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Investors bet on Indonesian coal, despite price

Coal is down 14% this year—but after a brutal 2013, some mining shares are up

nvestors are piling back into Indonesia's biggest coal miners in the belief that the long-shunned sector is ready to benefit from a recovery in commodity prices.

Two of the largest Jakarta-listed producers— PT Adaro Energy and PT Tambang Batubara Bukit Asam —have rallied 19% and 12% this year, respectively, following falls of over 30% last year.

Investors are betting that the price of coal, down 14% this year, may be bottoming out and that one of one of Indonesia's most valuable industries—the country is the world's largest exporter of coal—is poised to benefit. Investment is flooding back into the country on the premise that domestic demand is improving and that buying from China may recover, which would have a knock-on effect on demand for Indonesian coal, used mostly in power stations.

"The analytical look at coal is pretty good—coal consumption goes up every day," said Richard Foyston, chairman at Navis Capital Partners, which manages more than US$600 million and is buying into Indonesian coal producers. "It's easy to think, 'Oh, what an oversold sector.'"

But not all companies have benefited. PT Berau Coal Energy BRAU has lost around a third of its value this year, as has PT Bumi Resources, BUMI.JK +0.47% the country's largest coal miner by revenue, which posted record losses in the past two years.

"There are lots of companies that can't make money at today's coal price, and there are some good companies than can, and they'll keep making money," Mr. Foyston said.

PT Indo Tambangraya Megah, ITMG.JK +3.10% a coal miner that also operates ports and terminals for export, has delivered an average return on equity over the past three years of 21%, while competitor PT Indika Energy INDY.JK +1.56% has returned just 6.8%, according to Navis. The measure shows how well companies use shareholders' money to generate income.

Bumi Resources director Dileep Srivastava said the company's main issue is high borrowing costs, while depressed coal prices have taken a toll on profits. He said the company is "doing extremely well" on a number of measures. Indika Energy and Berau didn't immediately respond to requests for comment.

Oversupply has sent coal prices to their lowest level in nearly seven years, with further pressure from China's attempts to reduce air pollution. Coal investors are hoping that the global recovery will boost demand for Chinese exports, and so demand for coal, which powers a large portion of the country's manufacturing base. Thermal coal in Australia trades at around $74 a metric ton, down from nearly $130 in 2011.

Price-to-earnings ratios, a widely-used valuation measure, show that even the past year's top-performing coal companies trade at a discount to the market. Adaro Energy and Indo Tambangraya Megah shares both trade at 11 times earnings, compared with 19 for the country's benchmark JSX index.

"The outperformance of Indonesian coal stocks against the coal price year-to-date suggests that the sector is under-owned and the market is pricing in a bottoming-coal-price scenario," said Erindra Krisnawan, an analyst for CIMB in Indonesia.

Some investors are finding value in coal companies after years of slumping share prices. "Coal players languished for much of this year along with coal price on continued concerns over China's economic growth. However, they have rebounded recently off depressed levels as investors rotated from overbought sectors in Indonesia," Lai Yeu Huan, senior portfolio manager at Nikko Asset Management in Singapore, said in an email.

At this stage of the cycle, investors are sticking with the safest options—the larger coal players with sizable reserves.

"We like miners with strong balance sheets that can continue to invest through the commodity cycle, particularly if it's a single-commodity miner," said James Thom, Asian equities investment manager at Aberdeen Asset Management, which has $3.2 billion invested in Indonesia. While Aberdeen isn't changing its exposure this year, it owns a miner in Indonesia and prefers the most cost-efficient operators with a significant reserve life and good governance.

Source: The Wall Street Journal