Infighting in Indonesian Coal Won’t Dampen Demand

By Peter Pham - October 30, 2012 | Tickers: EIDO, KOL, IDX, PKOL.DL | 0 Comments

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The shares of the London listed Indonesia based Bumi Plc, which has a significant representation in Market Vectors Indonesia Index ETF : IDX), have gone up by as much as 48% since October 11 following the revelation that Indonesia’s Bakrie family has decided to split the business by buying back their stake from Bumi for $1.4 billion.

Financial irregularities in one of the firms owned by Bakries have created tension between the Bumi and Bakrie families and the latter is now looking to end the dispute. Bakrie is not only looking to buyout Bumi’s 29% stake in the Indonesian PT Bumi Resources, the country’s largest thermal coal producer, but also purchase Bumi’s majority stake in PT Berau Coal Energy in the coming six months. If the acquisition is approved, then Bumi Plc will become just a holding company without any mining assets.

Bumi Plc was the marriage of one of the most influential Indonesian and British families. Representing Britain on Bumi’s board was financer and co-chairman Mr. Nathaniel Rothschildof the Rothschild family that has more than 200 year old history in the European banking sector. The revelation of irregularities prompted Rothschild to demand a change in Bumi’s executives while its co-Chairman Indra Bakrie, Chairman Samin Tan, moved to remove Rothschild. Just a few days later, Rothschild handed his resignation letter saying that he regrets his decision to bring the Bakrie family to London and believes that the current buyout is "not in the interests of minority shareholders."

Despite the recent surge, due to this managerial tumult, Bumi’s shares have fallen by more than 70% in London since January. Its H1 revenues have fallen by 17.1% to $770 million as it increased its quarterly losses from $11 million in H1 2011 to the current loss of $117 million. Given the current financial constraints the business is in, it is difficult to give weight to Rothschild’s argument that minor shareholders won’t benefit from a buyout. In fact, the recent surge suggests that they have already regained some of the lost value. The dispute between Rothschild and the Bakrie family has highlighted the problems associated with cultural integration more than anything else.

In the meantime, Indonesia’s second biggest coal producer and Bumi’s main rival, Adaro Energy(NASDAQOTH:ADOOY.PK), has also seen its shares decline by 31% since the start of the current year but its fall hasn’t been as severe as Bumi’s. Adaro was able to increase its revenues by 9% to $1.9 billion despite the more than 20% slump in coal prices. However, rising fuel costs which drive directly to the company’s COGS will continue to swamp any further rebound in coal prices so, realistically this situation is short-lived. 

This is reflected in the price of the Market Vectors Coal ETF : KOL).  Since January it has fallen by 22.3% but has recently started rising since the beginning of October and has been up 7.2% after natural gas prices in the U.S. found their footing above $3 per MM BTU.  An increase in natural gas prices, which collapsed earlier in the year to all-time lows, will cause substitution out of it and back into coal. 

The PowerShares Global Coal ETF ) is weighted more towards Asian firms and therefore focuses on the supply side, like KOL, has also been  down 19.4% overall since January and up 5.5% since the beginning of the current month.

KOL, which is relatively larger in terms of asset value, has seen a bigger decline this year with a beta of almost 2, which makes it slightly more volatile than PKOL which is trading at a slightly higher P/E. 

Indonesia’s economy depends, to some extent, on exports of coal, particularly to China. A decline in Chinese growth by 1% pulls Indonesia’s expansion down by 0.5%. The country is expected to grow by 6.1% this year and 6.3% in the next. However, a further slowdown in the Chinese economy next year can pull Indonesia’s GDP growth for 2013 to just about 5%. Moreover, Indonesia’s other primary buyer of coal is India; a country whose growth forecast has been currently reduced to just 4.9% for the current year amid both economic and political turmoil due to an unbalanced power grid among other issues.

However, for the time being, the demand for Indonesian coal from India and China is likely to remain stable. The low-grade thermal coal supplied by Indonesia is the cheaper alternative for fulfilling energy needs, particularly of emerging markets. The current increase in bid prices from China is largely due to the opening of businesses in the country after the holiday season and is cyclical. However, the demand will remain strong therefore the outlook for the industry will remain stable in the long term. According to EIA’s data, China’s coal demand has trebled in the last decade ending 2010 and there is no reason to suspect tits decline in the future.

The rise in coal prices, coupled with stable demand, is going to translate into better stock performance for Indonesia’s coal producers. However, Bumi’s dispute is going to continue which means that its stock will remain highly volatile.

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