TAVAN TOLGOI JSC - Initiation Report, BUY

Portfolio. Tavan Tolgoi JSC (TTL) offers exposure to high-quality coal resources in Mongolia. Total proven and probable reserves for TTL’s deposit (also known as “small Tavan Tolgoi”) are 40Mt of primarily coking coal and resources are estimated at 90Mt, according to company estimates. The company’s 270ha coal mining license area is located within the world-class 6.4Bt Tavan Tolgoi coking and thermal coal deposit (known as “large Tavan Tolgoi”).

Growing Production. TTL’s coal output increased at CAGR 77.2% from 2002 to 2010. Annual output hit 3Mt in 2009 and is estimated to have further increased to 3.5Mt in 2010. We expect coal output to continue growing, reaching 4Mt by 2013 and stabilizing at around 5Mt per annum afterward.

Healthy Cash Flow. TTL exports most of its output to China and generates healthy cash flows. Exports to China grew from 0.79Mt in 2006 to an estimated 3Mt in 2010. Sales increased 11.8 times to MNT95.4bn and net profit grew 8.8 times to MNT42.8bn from 2006 to 2009. The Company has high ROA, ROE, gross margin and net margin ratios at 103%, 116%, 58% and 44.8%, respectively.

Advantages. TTL maintains a highly competitive standing within its industry based on cost advantages over peers (production costs of only US$9/tonne), high coal quality (6,500-7,500kcal/kg, 20% ash and 8.5% moisture), proximity to China (250km) and state-supported railroad infrastructure development in the region.

We initiate equity research coverage on TTL with a BUY rating, targeting a MNT1,209,250 share price by year-end 2011 or an 83% upside in MNT and 102% in US$ (due to an expected 10% MNT appreciation against US$) compared to the current price. We view TTL, with its 2010e PE of 5.6x and current EV/Reserve of 6.7 US$/t, is substantially undervalued compared to its international peer average at 13x and 11.5 US$/t, respectively.

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