Monday, October 12, 2009

Straits Asia Resources - Hold by OCBC (9 Oct 09)

Caught in the rain

Jembayan facility damaged by rain. Continuous rain over the past several days has dealt Straits Asia Resources Ltd (SAR) a setback. Its new loading facilities at the Jembayan mine, which were just commissioned this year, have been damaged as heavy rainfall led to a failure of its foundation structure. Although the extent and impact of the damage have yet to be ascertained, the group has warned that no further loading will be possible from this facility for at least some time. We expect production volume to be hurt as a consequence. The facilities are insured against business interruptions and we expect SAR to claim against these damages.

Production to take a hit. The failure of its new loading facilities will no doubt cast a shadow over SAR's expansion plans. The group had originally planned to raise Jembayan's output from 5.5m tonnes in FY08 to 7m tonnes in FY09 with the help of the enhanced capacity. With the destruction of its new facility, we have cut our projections to 5.8mt. Meanwhile, SAR will seek alternatives to boost its output via access from neighbouring mines. We understand that the latest damage merely cripples the transportation of coal from mine to barge. Actual production at its mines remains on track.

Operations supported by original facilities. On a comforting note, SAR's original loading facilities have withstood the rain. Operations continue to run normally both at Jembayan's original facilities (SAR operates two loading facilities at Jembayan) and also at Sebuku. Production from these facilities formed 83% of our original projections. The smooth running of their operations mitigates the negative impact brought on by the latest damages and also provides support to our projections.

Downgrade to HOLD with lower earnings forecast. SAR will provide further updates as they assess the impact of damages. We have cut our FY09 and FY10 earnings forecast by 18% and 15% respectively on lower production volumes. Accordingly, our DCF-based fair value estimate falls to S$2.20 from S$2.38. Downside risk could arise from (i) further disruptions to mining operations in the event of persistent rain and (ii) translation losses from a weakening USD. We downgrade SAR to HOLD.

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