We are now more convinced than ever we made the right choice to move downstream into power ... The outlook suggests our "three engines of growth" approach to value creation will deliver sustainable value for many years to come.
Dear esteemed shareholders,
We are happy to announce that in 2018 Adaro Energy delivered on its operational and financial targets. Our overall profitability improved last year, driven by higher ASP and sales volume. We achieved our production guidance and beat our operational EBITDA target, which demonstrated the strong performance of our core business and operational excellence. On the other end, our non-coal mining businesses also posted solid results in 2018, contributing approximately 20% of our total operational EBITDA.
We started 2018 with strong optimism as we saw significant improvement in the fundamentals of the coal market. No one had expected that in the second half of 2018, the divergence between 6,300 kcal Newcastle benchmark coal and lower CV coal, including Indonesian coal, would increase significantly due to the Chinese policy on coal imports. Key Asian markets also experienced a milder winter, which affected demand in the latter part of 2018 and kept the spread high until end of the year. Despite the volatility in the coal market and pressures on lower CV coal, underlying demand remained healthy and we saw stronger than expected seaborne market in 2018. Imports to China remained significant in 2018 and we understand that China’s policy on coal imports will continue to be a key risk in the coal market going forward.
Coal market once again showed cyclicality
We feel that coal market fundamentals are strong and that the market is relatively well balanced. We see healthy demand pipeline from the emerging countries in Asia while supply struggles to respond to the requirement due to, among others, limited development capex and access to financing. 2018 was a year of discovery for the coal industry, a year that started with stronger market optimism but ended with the opposite. The macro environment and increased volatility due to governmental policy controls created significant challenges in the coal market. Despite this, the global seaborne thermal coal market in 2018 increased by approximately 5% year-over-year, supported by consumption growth in China, India and Southeast Asia. Demand growth for low CV coal remained strong in 2018 as Southeast Asia came through with new power stations. Established importers in Japan, South Korea and Taiwan took advantage of the wide differentials between higher and lower CV coal prices and maximized their intakes of lower CV coals.
In the longer term, we are very excited with pockets of growth in seaborne thermal coal demand from India and Southeast Asia, which were driven by economic expansion and the need for inexpensive, reliable energy source. The Southeast Asia region currently has roughly 70 GW of coal-fired capacity in operation, and has approximately 35 GW of capacity under construction. Other coal importing countries such as Japan, South Korea, Taiwan, and Hong Kong continue to show strong appetite. As for China and India, even though those two countries may indicate some uncertainty, the demands from them remain significant as of today. Indonesia is in a very good position to be the key supplier to the Asian region due to the proximity and matching coal requirements. Coals with low pollutant content such as our Envirocoal will continue to play a significant role in the energy mix.
Meanwhile, we saw metallurgical coal market to be undersupplied for most of 2018 albeit slowing demand in the fourth quarter with increased demands from India, Europe, Brazil and Vietnam lifted the seaborne import volume. India was the key driver of demand growth in 2018, due to the improvement in its construction and manufacturing sectors as its economy posted an 8% growth. On the other hand, China, which consumed 16% of total seaborne volume of metallurgical coal in 2018, had slightly lower imports year over year following decelerated GDP growth.
On the supply side, China continued to rationalize its production capacity and restructure its steel and mining sectors which resulted in weak domestic supply due to reserve depletion, capacity cuts and stringent environmental and safety measures. Meanwhile, supply from Australia only increased by approximately 2% in 2018 due to production issues and higher than usual maintenance outages at ports and rail. The supply tightness supported prices in 2018 with premium hard coking coal reaching above US$200 level on average.
Energy for change
We believe that competitive advantage, costs, and core competence are important components in doing business. We need to be both nimble and consistent on our business strategy while looking at possibilities to renew and refresh our business perspective to have an effective, efficient and resilient business model. Further, cost is a component that we can actually control and thus it is our endless efforts to achieve the most efficient cost. We are also identifying core competence in every line of our business and focusing on developing them. Our business across all pillars in the sectors of mining, energy and infrastructure remained resilient.
We understand the cyclicality of the coal market and thus strive to minimize the impact of coal price fluctuations on our business. The courage to introspect and disrupt our business is essential to anticipate any uncertainty in the market. We continue to develop our eight business pillars as main engines of growth going forward. These eight business pillars; Adaro mining, services, logistics, power, land, water, capital, and foundation will allow us to further strengthen our business fundamentals, capitalize on today’s positive momentum and capture future opportunities in both coal and non-coal businesses. We will continue to execute our strategy for long-term growth in each of these business pillars. The noncoal mining pillars will continue to expand, to provide protection in all phases of the commodity cycle and to be one of the important contributors to long-term value creation.
Solid 2018 operational and financial performance
Our core coal mining operations continued to deliver operational excellence and we achieved operational targets on both production volume and strip ratio. We produced 54.04 Mt, a 4% increase over 51.79 Mt in 2017, and achieved our production guidance of 54 Mt to 56 Mt. We recorded a slightly higher annual strip ratio than our guidance of 4.9x, at 5.06x as favorable weather in the third quarter allowed for more overburden removal activities.
Sales to Southeast Asia, including Indonesia, comprised approximately 40% of total sales volume in 2018. The region has been showing strong demand as more coal-fired power stations are commissioned. Meanwhile, East Asia (excluding China) made up 30% of sales, followed by China and India at 14% and 11%, respectively. This is in line with China and India’s higher demand for coal import in 2018.
We beat our 2018 operational EBITDA guidance of US$1.1 - 1.3 billion by achieving operational EBITDA of US$1.4 billion, up by 7% compared to 2017. Our core earnings increased 13% to US$728 million, demonstrating the quality performance of our core business and operational excellence.
As our business expanded and our business model evolved, we adjusted our mine plan to ensure that it is in line with our business strategy. Some assets were affected due to these changes and will not achieve optimal utilization. Therefore, in 2018, we recognized impairment on one of our fixed assets as we identified under-performing assets to maintain healthy balance sheet. Our performance was not impacted by this charge as this was a onetime, non-cash and non-operational expense.
Our free cash flows continued to be strong in 2018 at US$660 million. Balance sheet remained healthy with liquidity of more than US$1.2 billion. Net debt to equity and net debt to last 12 months operational EBITDA stood at 0.10x and 0.29x, respectively.
Consistent dividend distribution for shareholders
We maintain the commitment to distribute dividends to shareholders and paid US$250 million of cash dividends, or 51.75% of our 2017 net income. Furthermore, an interim cash dividend payment for financial year 2018 of US$75 million was distributed on 15 January 2019. We continue to remain disciplined to ensure the balance between the money reinvested to capitalize growth opportunities and the returns distributed to shareholders.
Kestrel acquisition – Deeper met coal portfolio
On 1 August 2018, Adaro Energy with EMR Capital Ltd, a specialist mining private equity manager, completed the acquisition of Rio Tinto’s 80% interest in the Kestrel Coal Mine (Kestrel). EMR and Adaro Energy will jointly manage and operate the Kestrel mine.
The acquisition of Kestrel is a signifiant milestone in our strategic expansion of metallurgical coal portfolio, which started with Adaro MetCoal. Having these two world-class metallurgical coal assets under our Adaro Mining pillar is going to strengthen our position in the metallurgical coal market and sustain Adaro Energy’s growth over the longer term.
Adaro MetCoal has among the world’s largest undeveloped metallurgical coal resources and the synergy between the two assets offers us exciting development potential and will maximize our value creation.
Our coal mining business now has two strong pillars: thermal coal, which is suitable for power generation, and metallurgical coal, an essential component in steel-making.
Power business is progressing well
Our power business underscores Adaro Energy’s strong commitment to be a major contributor in ensuring the success of the government’s electrification program. Adaro Energy is focused on executing its plan to increase access to electricity in supporting Indonesia’s growth.
The constructions of Adaro Power’s two power projects are progressing as planned and on track to achieve Commercial Operation Date in 2019 for PT Tanjung Power Indonesia (TPI) and 2020 for PT Bhimasena Power Indonesia (BPI). At the end of 2018, Engineering, Procurement and Construction (EPC) activities at BPI had reached approximately 60%, while EPC activities at TPI had reached 99%. TPI is set to come on line in 2019.
We continue to work with potential partners to explore power development opportunities from coal and other sources such as gas and renewables, which can support the government’s electrification program and to deliver positive contributions to the nation.
Continuous contribution to the nation
We are committed to create value for our stakeholders and further emphasize our commitment to the nation through royalty and tax contribution as well as communities’ empowerment. In 2018, we contributed a total of US$721 million in royalty and tax, consisting of US$378 million in royalty and US$343 million in corporate income tax. We also emphasize that Adaro Energy has strong commitment to be a responsible corporate citizen and each of our business pillars is committed to support the nation.
As we further develop our business and excellence, we shall continue being committed to empowering Indonesia by providing sufficient supply of energy and contribute to the nation’s education and welfare.
Commitment to “Green Initiatives”
As far as green initiatives are concerned, we always look to deliver beyond compliance. The environmental management activities that the group is doing include pioneering in processing waste water from mining activities into clean potable water and pioneering as the only coal mining company to date that owns a biodiesel plant. Further, in line with the Indonesian government’s program to enhance the country’s clean-water supply, the group is expanding operations to Indonesia’s water treatment sector through the Adaro Water pillar.
Since the beginning of its operations, the Adaro Group has always striven to apply good and proper mining practices to ensure safety and environmental sustainability. We believe that high-quality sustainability programs support long-term value creation.
Implementation of Good Corporate Governance
The commitment to uphold the principles of transparency, accountability, responsibility, independence and fairness to protect the interests of all stakeholders is key in how we conduct our business. Our approach to governance is to go beyond compliance. Adaro Energy’s standard operating procedures are aligned with GCG best practices and we conduct periodic reviews and evaluations.
The GCG principles must be embodied in Adaro Energy’s strategies, philosophies, purposes and values for the company to maintain proper and balanced businesses. Therefore, we have in place a code of conduct as a reference of how to behave in the work place in addition to the self-assessment mechanism and orientation program for our BoC and BoD’ members.
Cautiously optimistic for 2019
We have entered 2019 and excited with what the year has to offer. We are ready to capture the opportunities for sustaining the company’s growth and continuing to deliver positive contributions to Indonesia.
In 2019, we expect TPI to commission and Kestrel to provide full contribution to Adaro Energy. We are hopeful that these projects will provide a positive push to our profitability in 2019.
Government policies in China will remain vital for the coal market condition. Global coal prices in 2019 are expected to be softer than 2018 as at this stage we see market to be well supplied and may require supply discipline and control from major coal producing countries such as Indonesia and Australia. We have seen the improvement in lower CV coal prices as demand on low CV coal recovers at the beginning of 2019.
Our cautiously optimistic stance is reflected in the company’s guidance for 2019, with coal production expected to slightly improve to 54-56 Mt. At this stage, we anticipate subdued coal price, albeit narrowing spread between prices of high CV coal and lower CV coal.
We are guiding a lower strip ratio compared to last year at 4.56x as we continue to maintain our long term reserves and stay in line with our life-of-mine strip ratio. Also with the assumption of slightly higher diesel fuel price, we are projecting flat to slightly higher coal cash cost this year. Thus, we are guiding US$1 – 1.2 billion of Operational EBITDA in 2019.
Further, we will continue to be disciplined and strategic with our capital spending and for 2019, we are guiding US$450-600 million. Our capital expenditure commitment in 2019 will mainly be used for heavy equipment additions and replacements as well as development of our coking coal projects at Adaro MetCoal.
Changes to the Board of Directors Composition
On October 29, 2018, we received a letter of resignation from Mr. David Tendian from his position as Director and Chief Financial Officer of Adaro Energy. We held an Extraordinary General Meeting of Shareholders on 14 December 2018 to restate the composition of Adaro Energy’s Board of Directors and approved the resignation of Mr. David Tendian from Adaro Energy’s Board of Directors.
We have appointed Mr. Lie Luckman as Chief Financial Officer to carry out the duties and responsibilities as the head of Adaro Energy’s Finance Directorate effective from 1 December 2018. With this appointment, our management team remains efficient and solid.
Thank you to our stakeholders
We wish to thank all of our stakeholders for their continuous support and trust. From our dedicated key shareholders, to our communities, to our loyal customers, to our governments and regulators, to our suppliers and contractors, to our public investors, but especially to our loyal and hard-working employees, we thank you all. None of our achievements in 2018 would have been possible had we not enjoyed the privilege of the support mentioned.
We are devoted to building a great company. Each one of us is passionate about Adaro and thoroughly convinced of its bright future. Together with our stakeholders, we will continue to deliver positive energy for many years to come.
On behalf of the Board of Directors,