Coal India?s net profit grew 55%QoQ to Rs 26.4 billion compared with our Rs 28.9 billion estimated Ebitda (earnings before interest, taxes, depreciation and amortisation) was Rs 33.8 billion in line with our estimates, but higher tax rate of 37% (our est. 33%) led to lower PAT (profit after tax). We cut our FY11-12e EPS (earnings per share) by about 4% and price objective to Rs 339 (from Rs 350) due to lower volumes (CEPI?Comprehensive Environment Pollution Index?impact) and higher tax rate.

The recent increase in government focus towards resolving approval issues is a positive for CIL?s volumes. However, logistics will remain the key constraint to shipments. Despite pricing flexibility to pass thru cost inflation, there is a risk around the government not allowing coal price hikes due to inflation concerns. CIL trades at 0.9x (times) our NPV (net present value) estimate (8x FY12e OBR?overburden removal–adjusted Ebitda) implying 12% upside potential. Hence Neutral.

Coal output of 114 mt (+26%QoQ) exceeded shipments of 110.5mt (+12%QoQ) due to logistics constraints leading to coal stock increase (+3.5mt). ASP (average selling price) rose 3%QoQ, (3% below our estimate). Wage costs declined 6%QoQ (2% below our estimate) due to the absence of one-time charges made in Q2. Total costs were flat QoQ as 2x (times) higher overburden removal charges were offset by lower mining costs/ overheads.

CIL?s FY11-12 output targets have been hit by 16-39 mt due to (CEPI) pollution norm related moratorium on output. The government has recently indicated that 15 projects could be cleared soon, which could boost output by 20-25 mt. Logistics issues persist—rake availability is 170-175 rakes/day vs. target 180-185 rakes/day. We cut volumes to 428mt (-1%) in FY11e & 444mt (-3%) in FY12e due to CEPI impact.

CIL has started consultation with government to hike base prices to offset wage cost hikes due to (i) higher inflation linked wage components, and (ii) expected wage hike in June 11. Other ASP levers are (i) higher e-auction premium (93% in Dec10 vs. 60% in FY10), and (ii) higher e-auction mix 12.5% of volumes (11.2% in FY10).

Stronger volume growth, higher realisations and lower costs pose upside risks to our valuations. Downside risks to our valuations are slower pace of environmental approvals, prohibition of coal mining in areas where CIL reserves are located, sharper than expected increase in wage costs and inability to raise prices to pass through wage cost hikes.

?Bank of America

Merrill Lynch