coal industry outlook. One major caveat on the counter is its low liquidity (USD0.8m trading value average in the last 3 months) and small market capitalization (USD394m).
Risk Factors
1. Production risk.
KKGI’s growth predominantly hinges on its capability to ramp up production. Hence the inability of its mining contractors to deliver or any extreme weather condition might affect its achievement of the target. That said, the company also has a relatively short track record.
2. Pricing risk.
Due to its generally small production scale, the majority of KKGI’s coal is sold through traders. Thus any significant downturn in global coal price might affect KKGI more than its larger peers. Nevertheless, the company is putting in more efforts to sell its coal directly to end-customers, as can be seen from its recent contract with PLN to obtain more favorable prices.
3. Liquidity risk.
With a market cap of USD394m and daily trading value of USD0.8m, KKGI might not most investors’ cup of tea given its relatively poor liquidity. One has to consider this carefully as any extreme negative movement in the overall market might cause the liquidity in small cap counters such as KKGI to shrink drastically.
COMPANY PROFILE
KKGI is currently majority-owned by its founder, Adjianto family, with a total ownership of 66.89% through several companies. The company was established in 1981 under the name of PT.Kurnia Kapuas Utama Glue Industries and listed on the IDX in 1991. The company obtained 3rd generation CCoW (Coal Contract of Work) coal mining concession in 1997 which covers a total area of 24,477ha.
KKGI began diversifying into coal mining in 2004 and formally changed its name to PT. Resource Alam Indonesia Tbk. It initially started its coal operation in two blocks – Simpang Pasir, Gunung Pinang and Bayur – and gradually expanded to 6 blocks in 2011. KKGI’s concession is strategically located next to Samarinda City along the Mahakam River in East Kalimantan.
