Coal India Ltd - Pricing concerns slowly easing off - CMP: Rs.331 - Not rated - Networth

Coal India Limited (CIL) came into existence in November 1975 with the government taking over private coal mines.CIL is World's largest producer of coal and has extractable reserves and resources of 21.7bn tonnes of coal. It accounts for 80% of India's coal production and supplies 80% of its coal output to power plants in India. CIL's coal production is carried out through seven wholly-owned subsidiaries in India which are spread across the country. CIL also fully owns a mining company in Mozambique christened as 'Coal India Africana Ltd'.

Shift to gross calorific value, price increase to boost revenues

CIL had proposed price increases across coal grades after announcing migration to price them as per GCV (Gross Calorific Value) based pricing as opposed to prevailing practice based on Useful Heat Value (UHV), in Jan-12, which had drawn lot of flak from user industries. Succumbing to such pressures CIL had to roll back the purported price hike. Subsequently, lending to the power sector got squeezed on lenders' sectorial exposure hitting peak and their tacit refusal to extend credit further to the sector on climbing receivable risk stemming from deteriorating financial health of sick SEBs. The piquant situation led ultimately to the much desired upward tariff revision by SEBs. We believe going forward SEBs will be visiting tariffs periodically to maintain their financials in good order and boost power sector growth. In such a situation, CIL would be able to draw comfort from the Coal Ministry to revise prices time to time. Currently CIL sells coal to the regulated and non‐regulated sectors at a 70% discount to the international coal. This steep discount of 70% provides an opportunity to increase prices by CAGR of 4-6% across all grades in FY12-14E.

Production to rise as CIL's operations are under closer scrutiny by PMO

Over FY11 and FY12 the production at CIL has remained flat at 430 million TPA due to delays in obtaining environmental clearances, excessive rains and workers strike. Roughly 180 projects of coal are awaiting environment clearances from the Centre and the state governments. Once given the clearance, these projects will significantly add to Coal's production. In January 2012, power companies lobbied PM to expedite resolution of coal availability issue, which led to a new high level committee looking into the issues and come up with recommendations for time bound resolution. While the committee is still working on the power sector grievances, it has already marked CIL's sluggish production growth as one of the major concerns and directed CIL to sign FSA (Fuel Supply Agreement) with power companies. Now that the lackluster production growth is scrutinized, we believe that CIL is under pressure to improve production going forward. Apr-May'12 production and overburden removal growth of 5.6% and 10.3% YoY, cements our view. We expect CIL to meet its FY13 production target of 470MT and produce 490 million TPA in FY14E. CIL is projecting 615MT production for FY17E, implying 7% CAGR volume growth over FY12-17E.

India's largest coal miner with a near monopoly position

CIL enjoys a near monopoly status as a coal supplier in the country. Its current coal production accounts for 80% of the total domestic coal supply. This, with the fact that coal is a primary fuel source for almost 55% of India's installed power capacity and the coal demand supply gap is only going to widen going forward, gives CIL robust revenue visibility. Once the regulatory hurdles soften, we believe that CIL will enjoy higher pricing power resulting in higher valuation going forward.

Abundance reserves lend visibility beyond doubt

CIL is the world's largest coal company both by production and reserves. As of FY12, its production was 436 million TPA and reserves stood at 21.7bn tonnes. These reserves at the current production level ensure production visibility for next 50 years.

Worries regarding FSA's agreement and MMDR are factored

Over the last couple of quarters, CIL has come under pressure in the bourses on order from Prime Minister's Office to sign additional FSA's and the impending proposals in MMDR Act, directing miners to spare 26% of profit with local communities. Prima facie, both the issues looks detrimental to the CIL's financial health. However, low penalty on FSA clause at 0.01% for 80% trigger level as made out by CIL has had solid backing of the Coal Ministry is pointing to a scenario, where we see government ultimately making some amendments in the Act so as to lessen loss to the coal behemoth.

Outlook

We are positive on CIL as 1) we expect production to increase going forward thanks to expected faster clearances by the Government and mounting pressure on it to meet the growing requirements of the coal starved power companies. 2) Gaining comfort from coal ministry in raising coal prices on the sideline of SEBs rationalizing their archaic tariffs and aligning them to growing necessity of bettering their financial health 3) the concerns regarding penalty clause in FSA agreements and regulatory overhang stemming from MMDR Bill are overdone.

Source : Equity Bulls

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