Resource Alam Indonesia, Plenty of excitement

Supported by adequate coal reserves and in-place coal processing and handling infrastructure, Resource Alam Indonesia (KKGI) is set to continuously ramping up its coal production volume in coming years. The company has an internal estimate coal reserves of 73m tonnes that translates to life-of-mine of 20 years. Production for 2011 is slated to reach 3.6m tonnes (+59.6% y-o-y) and 2012 at 4.5m tonnes (+26.6% y-o-y), this also supported by in-place infrastructure capacity of 6m tonnes.

Massive production growth
Since its full-scale production commencement in 2007, KKGI continues to deliver superior growth in its production volume with CAGR of 132% between 2007-2010 periods. For 2011 and 2012, we estimated KKGI able to achieve total coal production of 3.5m tonnes (+59.6% y-o-y) and 4.5m tonnes (+26.6% y-o-y) each respectively driven by ever-rising coal demand as well as adequate capacity to deliver such volume.

Demand for coal will emerge from both global and domestic market as the latter will be driven by recently developed coal-fired power plants in order 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 an estimated coal reserves of 73m tonnes and coal resources of 126m tonnes. Noted that this figure is not yet verified by industry norm third party reviewer such as JORC (Joint Ore Reserve Committee). Taking the figure into account, KKGI’s life of mine will stretch to 20 years with assumption of 3.6m tonnes production p.a., more than sufficient to support the long term operation in our view.

KKGI total mine concession area is 24,477ha with only 23% of it already in production stage. On top of that the mine location has a close proximity to port with only c.13km hauling distance thus offering more efficient operation. KKGI mining license is a CCoW generation III that has more tax-friendly clause than its predecessors.

Healthy balance sheet with strong cash flow
As of Sept 2010, KKGI already in net cash position with total cash balance of IDR74bn that accounts for 17% of the total assets. This year, the company is budgeting a total capex of IDR30bn to support the expansion that will simply funded by internal cash. Having said that, possibility of earnings distribution as dividend is imminent.

Initiate with a BUY
We set our target price for KKGI at IDR5,478, implying 16.4-12.5 2011-12F PER based on PE valuation using industry’s weighted average of 16.4x for 2011. The undemanding multiples and exciting growth profile for KKGI underpinned our positive stance on the counter.

CHANGING FOR THE BETTER
Shifting its focus on to coal mining
KKGI was initially established in 1981 under the name of PT. Kurnia Kapuas Utama that engage in glue Industries focusing on wood adhesive production business with a vertical and horizontal integrated business model. In 1997, the company acquired a coal mine concession in East Kalimantan area, under CCoW generation III license with total area of 24,500 ha. One of the key advantages of this type of license is its more tax-friendly feature compared to the previous generation.

Steadily ramping up its production
Since its full-scale production commence in 2007, KKGI continues to deliver superior growth in its production volume with CAGR of 132% between 2007-2010 periods supported by KKGI’s well-planned infrastructure development prior full-production period. Q-o-q production growth in 2010 demonstrates an astounding growth and well pace to meet the initial target of 3.5m tonnes annual production, good for a 59% increase from previous year. In order to boost production, the company will open more sites in its concession and engage with its contractor to deliver more coal.

Enriched with resourceful and strategically positioned mine area
KKGI has an estimated coal reserves of 73m tonnes and coal resources of 126m tonnes located in Kalimantan. Noted that this figure is not yet verified by industry norm third party reviewer such as JORC (Joint Ore Reserve Committee) as the management did not consider it 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 to 20 years with assumption of 3.6m tonnes production p.a., more than sufficient to support the long term operation in our view.

KKGI total mine concession area is 24,477 ha with only 23% of it already in production stage. The coal was sold mostly to the export market that constitutes for 95.2% of the total sales volume as of 9M10. Having a mine concession in East Kalimantan has been a key advantage for KKGI as it has proximity to large thermal coal markets in Asia such as China (58% of total coal sales).

Furthermore, the mine concession location is close to the port (13km average hauling distance which offers more efficient operation cost. Adding to that is the company’s relatively less vulnerability to bad weather conditions due its strategic location and adjacent mining site from one to another.

As a result of bigger economic of scale, higher production volume has resulted KKGI production cash cost to decline historically. Though we don’t expect this trend to continue as cost will steadily rise along with more coal being extracted, we believe the growth will relatively modest due to factors such as 1) the company usage of mining contractors that offers more competitive fees compared to the big names such as Pamapersada or Bukit Makmur, 2) short hauling distance of only 13km from pit to port, and 3) average stripping ratio of 8x with average CV of 5,355 kcal. Thus, with ASP expected to increase, the company will definitely able to generate better margin.

Beneficiary of rising coal demand
Recent surge on global coal price was largely due to higher coal demand from countries with strong economic growth such as China and India as well as recent flood in Australia that disrupt the sea-borne coal supply. McCkloskey Newcastle Index coal price has surge to USD138.5 per ton, a 74.2% increase since January 2009.

On-going demand for coal will emerge from both global and domestic market as the latter will be driven by recently developed coal-fired power plants in order 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. This would provide a more balanced sales proportion for KKGI as current productions are mostly exported.

On expansion mode
We expect coal production will reach 3.5m tons in 2011, before reaching 4.5m tons (+26.6% y-o-y) in 2012 on the back of higher production volume and ASP. As large concession area has not been fully exploited, growing coal extraction is imminent and fully supported by installed coal crushing capacity of 7.7m tonnes p.a and loading capacity of 12m tonnes p.a. KKGI will open another 6 sites in its mine area that brings a total of 11 sites for 2011 in order to ramp up its production volume.

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 the infrastructure is already in place as well as the huge demand for coal. This would boost 2011 revenue to reach IDR1,821bn (+ 87.8% y-o-y) driven by increase in sales volume of 59.6% (3.56m tonnes) as well as higher ASP of 14.6% (USD55/ton).

As a result, net profit will increase by 141.2% to IDR417bn in 2011. For 2012, we are estimating a sales volume growth of 26.4% (4.5m tonnes) with ASP growth of 9.1% (USD60/ton) that translates to revenue and net profit growth of 37.9% y-o-y and 57.6% y-o-y, each respectively.

As of Sept 2010, KKGI already in net cash position with total cash balance of IDR74bn that accounts for 17% of the total assets thus the planned capex will simply funded by internal cash. Strong cash flow generations and balance sheet position suggest for potential rewarding dividend distribution. Assuming a 40% dividend payout ratio, the dividend yield for 2011-12F is around 1.7% – 4.4%.

Brief overview of 9M10 results
KKGI recorded a strong 116.2% and 265.5% y-o-y increase in the top and bottom line for its 9M10 results due to strong production volumes. Also, KKGI managed to increase cost efficiencies given that 9M10 gross margin increased to 50.0% compared to 9M09 of 37.4%. This results in net margin expansion to 18.0% in 9M10 from 10.6% in 9M09.

Valuation
We calculate a target price for KKGI at IDR5,478 based on targeted 2011 PE ratio of 9.1x which implies a 44.5% discount from the industry average. We assigned the discount to reflect KKGI lack of size and long-term track record compared to its larger peers. At present the counter is still trading at an undemanding multiples of 9.1x given its robust volume growth and strong momentum within the sector.

As such we believe KKGI will serve as interesting alternatives to get exposure on robust Indonesia coal industry outlook. One major caveats for the counter would be its low liquidity (USD0.7m trading value average in the last 3 months) and small market capitalization (USD417m).