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UBS Investment Research
Coal India
Powering the tiger
We initiate coverage of the world’s largest coal company
Coal India is the world’s largest coal company by both production and reserves. In
FY10, it produced 431Mt of raw coal (92% thermal coal), and had 64.8Bt of
resources and 21.8Bt of extractable reserves. The company produces around 80%
of India’s coal output. We forecast FY10-13 sales/earnings CAGRs of 12%/18%,
to reach Rs662bn/Rs161bn by FY13E. We believe Coal India is best positioned to
capitalise on rising domestic coal demand.
Key catalysts: capacity expansion; sustainable low costs; higher ASP
Coal India plans to increase its raw coal output by 50% to 647Mtpa in FY18. It is
one of the lowest cost coal producers globally, due to its high share (around 90%)
of production from open mines. The company is highly profitable, despite selling
at a 55-60% discount to global prices, and plans to increase realisations by raising
its beneficiated coal sales to around 40% of sales by FY18 and selling higher
quantities through the e-auction route, where discounts are lower.
Our proprietary model estimates coal imports will rise on strong demand
We estimate a 9% FY10-15 coal demand CAGR (901Mt in FY15E), on higher
capacity in major coal consuming sectors such as power (70% of total demand),
steel (7%), and cement (4%). We expect coal imports to rise at a FY10-15 CAGR
of 24% (207Mt in FY15) on slower capacity additions in the domestic coal sector.
Valuation: initiate coverage with a Buy rating and Rs400 price target
We value Coal India using a target PE multiple (16.5x December 2012E EPS).
This is broadly in line with the UBS target multiple for China Shenhua Energy
(Coal India’s largest regional peer) and a marginal discount to the UBS target
multiple for National Thermal Power Corp (NTPC). UBS values China Shenhua
Energy at an implied December 2012E PE multiple of 16.7x and NTPC at 17.5x.
Investment Thesis
We initiate coverage of Coal India with a Buy rating and price target of Rs400.
Coal India is the market leader with around 80% of India’s FY10 production, and
we believe it provides the best exposure to domestic coal demand. We expect this
demand to increase (at a 9% CAGR to 901Mt in FY15) due to strong capacity
additions in sectors such as power, steel and cement. Domestic production (with a
6.2% FY10-15E CAGR) should lag demand growth, resulting in increasing
dependence on imported coal (a 24% CAGR, to reach 207Mt in FY15E).
We believe Coal India has four key advantages. 1) It is well placed to capitalise on
domestic demand, with plans to expand its raw coal output 50% from 431Mtpa in
FY10 to 647Mtpa in FY18 to meet higher demand. 2) It has sustainable low cost
production. It is one of the lowest cost coal producers globally (US$16/t compared
with the global thermal coal average of US$33/t). due to advantages such as a high
share of open mines (around 90% of output), and favourable geological conditions
including low stripping ratios, thick flat coal seams and gentle inclines. 3) It has
scope to improve realisations, as it sells its raw coal at a significant discount
(55%-60%) to global prices. It plans to improve realisations by increasing sales of
beneficiated coal, and coal sold through e-auctions where the discounts are lower.
4) It has a strong balance sheet, with cash of Rs370bn (US$8.2bn) at end-FY10,
which we believe positions the company well to pursue large global M&A
opportunities without significantly risking its capital structure.
We base our Rs400 price target on 16.5x December 2012E EPS. Our target PE
multiple is broadly in line with the UBS target multiple for China Shenhua Energy,
Coal India’s largest regional peer, which has an implied target valuation of 16.7x
December 2012E PE. We believe this is conservative, as: 1) Coal India’s accounting
practices are more conservative than peers (it accounts for overburden provision in
its P&L, which was Rs19bn in FY10); 2) it is the largest coal company in the world
and the only listed coal company in India; and 3) China Shenhua’s forecast ROE is
lower than Coal India’s—for example, in FY11/12, UBS estimates Shenhua’s ROE
at 19%/15% compared with 39%/33% for Coal India.
China Shenhua also sells coal at a significant discount to international coal prices,
which makes it more comparable with Coal India than other listed regional coal
companies (that largely sell at international market prices). Our Coal India valuation
implies a marginal discount to NTPC (ROE of around 14.4%), which has an implied
target valuation of 17.5x December 2012E EPS. Coal India has stable cash flows,
similar to a utility, but its earnings are not as assured as those of a utility.
We believe Coal India should trade at a premium to global coal companies
because of its sustainable and better quality earnings, conservative accounting
practices, and scarcity premium.
We expect Coal India’s revenue to increase at a 12% CAGR in FY10-13 to
Rs662bn in FY13, and net profit at an 18% CAGR to Rs161bn. We expect the
average EBITDA margin to be 26% and average ROE of 35% in FY11-15.
Key catalysts
We believe the key catalysts for the stock are:
Low cost of production—Almost 90% of Coal India’s coal is produced
through open cast mines; hence, its cost of production is low compared with
its global peers. In FY10, Coal India’s production cost in open mines was
one-fifth that of underground mines (Rs520 in open cast mines compared
with Rs2,796 in underground mines). The average cash cost of production
for Coal India in FY10 was US$16/t, compared with the global weighted
average thermal coal cost of US$33/t; its average ASP was US$23, and
average EBITDA/t US$6/t.
Potential for price increases—Coal India sells coal at quasi market prices,
which are at a 55-60% grade-adjusted discount to international prices. Its
average raw coal selling price was Rs1,045/t in FY10 (US$23/t). Raw coal
prices increased at a CAGR of 9% in FY07-10 and have risen at a CAGR of
4.9% since deregulation in 2000. While the substantial discount to
international prices is unlikely to be eliminated for social reasons, Coal India
has increased the frequency of price rises recently. Raw coal accounted for
92.6% of total sales in FY10, while beneficiated coal accounted for only 7%
of total sales. Further, improvements to sales mix by increasing the
proportion of beneficiated coal sales and selling a higher proportion of coal
through e-auctions should improve Coal India’s realisations.
Capacity growth—Coal India plans to increase its raw coal production from
431Mt in FY10 to 460Mt/486Mt in FY11/FY12. The company plans to
expand raw coal capacity to 647Mt by FY18 and also intends to increase
beneficiation capacity from 39Mt in FY10 by another 111Mt by setting up
new washeries. In addition, the company intends to construct in-built
washeries for the raw coal expansion (where the mine size is more than
2.5Mt capacity). Effectively, Coal India targets to achieve 35-40% of total
sales through beneficiation coal by FY18 (from less than 5% currently).
However, we factor in only 15% of total sales from beneficiation by FY18
and plan to revisit our estimates as Coal India achieves stated milestones.
Robust domestic demand growth—Indian raw coal demand expanded at a
CAGR of 7.5% in FY05-10 and we expect demand to increase at a faster
pace driven by capacity expansions in the power, steel and cement sectors.
India is currently a net importer of coal, importing about 12% of total
domestic coal demand. We believe the company, which sells 100% of its
output in the domestic markets, is well positioned to capitalise on the high
demand for coal in India.
Attractive valuations—We believe Coal India’s valuation should be at a
premium to global coal companies, as it is less exposed to international coal
prices (since Coal India sells coal at a significant discount to international
prices) and hence has a better quality earnings stream. Coal India also has
very conservative accounting practices compared to global peers (overburden
charges to P&L). We also believe it should trade at a marginal discount to
regulated utilities’ (such as NTPC) valuations, as Coal India’s earnings are
more regulated, though not as assured as those of a utility.
attractive than that of China Shenhua, which is trading at 14.2x FY12E
(China Shenhua has lower ROEs of 19%/13% for FY11/12E than Coal
India’s 39%/33%). Coal India is trading broadly in line with NTPC, which is
at 16.1x FY12E PE, (on ROE of 14.4%/14.6% in FY11/12E). Currently,
global coal companies are trading at an average of 11x 2011E PE.
Risks
We believe the key risks for Coal India are as follows:
Company-specific
Delay in expansions/beneficiated coal capacity additions—Coal India has
aggressive plans for capacity additions (raw coal: from 431Mt FY10 to
486Mt in FY12F). It also plans to significantly increase the share of
beneficiated coal production (to around 40% of total capacity by FY18). Any
delays in these plans would be negative for earnings.
Insurance risk—Coal India currently does not maintain insurance coverage
for the loss of assets such as equipment, plant and machinery, and buildings;
therefore, any claims against the company in the absence of adequate
insurance could have a material impact on business.
Industry-specific
Higher taxes/statutory levies—Coal India could be affected by any increase
in taxation by the government. In particular, after the approval of the Mines
and Minerals Bill, 2010, the risk of obligatory payments on mining land has
increased.
Valuation and basis for our price target
We have a Buy rating on the stock with a 12-month price target of Rs400. We
base our price target on 16.5x December 2012E EPS. Our target PE multiple is
broadly in line with the UBS target multiple for China Shenhua Energy, Coal
India’s largest regional peer, which has an implied target valuation of 16.7x
December 2012E EPS.
We believe this is conservative, as: 1) Coal India’s accounting practices are
more conservative than peers (for example, it accounts for overburden provision
in its P&L, which was Rs19bn in FY10); 2) it is the largest coal company in the
world and only listed coal company in India; and 3) China Shenhua’s forecast
ROE is lower than Coal India’s—for example, in FY11/12 UBS estimates
Shenhua’s ROE at 19%/15% compared with 39%/33% for Coal India.
China Shenhua also sells coal at a significant discount to international coal
prices, which we believe makes it more comparable to Coal India than the other
listed regional coal companies that sell at international market prices. Our Coal
India valuation implies a marginal discount to NTPC, which has an implied
valuation of 17.5x December 2012E EPS, as Coal India’s earnings mirror that of
a utility company (given the significant discount to international prices). We
believe a marginal discount is justified because, despite Coal India having stable
cash flows, similar to a utility’s, earnings for Coal India are not as assured as
those of a utility.
We believe Coal India should trade at a premium to global coal companies due to
its: 1) better quality earnings, as its profitability is not impacted significantly by
volatility in global coal prices; 2) its conservative accounting practices—Coal India
makes a provision for overburden removal in its P&L, which global companies do
not; and 3) Coal India should command a scarcity premium, given it is the largest
company in the world and the only large listed coal exposure in India.
Risk analysis
Risk of higher taxation: On 17 September 2010, a group of ministers
headed by the Finance Minister, Pranab Mukherjee, approved the Mines and
Minerals (Development and Regulation) Bill, 2010 (the Mining Bill). If the
bill is passed in its current form, mining lease or prospecting licence holders
would be required to pay annual compensation to whoever has rights to the
surface of the land above the mine/prospecting area, and also contribute to
resettlement costs. Media reports indicate that such payments could amount
to around 26% of post-tax profit. The government plans to introduce the bill
to parliament before the end of 2010. If passed without amendment, the
resulting law could have an impact on Coal India’s business, its acquisition
of future mines, and its financial position.
Costs fluctuation risk: A portion of the company’s coal production and
handling operations are conducted through third-party contractors. This
exposes the company to the external risk of contractors’ costs varying more
than the company’s expectations. The same situation applies to raw material
costs, employee remuneration and benefits, and statutory levies and taxes. This
is because these can all increase overall input costs, which will affect Coal
India’s margins adversely if it is not able to pass on the burden to customers.
Security risks: Some mining assets and operations are located in areas of
India that are exposed to the risk of attack by rebel groups, such as in
Jharkhand, Chhattisgarh, Orissa and Assam. As such attacks have happened
in the past they cannot be ruled out in future, which presents a risk for the
company’s operations.
Government regulation risk: Two of Coal India’s subsidiaries, Bharat
Coking Coal (BCCL) and Eastern Coal (ECL) have been referred to the
Board for Industrial and Financial Reconstruction (BIFR) because they are in
financial difficulties. Any disruption in the operation of these two companies
could have an adverse affect on Coal India’s operations and profitability.
Also, as Coal India’s operations are governed by competition laws and the
government plans to introduce a regulator for the coal sector, changes to laws
and regulations are possible that could affect its business operations.
Mining rights/lease renewal risk: Continuity in Coal India’s exploration
programme in currently operational and future mining assets depends on
timely approval of mining related activities and the renewal of required lease
mining rights.
Strategy/expansion/exploration risk: The success of Coal India’s growth
strategy to enhance its coal reserves and resources base in India and abroad
depends on its ability to successfully exploit existing reserves and acquire
and develop additional economically viable reserves and favourable
geophysical and geological conditions. Any delay or failure in this can
impact its profitability and finances.
Operational risk: Coal India’s operations could be impacted by any delay or
unavailability of transportation, labour, material and adequate transportation
infrastructure and capacity required for the offtake of coal. Besides, Coal
India does not maintain insurance coverage for loss of equipment, plant and
machinery or buildings and is not fully insured for all operational risk. Any
claims against the company due to any operational accident or natural
disaster could materially affect its financial condition.
Environmental risk: Coal India’s business is subject to extensive
environmental and hazardous waste management laws and regulations in
India. Any changes in laws may cause interruptions in operations and affect
results negatively (for example, a recent government proposal to categorise
certain coal-bearing forest areas and prohibit activities in some categories
may adversely affect company’s business prospects).
Diversification risk: Coal India is a pure coal play company and does not
have any other significant revenue stream. Therefore it possesses
diversification risk with any decrease in coal demand (for example if the
power sector, which is the largest consumer of coal, starts using other energy
sources), which could directly impact company’s profitability.
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