Adaro keeps the coal fires burning

The Indonesian coal miner tells FinanceAsia that the plunging coal price is manageable with a tweak to operations.

The global coal industry has had a lamentable couple of years.

Prices have plunged, profits have been eroded and business models have been torn up due to the chronic oversupply that followed the end of the great commodities supercycle.

This is especially bad news for Indonesia, the world’s biggest exporter of coal by volume, according to the World Coal Association.

Adaro, one of Indonesia’s largest coal miners, this week provided the latest evidence of this dismal trend when it reported a 40% drop in full-year net profit.

“The industry is facing a head wind. There was over-investment in the strong years, when the coal price was very robust,” David Tendian, the company’s chief financial officer, told FinanceAsia. “We are now living with the consequences of that. The coal price fell and we have an over-supply situation.”

What this means in practise is that the coal price (Australian thermal coal) has plunged from US$128.71 in 2011 to US$81.74 as of February.

This is unlikely to change anytime soon, according to Tendian. “The head winds will likely continue for another 12 months,” he said.

Analysts agree.

“We expect market conditions in 2014 to remain challenging as an oversupply of coal in the region will dampen prospects for a meaningful rebound in coal prices,” said Brian Grieser, Moody’s senior analyst, in a report this week.

Regional bellwether

As an on-the-ground case study of the crash that hit the industry, Adaro’s is a compelling story.

Founded in 1982, Indonesia’s largest domestic supplier went public in July 2008 just as the financial crisis was about to strike. Although this had minimal effect on the mining industry, a far greater issue was being created in the form of the commodities bubble.

For Adaro this meant production volumes jumped from 38.5 million metric tons in 2008 to 47.7mt in 2011, capital expenditure increased from US$228 million in 2008 to US$625 million in 2011, and Ebitda trebled from US$500 million in 2008 to US$1.5 billion in 2011.

The end of the supercycle changed everything; except when it came to production.

Ebitda sank to US$822 million in 2013, while capex dropped to US$165 million. However, production rose to 52.3mt, a 11% increase on 2012. 

Of course Adaro is not alone. State-controlled coal miner Bukit Asam posted a 37% fall in net profit in 2013, while Indo Tambangraya, the local coal mining unit of Thailand’s Banpu, saw its net profit fall 47%.

This situation has been replicated across the industry globally, decimating the US market and sending the coal price sharply lower. As such, much rests on it rebounding.

“Everything is down to the coal price,” said Tendian. “It is a factor for every company in the industry. If the coal price hits $40 everyone is underwater; no one would produce coal.”

As such, he expects the region's coal mining industry to consolidate since the weaker players will be unable to operate with the coal price under sustained pressure, with supplies still sky high.

“It is very simple. [There will be a shakeout]. Many Australian companies are operating at a loss,” said Tendian. “It is worse for Indonesian companies. Many are struggling and, through a process of natural selection, supply and demand will once again be balanced.”

In dealing with the crisis, Adaro, again, is something of a bellwether for the region.

Capex has been slashed and there have been divestments, and although the bottom line has continued to bear the brunt of the pain the group is so far pleased with the results.

“The coal price has been hovering at an unattractive price, so we are extremely happy with our results, considering the head winds we face,” said Tendian.

Moody’s said Adaro’s capex reduction is positive for the group and, as a result, its funding needs will be reduced. The ratings agency also cited the company’s strong sales volume growth last year and lower production costs as positives.

Still bullish on China, India, Japan

Furthermore, Tendian is bullish on the outlook for demand from the region’s two largest coal importers, China and India, as well as Japan.

China, for example, was a net exporter of coal in 2009 but its huge growth turned it into the world’s largest importer. It imported a record amount of coal in 2013.

Even though Moody's estimates that 80% of Adaro's products are exported to Southeast Asia, the US and Europe, with the rest earmarked for domestic use, this is surely a positive sign going forward -- even as doubts are raised over the Chinese economy's forward momentum.

“These countries can’t simply cut coal unless they want blackouts," he said. “Thermal coal is a basic commodity and crucial to the generation of electricity. That need will not go away overnight. Energy poverty is a very real problem in Asia."

“Also, Japan has no growth from the nuclear industry right now and it is facing its own power crisis. It is not just China and India.”

Wishful thinking perhaps but this week's third anniversary of the Japanese tsunami and subsequent nuclear crisis is a reminder that the subject is still highly sensitive.

Confusing the picture is the broader push globally -- and in Asia -- to use more clean or cleaner energy sources rather than rely on so-called dirty coal. 

But Tendian is not worried about a scenario where Japan might embrace nuclear energy again. 

“No, because it takes years to build new nuclear plants even if they changed their policy today and, anyway, Japan wants to keep a good energy mix and not be too reliant on one energy.”

Tendian adds that demand is “constructive” and that the group has enough cash to face the challenges ahead.

He said Adaro has $680 million in cash, with access to a further $430 million in undrawn loan facilities, while cash flow is also strong, so the pain suffered by the drop in coal prices should not be fatal to the group.

Moody’s remains positive on Adaro but said it would consider downgrading its ratings if the company experienced “material disruptions” to its operations that weakened its ability to service its debt.

According to Moody's, Adaro's adjusted debt-to-Ebitda now stands at 2.7-times, up from 2-times in 2012.

“Yes, this is a concern as the coal price has a significant impact on the debt-to-Ebitda ratio,” Tendian said. “No one knows where the coal price will go. All we can do is look after our own operations; our own company.”

"Sunny days are on the way."

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