Straits Asia Resources Limited (CIMB)

UNDERPERFORM Downgraded
S$3.14 @04/06/11
Target: S$3.29
Coal Mining

Growth priced in

• Recent rally calls for caution. We adopt caution on the stock following its sharp appreciation, which in our view has not been supported by significant fundamental improvements. SAR has climbed to a 52-week high despite a 15% retreat in the benchmark Newcastle Coal price from its January highs. It now trades at 12.5x CY12 P/E, above its peers’ 10.2x average. We resume coverage with new earnings forecasts, an Underperform rating (from Neutral) and DDM-derived target price of S$3.29 (discount rate 9.8%), expecting de-rating catalysts from lower-thanexpected ASPs or delays in production ramp-up.

• How realistic are expectations? Expectations that China will increase its imports following attractive price arbitrage, coupled with anticipation of a switch from nuclear to thermal energy, have been fuelling thermal coal price expectations higher. In reality, Newcastle Coal has declined from US$138.50/tonne in January to US$118.40. We expect Newcastle Coal to hover at US$100-130/tonne between 2011 and 2013, implying limited medium-term upside.

• Near-term cost challenges persist, fanned by high fuel costs and inflationary pressure in Indonesia. We are projecting a 14% increase in unit production costs in FY11. Our projections imply a ramp-up from Northern Leases in 2H11; any delays could pose risks to volumes and unit production costs.

Share price up despite falling coal price Favourable events drive sentiment. Sentiment surrounding thermal coal has been buoyant, fuelled by: 1) expectations that China will resume imports as the price arbitrage between its domestic and import prices has become attractive; and 2) anticipation of spillover demand for thermal coal as nations grow increasingly wary of nuclear energy following Japan’s disasters. These could have spurred SAR’s recent outperformance, in our opinion.

Reality bites. However, that could be changing. While we remain sanguine over the long-term outlook for thermal coal, current expectations could be too high. First, Newcastle Coal has fallen from its 52-week high of US$138.50/tonne in January to US$118.40. Second, our longer-term thermal coal price forecasts of US$100-130/tonne for the next three years suggest limited upside. Third, even if thermal coal prices spike momentarily, SAR may not be in the position to benefit from higher ASPs since some 40% of its 2011 output has already been priced.

Undeserved recent outperformance versus peers. SAR’s stock has been outperforming peers even though fundamentally, there have not been significant drivers. The benchmark Newcastle Coal has been reversing from its January high. SAR has outperformed the Newcastle Coal benchmark and several of its Indonesian peers over the past 12 months. We are increasingly cautious as the risk-reward proposition has become less appealing.

Attractive growth profile, but in the price Leap in earnings widely expected, but also priced in. We expect FY11 earnings to jump 77% yoy to US$156m, powered by higher volumes and ASPs as more output from Sebuku comes on stream. However, strong output growth is reflected in its above-industry valuations at 12.5x CY12 P/E vs. its peers’ 10.2x average.

All eyes on Sebuku; no room for disappointment. The risk stems from negative earnings surprises, given such tall expectations. SAR’s growth prospects are premised on improvements in ASPs, margins and volume, which in turn hinge on successful expansion at Sebuku. Any hiccups over developments at Sebuku could threaten our projections.

We forecast sales volume growth of 16% CAGR for the next three years, primarily on increased production from Sebuku. Having been granted Pinjam Pakai permits in 2Q11, exploration of the Northern Leases has commenced and we anticipate initial output in 2H11. Any delays in ramp-up, for instance due to wet weather or execution, could pose risks to volume, unit production costs and ASPs.

Our projection of higher blended ASPs is also premised on increased contributions from Sebuku, whose output fetches higher selling prices (due to better quality) and margins. As such, should Sebuku fall short of expectations, this would have negative implications on group ASPs, margins and volumes.

Risk-reward proposition less appealing. With lofty expectations already built in, any disappointment could deal a blow to the stock. Industry watchers remain generally cautious, citing weather as the main source of uncertainty. Rising costs due to costlier fuel, parts and labour are another concern.

We are projecting a 14% increase in unit production costs in FY11, and our projections imply a ramp-up from Northern Leases in 2H11. Risks to our assumptions are higher-than-expected costs, wet weather, and delays in ramp-up at Northern Leases.

Valuation and recommendation

Resume coverage with Underperform rating and S$3.29 target price. Our negative view is due to its relatively more expensive valuations versus peers, which make further outperformance difficult. In our view, the stock’s rapid ascent has also not been supported by a stark improvement in fundamentals. Rising coal prices typically lift all industry peers together but Straits Asia Resources have been outperforming despite falling coal prices. Events that have catalysed its recent outperformance, such as the receipt of Pinjam Pakai permits, have already been incorporated in our assumptions. SAR now trades at a 23% premium to its peers in terms of CY12 P/E.

We derive a target price of S$3.29 based on DDM (discount rate 9.8%, growth 4%). De-rating catalysts could arise from: 1) lower-than-expected thermal coal prices; 2) delays in ramp-up at Sebuku; and 3) higher-than-expected costs, in our view.

CapitaMall Trust (OCBC)

Downgrade to HOLD
Previous Rating: BUY
Current Price: S$1.98
Fair Value: S$2.05

Acquisition of the Jurong Gateway site

$S969m tender award. CapitaMall Trust (CMT) has been successfully awarded the Jurong Gateway site, located at Boon Lay Way by URA on 30 May at a tender price of S$969m (S$1,1012 psf ppr). This was a joint tender by CMT, CMA and CapitaLand, of which CMT has a 30% stake in the JV. The total development cost is expected to be about S$1.5b (S$1,566 psf ppr).The land parcel has a prime location next to both Jurong East MRT station and Jurong East bus interchange. Jurong is slated to be the largest regional centre in Singapore for commercial developments outside the city centre (under URA's Jurong Lake District Masterplan). Jurong Gateway is about 2.5 times the size of Tampines Regional Centre.

"3-in-1" Mega Mall in Jurong. CMT will be building a 25-storey retail-cum-office property at the new site, adjacent to another upcoming Lend Lease office/retail building, scheduled for completion in 2014. With two other CMT malls in the vicinity (IMM and JCube), CMT's selling proposition is to create a "3-in-1" mega mall in Jurong, offering 1m sqft of retail NLA within three minutes' drive from each other in Singapore's soon-to-be largest regional hub. CMT intends to finance the development by internal funds and debt.

Downgrade to HOLD on valuat ion grounds. We have factored in contributions from both the retail mall and office building into our valuation, commencing on Dec 2013 and Jun 2014 respectively. Our total development costs for CMT works out to about S$469m, which accounts for 5.8% of CMT's total assets as of 31 Mar (within the property fund guideline of 10% development cap). CMT has guided that it is targeting rentals of S$16-S$18 psf pm and S$7-S$8 psf pm for the retail and office segments respectively, with an initial yield-on-cost of 6%. According to our model, these targets are fairly tight and require somewhat vigorous occupancy rates in the first year to attain the desired 6% yield. In addition, unlike the Tampines Regional Centre, which is hailed as the "financial hub in the east", the Jurong precinct does not have a strong financial institution catchment base. We therefore remain wary of (1) the office take-up in that area, with the nearby International Business Park, JTC summit and iHub buildings offering cheaper alternatives and (2) "retail tenants' fatigue" among the four malls within a 500m radius from the MRT station. Moreover, CMT's share price has appreciated 6.5% since our last report dated 21 Apr. Downgrade to HOLD on valuation grounds with an increased fair value of S$2.05 (prev: S$2.02). We will turn buyers at S$1.93.

Location, location, location. The Jurong Gateway site is strategically located beside the Jurong East MRT interchange station, which has two train lines, and the Jurong East bus interchange and is close to JCube and IMM, both of which are owned by CMT. The Jurong Gateway site is part of the Jurong Gateway precinct, which together with the Lakeside precinct, form the Jurong Lake District which is earmarked to be a regional centre. Jurong Gateway is to be a commercial hub with offices, retail space, hotels and homes while Lakeside is to be a leisure destination with attractions for the whole family.

25-storey retail-cum-office property. The planned 25-storey retail-cum-office development has a site area of about 195,465 sqft and maximum permissible total GFA of about 957,780 sqft. The office component will be equivalent to at least 40% of the total GFA of the development, with the remaining GFA for retail. Subject to planning approval from URA, the shopping mall is expected to have five levels including one basement level. The one-stop family mall will both cater to residents' everyday needs and offer specialty shops. Shoppers will also enjoy seamless accessibility to transport options from the mall - Level 1 will be linked directly to the new air-conditioned Jurong East bus interchange, while both Level 1 and Level 2 will be linked to Jurong East MRT station. Together with link bridges connecting the mall to the Ng Teng Fong Hospital and a neighbouring development, the shopping mall will have five direct connections to transport infrastructure and amenities. The shopping mall is expected to commence operations in time for the Christmas shopping season in 2013. In addition, the prime office tower sited on top of the shopping mall is expected to span 20 storeys (from Level 6 to Level 25) with about 383,000 sq ft of GFA. As one of the taller developments in the vicinity, the retail-cum-office development is envisaged to become a new landmark in Jurong Gateway when it opens in 2014.

Portek (DMG)

ICTSI mops up shares in Portek

The news: According to BT, INTERNATIONAL Container Terminal Services Inc (ICTSI), which launched an offer to take over Portek International, has raised its stake to 16.93 per cent through open-market purchases. ICTSI bought 18.195 million shares on Thursday at $1.19-1.20 per share. The offeror held a stake of 4.82 per cent when it first launched its offer last Wednesday. Portek closed trading one cent lower at $1.19 last Friday. According to the media, Portek's founder chairman Larry Lam, who holds 41.96 per cent of the company, is 'still studying' the offer.

Our thoughts: This general offer differs slightly from the script in recent takeovers, where the acquirer secures the support of the major shareholder prior to the launch of the takeover. We believe Larry Lam is leaving the door open to other suitors (and there should be more than one interested parties) willing to come up with a higher offer. After all, prospect for the company is shaping up nicely with its North African ports enjoying strong growth in throughput and profitability while the engineering arm has built up a robust orderbook. ICTSI is strengthening its hand by mopping up as much shares as it can in the market. Time will tell whether there will be new bidders coming in and it would be worthwhile to wait for the recommendations from the independent financial advisors.