1. Coal India: Gaps in word and deed

Coal India: Gaps in word and deed

Modest volume growth seen in medium term

Updated: December 1, 2014 4:31 AM

Coal India
Rating: Add

Clarity on coal: Taking an objective view on Coal India without absolute clarity on (i) status of e-auction sales, (ii) road map to achieve aspired volume growth that has been languishing in low single digits and (iii) a well-defined pricing regime owing to incremental sales being allotted to the lower price-point power sector, is difficult prior to the anticipated stake sale by the government. While healthy free cash-flow generation and reasonable multiples prompt our positive stance, lack of clarity on the above issues caps the upside. Maintain Add rating with target price of R360.

Status of e-auction still remains elusive: The ministry of coal has recommended a cap on e-auction sales at 30 million tonne (58 mt in FY14) that improve earnings by 13% (fair value impact of R30 per share), and is factored in our current estimates. The CIL management, however, reiterates that there is no formal policy in place to cap e-auction sales, and the suggestion of the government to cap e-auction sales is only recommendatory in nature. Similar recommendations floated in the past have not fructified, though the current proposal gains more strength on grounds of a unified ministry for power and coal.

Improved visibility on volume trajectory: CIL has reported a tepid volume growth of 2.4% in H1FY15, on the heels of an equally unexciting 1% growth in FY14 even as the government aspires for 1 bn tonne of coal to be dispatched by FY20e (467 mt in FY14). A more concrete plan that backs this vision would help investors take a view on the stock owing to the high operating leverage of volume in the overall earnings profile.

graph-coal-india

CIL’s raw coal realisations have remained in a narrow range of R1,250/ton-R1,300/tonne over the past eight-ten quarters despite having taken price increases. The slump in sales as well as the increasing proportion of coal sold to the lower price-point weighed on realisations.

Predictability of price revisions is poor and is usually a measure of last resort to overcome rising costs and dwindling volume growth profile. A more structured approach to price increase is needed to improve the earnings predictability of CIL.

Modest valuations, rich cash-flow generation: Modest valuations (9.5x FY16e), attractive dividend yield (4%) and the upside potential of R30/share to out fair value estimate from likely sustenance of e-auction volumes as being guided by the management prompt our positive bias on Coal India. However, clarity on (i) status of e-auction sales, (ii) road map to achieve aspired volume growth and (iii) a well-defined pricing policy could significantly improve the company’s prospects.

E-auction cap may provide incremental supply to power sector: We remain circumspect of the recent announcements of capping coal supplies through e-auction as a step towards solving power sector problems. For the same to be plausible, it is imperative to have (i) rail infrastructure for transportation of coal to power plants, (ii) coal made available in sufficiently large quantities given the power sector requirements, and (iii) a steady supply of coal earlier used for e-auction is diverted towards power plants.

We note that only 15% of coal sold through e-auction is through railways, while 70% of the coal sold through e-auction is contributed by three subsidiaries with a lumpy supply of coal put up for auctions.

Volumes—macro indicators not showing a resurgent revival: Coal India ended FY14 with a dismal 1% growth in dispatches, and continued to miss targets for another year. CIL aims to dispatch 525 mt coal in FY15e, implying a growth rate of 11%. While YTD (year-to-date) performance at 2.4% is more in tune with our estimates of full year growth of 4%, the company is already running behind targets on production and dispatch volumes.

Data on clearances remain almost stagnant in FY14 in comparison to the previous year even as activity on new railway evacuation infrastructure appears distant. We would stick to our stance of modest volume growth for CIL in the medium term, while remaining watchful of progress on clearances as well as development of evacuation infrastructure.

—Kotak Institutional Equities

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