Adaro Energy (ADRO): Delivered a record production

Bareksa.com - We reiterate Buy rating on ADRO with TP Rp1,290. We remain positive due to: 1) Proven operational performance suggesting better earnings reliability; 2) Defensive nature, being a low cost producer with a volume growth of 6.8% CAGR 2012-2015F; 3) Benefiting from IDR depreciation as most revenues (in USD) come from exports, forming 80% of total sales; 4) Attractive valuation, trading below its book value at 0.76x 2014F P/BV. ADRO trades at 9.3x 2014F P/E, offering ~12% discount to our coal sector.

Delivered 2013 production guidance. In 2013, ADRO achieved a record coal production of 52.3 mt, or +11% YoY growth. The result was at the higher end of 2013 guidance, forming 101% of our forecast. The management attributed the positive results to the combination of solid market demand, normal weather conditions and well-run operations.

Increasing production volume at a slower pace. ADRO is guiding for production volume of 54-56 mt (pending government approval), or +3% to 7% growth for 2014. The government intention to limit production to 397mt in 2014 (-5.7% YoY) may have driven this slower growth target.

Deferred stripping cost could trim FY13 earnings. If we use last year as a guide, it is likely that ADRO would expense out a portion of deferred stripping cost to P&L (US$71.7m at 9M13). Thus, we have increased 2013F cash cost/ton by 1.2%, arriving at 2013F earnings which is 4% below the consensus. We have also increased 2014-15F cash cost/ton by 2.3% and 3.7% to be in line with the latest guidance. We have lowered 2014-15F earnings by 6% and 8.7%, which are 5% and 13% above the consensus.

Our 2014-15F cash cost/ton vs. consensus. The consensus implied cash cost/ton appear to be ~2.7% higher than our forecast. Going forward, we believe that OPCC system will keep the cash cost in check. The physical construction of OPCC is complete and testing stage was still underway. The cost savings could reach US$34m to US$41m per year which translates to a savings of 2.0% to 2.4% (based on 2013 cash cost projection).

Delivered 2013 production guidance

ADRO achieved a record production volume of 52.3 mt in 2013, or +11% YoY growth, which is at the higher end of 2013 guidance, forming 101% of our forecast. The company attributed the positive results to the combination of solid market demand, normal weather conditions and well-run operations.

The company achieved coal production of 13.6mt in 4Q13, or the second best quarterly production. ADRO booked a record quarterly sales of 14.36mt in 4Q13, due to strong demand for its coal. It removed 294.9 Mbcm of overburden in 2013, or –11% yoy, forming 98% of our forecast. The pre-stripping activities done in 2012 enabled ADRO company to lower strip ratio to 5.64x in 2013, from 7.02x in 2012.

2014 Guidance - Increasing production target at a slower pace

ADRO is guiding for production volume of 54 to 56 mt, or +3% to 7% growth for 2014. The government intention to limit the coal production to 397mt in 2014 (-5.7% YoY) may have driven this slower growth target.

- Production volume: 54 to 56mt (pending government approval)
- Cash cost (ex. royalty): US$35 to US$38/t
- Planned Stripping Ratio: 5.78x
- EBITDA: US$750m to US$1bn
- Capital Expenditure: US$200m to US$250mn

Forecast Changes - Deferred stripping cost could trim FY13 earnings

We have incorporated 2013 operational results and 2014 guidance into our forecast. At end FY12, ADRO had a deferred stripping cost of US$42.8m. As of 9M13, the balance increased to US$71.7m. In 2012, ADRO expensed out about US$55m of the deferred stripping cost to P&L. If we use last year as a guide, it is likely that ADRO could expense out a significant portion of that cost to P&L in 2013. Thus, we have increased 2013F cash cost by 1.2%, arriving at lower 2013F earnings (-3.8%). Our 2013F earnings is now 4% below the consensus.

We have fine-tuned 2014-15F sales volume by 0.9% and increased our cash cost/ton assumption by 2.3% and 3.7% to be in line with the latest guidance. We keep our 2014-15F revenues largely unchanged which are now in line with the consensus. We have lowered 2014-15F earnings by 6% and 8.7%, due to adjustment in cash cost per ton. Our 2014-15F earnings are 5% and 13% higher than the consensus.

Our 2014-15F cash cost per ton vs. consensus

The consensus implied cash cost per ton appear to be ~2.7% higher than our forecast. Going forward, we believe the Overburden Out of Pit Crushing and Conveying (OPCC) System will keep the cash cost per ton in check. The physical construction of OPCC is now complete and testing stage was still underway. Based on our calculation, the cost savings could reach US$34m to $41m per year. This translates into a cost saving of 2.0% to 2.4% (based on our cash cost forecast for 2013).

Valuation and Recommendation

Following 6% lower 2014F earnings, we trimmed our target price to Rp1,290 (-6.5% than previous), based on the same 13.2x 2014F P/E. ADRO has been trading below its book value (0.76x 2014F P/BV) and at 9.3x 2014F P/E, offering ~12% discount to our coal mining sector (10.6x P/E) and ~29% discount to our universe (13.1x P/E).

We remain positive on ADRO due to:

- Proven operational performance suggesting better earnings reliability.
- Defensive nature, being a low cost producer with a volume growth of 6.8% CAGR 2012-2015F that compensates for weakness in coal price.
- Benefiting from IDR depreciation, as most revenues (in USD) come from ex-ports, forming 80% of total sales.
- Attractive valuation. We believe the stock price decline of -26% from its recent high (about 2 months ago) has brought the valuation down to more attractive level. This should offer a good entry opportunity to get exposure in the global cyclical stock, in our view.

Key Risks

Key risks to our forecast and valuation:

- Benchmark Newcastle coal price to fall below our 2014-15F assumptions (US$85-87/t) due to prolonged oversupplied coal market. Recently, the benchmark ICE Future Newcastle coal price (for March delivery) fell to US$78.2/t recently, vs. ~US$85 at end of 2013.
- Unfavorable weather conditions, e.g. more rainfall than expected.
- Regulation risks, such as export limit, import ban, export tax, higher royalty rate etc.

*Franky Kumendong is PT Buana Capital's market analyst. This article is part of the Equity Research of PT Buana Capital