Invest in Coal India IPO says IIFL- Black Diamond: High (c)ash content

Black Diamond: High (c)ash content 
India’s coal shortfall is set to widen from 65mtpa in FY10 to 155mtpa by FY13 and 277mtpa by FY17.
Additional Indian demand would amount to ~20% of current global trade in thermal coal, causing
regional prices to firm up. Until now, there has been no direct play on this theme in the Indian equity
market. Coal India’s (CIL) IPO is set to change this. CIL is in a sweet spot—its growth is limited by
production, not demand. Its earnings are far less sensitive to global prices than those of global peers, as
it sells ~75% of its output at quasi-regulated prices. Efficiency gains should contribute to 13% CAGR in
free cash, from Rs83bn in FY10 to Rs195bn in FY17. We value CIL between Rs300 to Rs345 per share –
implying an upside of 22-41% to the upper end of price band. SUBSCRIBE.

Acute coal shortage is imminent: We estimate Indian coal demand CAGR at 10% over FY11-17. Domestic
supply would grow at 7.1% annually at best, even after assuming rapid growth in private captive mining. Land
acquisition issues, forest clearances and Naxal attacks would continue to constrain supply growth. Policy response
would be stymied by the need for coordination across multiple agencies. India’s imports at 226m tonnes in FY17
(adjusted for calorific-value differences), would account for ~20% of global coal trade in that year. This will keep
regional prices firm. The worst-case scenario is slippages / sub-optimal capacity utilisation in user industries.
Coal India – a direct play on the theme: CIL accounted for 81% of domestic coal production in FY10. The
company achieved a profit CAGR of 23% over FY04-10, aided by a 6% CAGR in both production and prices. We
forecast production CAGR will sustain at 5.5% over FY11-17. Increasing flexibility to link larger proportion of
its production to global prices would enable it to capture upsides from firm global prices, while selling the bulk
of its output at steep discounts to market prices offers significant downside cushion. 10.2% revenue CAGR and
efficiency gains through reduced manpower should result in 13% profit CAGR over FY11-17ii.
CIL can trade at a premium; mine delays the biggest concern: Lower earnings volatility, a large
undeveloped resource base and potential to improve realisations warrant a premium to global peers. However,
constraints to production growth due to serious difficulties in commencing new mines and an increase in the
proportion of lower-grade coal could dampen valuations. A holding-company structure resulting in higher tax
incidence, and 28% of the resource base being in weaker subsidiaries, would also warrant a discount.