Majority of Listed Coal Companies’ Shares are Undervalued

Shares of coal producers in 2011, have the potential to rise due to the cheaper valuation aside from the increasing performance projection. According to IFT Research Department analysis, the majority of coal producers company shares are undervalued based on the multiple enterprise and return on equity (ROE) methods.

The ROE, one of the profitability ratios, is calculated by dividing net profit with total equity. The ratio is the measure rate of return received by investors if they invest in a company. The higher the ROE value, the higher rate of return for the investor.

Enterprise multiple is calculated by dividing the enterprise value (EV) with Earnings before Interest, Tax, Depreciation and Amortization (EBITDA). The EV/EBITDA ratio is similar to valuation ratios, such as Price to Earnings Ratio (PER) or Price to Book Value (PBV).

Based on the performance data of Q3/2010, majority of listed Indonesian coal mining companies had the same ROE rate, with the exception of Bumi Resources Tbk (BUMI) and Adaro Energy Tbk (ADRO), which are at 1.95 percent and 14.37 percent, respectively.

Regardless of an ROE below the average of 47 percent of the coal industry, share prices of the listed companies hold potential due to their enterprise multiple calculations which are below the average of 19.29, or categorized as undervalued. Investors should be wary of the huge debt to equity ratio of Bumi which has reached 4.37 as of September 2010.

Shares of Bayan Resources Tbk (BYAN) have a lower ROE compared to the average coal industry, while their EV/EBITDA are higher than average. This categorizes Bayan shares as overvalued with a below average rate of return.

Harum Energy Tbk (HRUM) shares have an ROE of 185.1 percent, far above the average, which attracts investors when observed from its rate of return. However, Harum also has an above average EV/EBITDA making their share price increase potential not as high as those in the undervalued category.

An attractive choice for investors are those with ROE above the average of listed coal mining companies with lower than the industry enterprise multiple. They are also interesting as acquisition targets because they are assessed as cheaper compared to similar companies. Only the Resource Alam Indonesia Tbk (KKGI) shares fit in this category, with an ROE of 54.23 percent and EV/EBITDA of 15.94. However, the prospects of Resource Alam shares is limited by their low number of shares and the lack of available information on the company.

Arief Wana, an analyst of Credit Suisse, in his research last January, stated that with the fluctuative condition of the stock market coupled by a sentiment of increasing inflation, investors should focus on shares that are undervalued compared to the industry, or even the market, as a whole. For the coal sector, Credit Suisse recommends the shares of Indo Tambangraya Megah Tbk (ITMG) with a 11.9 PER projection in 2011 or 13 below the market.

UOB Kay Hian research regarding 2011 investment strategies entitled "Rain On A Sunny Day", estimated that coal companies’ shares will surpass other sectors within the first half of this year. A few shares that they recommend are Adaro Energy, Indo Tambangraya and Tambang Batubara Bukit Asam Tbk (PTBA).

According to CLSA research, Bumi Resources’ Tbk (BUMI) 2011 performance will increase along with their plan to payout their first tranche debt to China Investment Corporation amounting to US$ 600 million. The debt payment will reduce Bumi’s interest expense to US$ 317 million from the Q3/2010 position of US$ 449 million.

Bumi’s shares are currently traded at around 9.2 from their net profit per share projection for this year, or below the average PER within five years of 15.3. EV/EBITDA of Bumi is projected at 6.0 in 2011. CLSA set a target price for Bumi shares at Rp 4,023 or 46 percent above Monday’s closing at Rp 2,750.