Coal India - Weak base wearing off; Hold - Anand Rathi

Volumes drive revenue. Coal India's sales volumes in 3QFY14 would have declined 2.7% yoy, to 117m tons (109m in Q2FY14) as inventory destocking fails to offset poor production performance. The blended realisation is expected to be up 0.7% yoy, to Rs. 1,448 a ton (3.1% qoq). E-auction volumes in total sales would have risen, leading to a better product mix resulting in 10.1% qoq revenue growth to Rs. 170bn.

High expenses to drag on earnings. Also, earnings growth would be hit by higher expenses, leading to a 5.7% yoy EBITDA decline. Employee expenses would have risen 6% yoy to Rs. 67bn, at an annual run-rate of Rs. 268bn. The increases in contractual expenses and fuel costs would be offset by realization growth and volumes, with EBITDA per ton rising to Rs. 345 (Rs. 257 in Q2FY14). OBR expenses might surprise positively, while fuel costs would begin to raise the cost structure further.

Cash deployment overhang. The high RoAE (~34%) offers assurance of strong cash generation, averaging Rs. 33 a share over FY12-15. Existing cash of Rs. 92 a share and cash generation provide downside support in the present volatile market, but cash deployment would be an overhang on valuations. The government can utilise cash-rich PSUs to counter the downturn in the private-enterprise capex cycle.

Our take. The cash-rich balance sheet and high RoEs make for defensive plays, but restrict benefits from aggressive growth options due to an unclear cash-deployment strategy. Management focus on volumes has considerably improved due to rising productivity and volumes. But growth has inherent limitations due to legacy and logistics issues. Despite a 5.4% dividend yield, the higher earnings cyclicality leads us to peg valuations at 7x. At the CMP, the stock trades at 6.4x FY14e EV/EBITDA. We maintain a Hold. Risks. Above-expected volume growth, higher global thermal-coal prices.

Source : Equity Bulls

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