Gujarat NRE Coke-Rains impacted sales volume, Macquarie Research,

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Gujarat NRE Coke
Rains impacted sales volume
Event
 Q2FY11 results – better margins but lower volumes: GNC Q2 results were
impacted by 40% drop in sales volume as heavy rains led to flooding of its
facilities. However, the improvement in margins is encouraging and company
remains on track to meet our full-year estimates. GNC stock has been rangebound,
but we believe that the strong performance of its mining subsidiary in
the results expected this month will drive the re-rating. We maintain our
Outperform rating and target price of Rs103.


Impact
 Q2 standalone results muted but on track for full year: GNC has reported
standalone H1 EBITDA of Rs1790mn, which is 41% of our full year estimate.
However, at the current profitability of US$107/t of coke, up from US$56/t
reported in Q1, the company is all set to easily achieve our target as volume
returns to normal.
 Coke margins to improve further: The main driver of margin improvement
in the coke business has been reduction in cost of coking coal. GNC uses
weighted average cost for its raw material. With increased purchases of
coking coal on new contract prices, the proportion of high-priced inventory
from 2009 which now reduced dramatically. With Q3 coking coal prices set
even lower by 7%at US$209 for Q3 while coke prices move up in the spot
market, margins can expand further.
 Rising coking coal inventory points to good performance of the mines:
Mine development is the key to unlocking value at GNC, and we are
expecting doubling of mine production to 2Mnt for FY11. The rise in coking
coal inventory this quarter by 400kt points to a production run rate in excess
of 500kt from the mine for Q2. The half-yearly result of the mining subsidiary
is expected this month and will be the key catalyst, in our view.
 Bullish fundamentals for coking coal: Spot coking coal prices have already
moved upto US$220/t and the risk remains on the upside, given the forecasts
of above-average rainfall in Queensland and possible disruption of production.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs103.00 based on a Sum of Parts methodology.
 Catalyst: Strengthening coking coal prices
Action and recommendation
 Maintain Outperform: GNC has underperformed the market in the past few
months, given concerns on execution of its expansion plans. We were very
much impressed by the development of the mines during our visit last month.
We believe that the current valuation is a good opportunity to take entry
before results of the mining subsidiary. Maintain Outperform recommendation.