Straits Asia Resources - Downgrade to HOLD; positives likely priced in (OCBC)

Downgrade to HOLD

Previous Rating: BUY

Current Price: S$3.04

Fair Value: S$2.99

1H11 results mostly in line. Straits Asia Resources (SAR) reported 2Q11 revenue rising 17.9% YoY (+5.7% QoQ) to US$225.8m, aided by higher ASPs (US$94.60/ton, +31.1% YoY/+15.1% QoQ); although sales volume dipped slightly to 2478 tons (-13.3% YoY/-7.5% QoQ). While gross margin improved to 30.1% in 2Q11 from 24.3% in 2Q10, it was lower than the 34.0% recorded in 1Q11; this was mainly due to higher diesel costs (+16% QoQ, +50% YoY). As a result, net profit fell 5.9% QoQ to US$38.9m, even though it jumped 67.5% YoY. For 1H11, revenue grew 27% to US$439.5m, meeting 47% of our FY11 forecast, while net profit surged 133% to US$80.3m, meeting 53% of full-year estimate. SAR also proposed an interim dividend of 4.24 US cents.

Lower coal production in 2Q11. For the quarter, SAR experienced lower coal production at both its mines - Jembayan saw a 4.6% YoY and 3.0% QoQ decline to 2352 tons while Sebuku registered a 41.7% YoY increase (but 28.4% QoQ drop) to 282 tons. According to management, the quieter production was mainly due to waste movement and higher strip ratios (Jembayan at 11.44, +6.1% YoY/+22.4% QoQ; Sebuku at 7.48, +24.0% YoY/+42.5% QoQ). While it is also going into the seasonally weaker quarter in 3Q, SAR stressed that the mine plans for 2011 remain on track; with the first sale of coal from Sebuku's northern leases anticipated in 4Q11. It further expects the longer-term outlook to remain robust, with all the main importing nations in Asia demonstrating "unrelenting appetite" for reliable coal supplies over the medium to long term.

Keeping an eye on rising costs. On its higher ASP of US$94.6/ton for 2Q, management notes that this also came about with increasing use of index-linked pricing; this as about half of the remaining shipments for this year are priced on an index-linked basis. And as of 30 Jun, SAR has committed around 87% of its planned 2011 production for sale. Meanwhile, management has repeated its cautionary note on industry pressures on costs, inflation and oil prices. This suggesting that cash cost for both mines could continue to rise; for 2Q11, Jembayan +29.3% YoY/+28.8% QoQ; Sebuku +5.5% YoY/+43.4% QoQ. Management also expects the effective tax rate, which fell to 27% in 2Q11, to trend upwards in 2H11 towards its 30-33% guidance.

Downgrade to HOLD. Although we modestly raised our FY11 estimates by 0.9-1.5%, which in turn bumps up our DCF-based fair value from S$2.91 to S$2.99, we note that most of the positives may have already been captured in the share price. Hence, given the limited upside from here, we downgrade our call to HOLD.