Research Report - Coal India Ltd

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Coal India Ltd
Buy (Target Price: Rs.460)

 

Market Data Price on reco. date (Rs) 320 (BSE) CMP - BSE / NSE (Rs) 320 / 320 Change since reco.  0.0% 52-week High/Low (Rs) 386 / 294 NSE Symbol COALINDIA BSE Code 533278 No. of shares 6316.4 m Free float 10.0% Market cap (Rs m) 2,021,248   Rs 100 invested is now worth   Stock price performance Coal India Index* 1-Yr -8.4% 9.2% 2-Yr -2.2% 3.0% Returns over 1 year are compounded annual averages * BSE Sensex Shareholding (Dec-12) Category (%) Promoter (Govt) 90.0 MFs, Banks and FIs 1.7 FIIs 5.6 Public 1.4 Others 1.3 Total 100.0

Investment Rationale A sleeping giant at attractive valuations: What comes to your mind when you think of a company that claims to be the biggest holder of cash in its balance sheet? Concerns, if any, would automatically elude once you learn that there is hardly any debt. Moreover, that the company has the largest reserves of a scarce natural resource. And its monopoly position allows it pricing power to quite an extent. Coal India (CIL) would have been a perfect fit in this dream scenario for investors. That is had it not been a PSU laggard with little focus on shareholder value creation. However, this is set to change. CIL accounted for 80% of domestic coal supplies in FY12. India's coal demand has accelerated over the years with the growth of sectors like power, cement and steel. However, the supply deficit has only widened over the last few years. It is expected that the deficit in the market will grow during the 12th five year plan (2012-17). This is due to the Power Ministry's target to install 80,000 MW of power capacities. For FY12, the total coal supply stood at 545 m tons, 19% short of demand. As of now, this deficit is being met through imports. It is estimated that by FY17, the demand is expected to grow by 29.5%. At the same time, supply deficit is expected to increase to 39%. Thus, there is huge opportunity for CIL to enhance their domestic supply and tap the import market. An increasing urgency to address domestic coal shortages by the government would benefit CIL the most. We see no reason why the company's volume growth cannot outperform the past long term average in the next three years. This, coupled with improving productivity levels, will drive operating leverage benefits going forward. Being near-monopolistic supplier in a coal-deficit market, high reserve to production ratio and cash rich balance sheet, the company can be an excellent wealth creator. We had recommended a 'Hold' on CIL in October 2012. We had advised investors to buy the stock if it corrected by more than 12%. The stock price of Coal India has fallen 20% from its September 2012 peak and 12% since our recommendation. The stock is currently trading at around 13.1 times our estimated FY15 earnings and 2.7 times our estimated FY15 book value. We thus recommend investors to Buy the stock with a target price of Rs 460 from two to three years perspective. This can offer average annual return of around 18.3% over this time frame. (We suggest you read the asset allocation for large cap stocks explained towards the end of the report.) Increased focus on production: We believe policy logjams which were apparent in the last few years are taking a backseat with strong focus of the Government to sort out coal supplies issues. Comprehensive Environmental Pollution Index (CEPI) norms and implementation of 'Go and No-Go' areas had affected coal exploration in the last 2 years. The Government has already scrapped the Go and No-Go policy and CEPI norms have also been relaxed. A majority of CIL's incremental production is expected through MCL (Mahanadi Coalfields Limited) and SECL (South Eastern Coalfields Limited). Hence we view this as a positive development as MCL's expansion (24% volumes contribution), largely through the Brownfield route, would now be expedited. Source: Company The Government is now also considering several other reforms such as land acquisition bill and MDO (Mining, Development and Operations) agreement to increase coal production. CIL plans to take its production capacity to 615 mt by FY17 from 433 mt registered in FY12. Out of the incremental volumes projected by CIL, more than 60% is likely to come from brownfield expansions (of which 40-45% fall under the open/clear forest regions and aid in increasing production through faster clearances of these areas) and ongoing projects; balance is likely to come from the new mines. At the end of 3QFY13, the company had already achieved 71% of its production target for FY13. Source: Company Shift to GCV (Gross calorific value) from UHV (Useful heat value) to benefit CIL: CIL has changed the pricing mechanism of non-coking coal from UHV based grading system to GCV based from January, 2012. Under the new GCV grading, coal would be classified under 17 slabs (300 (kilocalories) kcal each) from 2,200-7,000 kcal and above 7,000 kcal. The same has been positive for CIL and has led to improvement in realizations in past three quarters, while having a negative impact on two of its subsidiaries i.e. WCL (Western Coal Fields) and ECL (Eastern Coal Fields). CIL has taken a price increase for 10-15% in case of WCL and we expect similar kind of action in regard to pricing for other subsidiaries as well. Transparency on FSA clauses to emerge as a relative safe haven for investors: CIL will have to pay penalty of 1.5%, where supply is between 65%-80%; 5% for supply between 60%-65%; 10-20% for supply between 50%-60%, and 40% if the supply is less than 50%. CIL will meet 80% requirement with 15% imported coal and 65% domestic coal. This would be an immaterial amount for CIL. So far NTPC has not yet signed the FSA (fuel supply agreement) and without NTPC, the supply requirement for FY14-16 remains difficult to predict. The new FSA agreement is yet to be finalized and we would look out for the fine print to understand the implications for CIL in terms of penalty, quality of coal and domestic supply ratio. Price pooling of coal looks more likely and we believe CIL needs to take a price hike before pooling is implemented given that for the end consumer pooling would result in higher prices. E -auction volumes to remain intact: E-auction sales contributed 11.8% and 21.2% to CIL's volumes and revenues respectively in FY12. CIL is likely to maintain e-auction volumes and offer the stock (lying at points which are not easily accessible) in the e-auction market. E-auction coal is important to CIL as every million tonne of coal diverted at FSA prices results in profits declining 0.7%. As there is no proposal from the Government to divert coal from the e-auction market, we do not see any risk to e-auctions volumes. The Government directive currently allows 10% of its volumes to be sold in the e-auction market, no incremental volumes is expected to be diverted to e-auction market. Realizations in case of e-auctions are derived on basis of auction over and above the reserve price of coal. The reserve price of coal is determined on the basis of prevailing market prices. Realizations in case of e-auctions were 80% higher than the average blended price of the company in FY12. After wage negotiations, time for higher employee productivity: CIL has been through with its wage negotiations under National Coal Agreement - IX for the next 5 years effective from 1st July, 2011. Employee cost constitutes 40% of the revenues and 54% of the total operating expenses of the Company. We expect the same to now grow in sync with the inflation rate going forward. Over the last few years, CIL has been taking increase in prices post increase in employee costs, but from last year it has changed its strategy by first taking a price increase and then increasing its employee expenses. Self sufficient for capex: CIL plans to incur a capex of Rs 45 bn per annum. over the next 5 years for increasing production, development of new projects and procure efficient machineries. It has also kept aside Rs 60 bn for acquisitions of coal blocks outside India. It is further planning to invest Rs 250 bn over the next 5 years to built necessary infrastructure including the development of 6 railway lines. CIL is self-sufficient to finance these capex plans through a strong cash balance of Rs 563 bn as of FY12.

 

Investment Concerns Environmental Constraints/delays may act as a hurdle : CIL's production growth has been constrained in last 2 years due to CEPI norms and 'Go and No-Go' Policies. The Government has already scrapped the 'Go and No-Go' policy and CEPI norms have also been relaxed. We view this as a positive development for CIL. Any such constraints in future and/or delay in environmental and forest clearances may act as a hurdle in CIL's production plan. Lower offtake due to logistical bottlenecks: CIL dispatches 50% of its coal through Railways due to its affordability as compared to other means of transport. Any problem in regard to availability of rakes may pose significant risks to our volumes estimates. However, the problem seems to be subsiding with improved availability of rakes from starting of CY12. Implementation of MMDR bill: The Mining and Minerals Development and Regulation Act (MMDR) Bill which has been cleared by the Group of Ministers is awaiting Parliament's approval and President's assent. The Bill will have negative repercussions if it becomes an Act without undergoing any significant changes from its current version. The proposed benefit sharing framework under the new Bill will increase the tax incidence on the mining entities which intends to levy a tax of 26% on coal mining profits (i.e. last operational PBT). Regulatory issues: CIL is exposed to regulatory/Governmental interference as seen in regard with signing of new FSAs and enforcement of President's rule. Any failure of such obligation leading to imposition of higher penalties may pose downside risks to CIL's earnings. The Government is also proposing setting up a coal regulator which may limit CIL's capacity to increase prices in future. The Government is also planning to charge CIL a reserve price for the 116 coal blocks allotted to it. No reserves would be allocated for free now. The details of how the reserve price for coal blocks would be calculated and the quantum of the outgo for the world's largest coal miner are yet to be worked out. Background Coal India (CIL) is the world's largest coal producer, with production of 436 mt, despatches of 433 mt in FY12, 18.9 bn tonnes of proven and probable reserves. It has eight subsidiaries in India - seven of which carry out coal production and Central Mine Planning and Design Institute Limited, which provides technical expertise and consultancy to CIL and others. CIL operates 471 mines in 21 major coal fields across 8 states in India, including 163 open cast mines, 273 underground mines and 35 mixed mines. 90% of CIL's production is from open-cast mines. CIL was established in 1973 and 90% of its equity is currently held by the Indian government. Non-coking coal accounts for 90% of production and 95% of the company's reserve estimates. CIL accounts for 80% of India's coal production. Power generation accounts for 70-75% of CIL's volumes. NTPC is its largest customer and accounted for 27-28% of its raw coal despatches.   Industry prospects India is the third largest producer of coal in the world. The total coal production in the country during FY12 stood at around 545 MT. India is also the third largest consumer of coal in the world as coal meets 57% of the country's energy needs. Around 77% of the total coal in India is consumed by the power sector. The mineral is also used in other industries such as steel, cement, fertilizers, bricks manufacturing, textiles and chemicals. Demand of coal from captive plants is projected to grow at a high rate, thereby increasing its share in total demand by FY15. Domestic coal production is unlikely to meet expected demand growth over the next five years. PSU companies, who account for four-fifths of the country's coal production, are finding it difficult to accelerate production growth. Environment clearance and rehabilitation and resettlement (R&R) issues are creating serious roadblocks for private companies as well. Hence, the demand-supply gap has to be met by raising imports. In response to this, a top government advisory body has proposed that the government should allow private firms to mine coal to plug supply shortages. At present, India does not permit commercial mining of coal by private firms. However, it allows power producers to access 'captive blocks' for their fuel needs. The country has 293.5 bn tonnes of coal reserves, of which 40% of these have been proven. But social and environmental concerns, in addition to policy inaction have kept the prospects of the sector on a tight leash. Key management personnel Mr. S. Narsing Rao took over as Chairman of Coal India from 24th April 2012. Mr. Rao an IAS officer of 1986 batch from Andhra Pradesh Cadre, was Chairman of Singareni Collieries Company Limited (SCCL), the AP based coal mining company since September 2006. A post-graduate in Chemistry and Economics he also holds a post-graduate higher diploma in forestry. Mr. A.K. Sinha, is the Director (Finance) at CIL. He graduated with honours in physics from Belur Ramakrishna Vidyamandir, Calcutta University in 1971 and became a member of the Institute of Chartered Accountants of India in 1977. He has also obtained a bachelor's degree in law from Calcutta University in 1976. Mr. Sinha has over three decades of experience as a finance executive in the mining industry. He joined CIL as Director (Finance) in March 2010 and is responsible for overall financial management and audit functions of the company and its subsidiaries. Risk Analysis Sector: While India's coal demand is likely to accelerate further over the years, with the growth of sectors like power, cement and steel, supply constraints and policy inaction may hinder the growth of players in the sector. Execution risks due to the menace of Naxalism or Maoism and issues concerning allocation of coal blocks, profit sharing with local land owners and logistical bottlenecks may continue to plague the sector. We assign a 'medium' rating to the company on this parameter. Company standing: As stated earlier, CIL is the world's largest coal producing company and accounts for almost 80% of total coal production in India. We assign a 'strong' rating to the company on this parameter. Sales: In the latest completed fiscal (FY12), CIL generated net revenue of Rs 624 bn. Going forward we expect the sales growth to be an average of around 8.5% per annum Based on our parameters, we assign a rating of 4 to the stock. Operating margin: Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as raw materials, wages, sales, marketing and administrative costs. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. The higher the margin, the better it is for the company as it indicates its operating efficiency. CIL's average operating margins for the past five years has been around 18%. We assign a medium-risk rating of 5 to the stock on this factor. Long term EPS growth: CIL has grown its consolidated net profits at an average annual rate of 27% in the past five years. However going forward we expect the profit growth to be around 3% per annum. As such, the rating assigned to the stock on this factor is 3. Return on capital invested (ROIC): ROIC is an important tool to assess a company's potential to be a quality investment by determining how well the management is able to allocate capital into its operations for future growth. A ROIC of above 15% is considered decent for companies that are in a growth and expansion phase. CIL has earned an average ROIC of almost 15.6% over the past five years. The rating assigned on this parameter is 6. Dividend payout: A stable dividend history inspires confidence in the management's intentions of rewarding shareholders. CIL's average payout ratio has been a healthy 40.6% over the past five years. Thus, we have assigned a low-risk rating of 8. Promoter holding: A larger share of promoter holding indicates the confidence of the people who run it. We believe that a greater than 40% promoter holding indicates safety for retail investors. At the end of December 2012, the promoter (government) holding in CIL stood at 90%. We have assigned a low-risk rating of 8 to the stock. FII holding: We believe that FII holding of greater than 25% can lead to high volatility in the stock price. The FII holding in CIL at the end of December 2012 stood at 5.6%. The rating assigned is 5. Liquidity: The average daily trading volumes of CIL's stock over the past 52-weeks stand at around 2.2 m shares. This indicates adequate liquidity for investors despite the high promoter holding. The rating assigned is 7. Current ratio: CIL's average current ratio during the period FY07 to FY12 has been 1.5 times. This indicates that the company is comfortably placed to pay off its short-term obligations, which gives comfort to its lenders. We assign a medium-risk rating of 6. Debt to equity ratio: A highly leveraged business is the first to get hit during times of economic downturn, as companies have to consistently pay interest costs, despite lower profitability. Considering CIL's average debt to equity ratio of 0.1 over the past five fiscals, we have assigned a low-risk rating of 8 to the stock. Interest coverage ratio (PBIT/Interest payment): It is used to determine how comfortably a company is placed in terms of payment of interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense for a given period. The lower the ratio, the greater are the risks. Given that CIL has always had very negligible debt and interest costs, the rating assigned is 7. P/E Ratio: The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the per share income or profit earned by the company. This is one of the important metrics to judge the attractiveness of a stock, and thus gets the highest weightage in our risk matrix. CIL's P/E on its estimated FY15 earnings stands at 13.1 times. As such, we have assigned a rating of 4 to the stock on this parameter. Considering the above analysis, the total ranking assigned to the company is 71 that, on a weighted basis, stand at 6.0. This makes the stock a low-risk investment from a long-term perspective.   Risk Matrix     Rating accorded Rating Weightage* (A) Rating# (B) Weighted (A*B) Sector risk - Medium NA Company's standing - Strong NA Performance parameters Revenue growth (%) 5.0% 4 0.2 Operating margin (%) 10.0% 5 0.5 Long term EPS growth (%) 10.0% 3 0.3 Return in invested capital (%) 10.0% 6 0.6 Technical parameters   Dividend payout (%) 10.0% 8 0.8 Promoter holding (%) 5.0% 8 0.4 FII holding (%) 5.0% 5 0.3 Liquidity (52 weeks) 10.0% 7 0.7 Safety parameters       Current ratio (x) 5.0% 6 0.3 Debt to equity ratio (x) 10.0% 8 0.8 Interest coverage ratio (x) 10.0% 7 0.7 Price to earnings ratio (x) 10.0% 4 0.4 Final Rating** 71 6.0 # Rating has been assigned on the basis of the company's performance over the past five years and expected performance over the next 3 to 5 years. Rating is on a scale of 1 to 10, with 1 indicating highest risk and 10 indicating lowest risk. * 'Weightage' indicates the relative importance in percentage terms of the parameter. For instance, for an investor, given all the performance metrics, return on equity should be the foremost criteria for buying/not buying stocks. ** The final rating has been arrived at by multiplying the rating/points given on each parameter with the respective weightage. Valuation rationale Being almost a zero debt company, with average return on equity (ROE) of around 30% and average net profit margin of 17% over the past 5 years, CIL's current valuations look quite attractive. However we have been adequately conservative in our volume growth and margin estimates. The stock is currently trading at around 12.2 times our estimated FY15 earnings and 3 times FY15 book value. Expecting a point to point return of around 33% from the current levels over next 3 years period, we recommend investors to 'Buy' the stock from a 2 to 3 years perspective. The target price of Rs 460 can offer average annualized return of around 18.3 % over this time frame. (We suggest you read the asset allocation for large cap stocks explained towards the end of the report.) Valuations (Rs m) FY12 FY13E FY14E FY15E Total Revenues (Rs m) 624,154 700,552 757,647 795,984 Net Profit (Rs m) 147,882 151,067 152,878 153,916 Fully diluted EPS (Rs) 23.4 23.9 24.2 24.4 Book value per share (Rs) 64.0 80.8 97.9 115.0 Price to earnings (x) 13.7 13.4 13.2 13.1 Price to book value (x) 5.0 4.0 3.3 2.8   Financials at a glance   (Rs m) FY12 FY13E FY14E FY15E Net Sales 624,154 700,552 757,647 795,984 Sales growth (%) 6.1% 12.2% 8.1% 5.1% Operating profit 156,678 161,127 162,894 163,177 Operating margin (%) 19.6% 27.7% 25.4% 23.5% Net profit 147,882 151,067 152,878 153,916 Net profit margin (%) 23.7% 21.6% 20.2% 19.3% No of shares (m) 6,316.4 6,316.4 6,316.4 6,316.4 Diluted earnings per share (Rs) 23.4 23.9 24.2 24.4   Balance Sheet Fixed Assets 163,437 181,479 197,602 210,730 Current assets 873,754 1,078,483 1,187,069 1,280,892 Investments 20,335 20,335 20,335 20,335 Deferred Tax Assets 11,941 11,941 11,941 11,941 Total assets 1,069,466 1,292,238 1,416,947 1,523,897   Networth 404,530 510,675 618,093 726,241 Loan funds 39,803 39,803 39,803 39,803 Current liabilities 341,884 458,511 475,802 474,605 Other liabilities 283,248 283,248 283,248 283,248 Total Liabilities 1,069,466 1,292,238 1,416,947 1,523,897