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Coal India (COAL.BO)
Buy: Volumes Cut; Value Despite Conservatism
Outlook more subdued — We see Coal India (CIL) supplying much less coal
than anticipated a few quarters ago. Management guidance on volumes is
disappointing with FY11-12 growth target being cut from ~6% earlier to 0-4% –
stumbling blocks being (1) the moratorium imposed in critically polluted clusters
and (2) railways failing to meet their commitments. While we believe it’s time to be
more conservative on volume expectations and cut FY10-17 CAGR to 3.7% from
5.5%, there appears to be value in the stock (most bad news discounted). Higher
global prices should benefit e-auction and washed-coal realisation in FY12.
Volume growth: a challenge — While the MOEF will likely relax pollution norms
and some of CIL’s projects are likely to be taken up for approval, the benefit is only
likely to come by FY13 – with a continuing lag effect for subsequent approvals.
Besides production, evacuation of coal is an issue. Additional coal can be made
available only if railways increase rake availability (currently 175/day). CIL hopes
for higher rake availability in FY12. Power generation could be an alternative.
Higher realizations— CIL is in discussions with the government to hike notified
coal prices on account of expected wage revisions (July11), higher global prices
and to make some projects viable. It has also proposed market-linked prices for
consumers with unregulated end-product prices. In addition, e-auction/washed
coal realizations will rise with global prices. E-auction premium to notified prices is
80%+ vs ~60% (FY10). CIL hopes to sell 12% (Citi est 11%) via E-auction vs 10%.
TP cut to Rs350 — Our volume cut has resulted in a lower DCF value (Rs425 vs
Rs448). On the other hand, our 12x PE based value (40%) goes up from Rs225 to
Rs236 as we raise FY12 EPS by 5% on slightly higher realizations.
Risks — Forest/environmental/pollution clearances, 26% profit sharing, transport
constraints, auction for future reserves, restricted ability to raise prices.
Analyst Meet Takeaways
Production
Opening stock at the beginning of FY11 was 63mt. In 1HFY11, CIL had
decided to focus on growth in off-take and reduction in stock. Higher
inventory and imposition of the moratorium resulted in an 11% yoy increase
in OBR (overburden removal) in 1HFY10. Coal production + OBR removed
grew 7.6% yoy for 9MFY11.The moratorium was expected to be lifted in
Aug10 but has been extended to March11.
CIL has tried to apprise the government of the consequences of low
production. Meetings between the Environment and Coal Ministries have
resulted in softening of the MOEF’s stance. Media reports indicate that the
Environment and Forests Minister Jairam Ramesh has agreed to relax the
comprehensive environment pollution index (CEPI) that could free up 16 coal
projects currently stuck. The MOEF Minister may increase the CEPI
threshold to 75 points from the existing 70.
CIL expects some of its projects to be taken up for approval by the MOEF but
expects the impact to be felt in the later part of FY12/early FY13.
The meeting on the ‘go’ –‘no-go’ areas was scheduled for 17 Feb 2011. CIL’s
focus is ‘go’ areas and they hope the clearances are expedited in these
areas.
CIL believes that if things go in its favour, a 5-5.5% growth expectation
beyond FY12 may be conservative.
Despatches
FY10 off-take was impacted by low rake availability (production 431mt,
despatches 415mt).
The only way CIL would have been able to meet its original dispatch target of
FY11 − 460.5mt (ignoring production problems) was if the railways provided
30 rakes more per day vs FY10. The railways did not meet their
commitments.
There was a meeting between the Railway and Coal Ministries in June 2010
to discuss the improvement in the availability of rakes. While there was no
increase in availability in 1QFY11, seven additional rakes per day were
available in 9MFY11 vs 9MFY10. Despite another meeting in Jan 2011, the
number of rakes available for coal movement is unlikely to improve yoy in
4QFY11. Currently, ~175 rakes are available per day for the movement of
coal. Based on the improvement in availability of rakes and the off-take via
road, despatches in FY11 are likely to be ~12mt higher vs FY10 i.e. 427mt.
One rake transports ~3,500 tonnes of coal.
~16,000 more wagons have been ordered (14,000 net). CIL hopes for higher
rake availability in FY12.
CIL is considering an alternate plan in the absence of infrastructure capacity
supporting rail movement − to set up power plants, especially in areas where
there is lack of rail support.
Pricing
CIL has started discussions with the government for a proposed price
increase on account of wage revisions, movement in international prices and
to make some projects viable.
It has also proposed to the government that consumers whose end-product
prices are not regulated should be charged market-linked pricing.
E-auction premium to notified pricing has gone up from 56% last year to 81%
and was as high as 93% in Dec10 given the movement in global prices. CIL
hopes to enhance the proportion of e-auction volumes to ~12% (vs 10%
earlier).
Costs
The dearness component was 27.7% in FY10; this has increased to 49.9% -
resulting in a 7-8% increase in employee costs.
The next wage revision is due in July11. The first meeting to discuss wage
provisioning was held on 28 Feb 2011.
FSA (Fuel Supply Agreement)
CIL has not defaulted on its FSAs. It has been able to supply 93-94% coal on
an average and get premium pricing for its coal. No new FSAs have been
signed.
International ventures
CIL was mandated to import 6mt of coal in FY10 but could find customers for
only 0.4mt.
The target was to import 6mt in FY11 again – but CIL has been unable to
conclude terms and conditions. CIL was seeking to deliver coal at the port
but customers have not agreed to it.
It is in discussions to assessing international acquisitions and tie-ups with
coal companies.
CIL and the Shipping Corporation of India (SCI) have signed a Memorandum
of Understanding (MoU) to promote a JV company to create a
comprehensive end-to-end logistic solution ''from load port to consuming
end''.
Washeries
CIL expects to set up 20 washeries with a capacity of 111mt. The order for
the first washery has been awarded to a consortium led by HEC.
Valuation
We calculate our Rs350 target price based on two metrics:
a valuation based on DCF + 30% premium (Rs425/sh)
a 12x FY12 PE-based valuation (Rs236/sh)
…which we then combine based on a 60/40 weighting.
This method incorporates both CIL’s asset valuation and also its earnings
potential. Our DCF valuation is enhanced by 30% to account for the probable
reserves (8.3bn tonnes – an additional 78% over the proven reserves) that we
have not incorporated in our valuation. We have not taken a terminal value and
thus also use a PE-based valuation as it assumes new reserves replace the
ones exhausted. The lower weightage to PE seems justified given CIL’s limited
exposure to international prices and that the benefits of beneficiation are likely
to have a meaningful impact only after 2-3 years – thus PE alone cannot fully
capture a fair valuation. At our TP of Rs350, CIL would trade at 15.1x FY12 PE
adjusted for the overburden removal adjustment.
DCF-Based Valuation
We have modeled DCF cash flows out to FY27E based on CIL's existing
proven reserves of 10.6bn tonnes. Our DCF valuation is enhanced by 30% to
account for probable reserves (8.3bn tonnes – an additional 78% over the
proven reserves) that we have not incorporated in our valuation. We do not
account for any terminal value due to lack of visibility on future reserves. Our
WACC is 11.8% which is calculated based on a beta of 1.0 (relative to Sensex),
a risk-free rate of 8.0% and an ERP of 6%, cost of debt of 6.8% (post tax), and
a target debt-to-total-capital ratio of 30%. We enhance our DCF-based
valuation by 30% – resulting in a price of Rs425/share.
Figure 2. Target price based on DCF
WACC (%) 11.8%
EV (Rs m) 1,519,382
Net Debt (Rs m) -545,886
Market cap (Rs m) 2,065,268
No. of shares (m) 6,316
Per share (Rs) 327
Value per share at 30% premium (Rs) 425
Source: Citi Investment Research and Analysis
Figure 3. WACC Estimation
Risk free rate (%) 8%
Equity risk premium (%) 6%
Beta 1.0
Cost of equity 14.0%
Cost of debt (post tax) 6.8%
Target debt to total capital (%) 30.0%
WACC (%) 11.8%
Source: Citi Investment Research and Analysis estimates
PE-Based Valuation
Chinese and Indonesian coal companies currently trade at 7-11x PE. We value
CIL at 12x FY12 PE – at a premium to the trading range for the Indonesian and
Chinese producers. Reasons:
CIL makes a higher provision for overburden expenses than actually incurred
− FY12E EPS would rise by 17% if we were to provide for only the actual
overburden removal expenses. Most Indonesian producers under-expense
their overburden costs – thus making their PE multiples appear cheaper.
No major downside risk to coal prices given the significant discount to
international coal prices.
High visibility on CIL’s mine life based on its proven and probable reserves.
Scarcity premium – CIL is a dominant coal producer in India and is well
positioned to benefit from India’s growing coal demand.
Our PE-based valuation results in a price of Rs236/share. The derived PE at
Rs236/share would be 10.2x, if we adjust for the excess overburden removal
expenses. Again, we would not use PE on a pure standalone basis given CIL’s
limited exposure to international prices; its long mine life and that the benefits of
beneficiation are likely to have a meaningful impact only after 3-4 years
Coal India
Valuation
Our target price of Rs350 is arrived at using (1) a valuation based on DCF +
30% premium (Rs425/sh) and (2) a 12x FY12 PE based valuation (Rs236/sh),
with a 60/40 weighting. This method incorporates both CIL's asset valuation
and also its earnings potential. Our DCF valuation is enhanced by 30% to
account for the probable reserves (8.3bn tonnes - an additional 78% over the
proven reserves) that we have not incorporated in our valuation. We have not
taken a terminal value and thus also use a PE-based valuation as it assumes
new reserves replace the ones exhausted. The lower weightage to PE seems
justified given CIL's limited exposure to international prices and that the
benefits of beneficiation are likely to have a meaningful impact only after 3-4
years - thus PE alone cannot fully capture a fair valuation.
Risks
We rate Coal India shares Low Risk based on our quantitative risk rating
system. We believe CIL's stable margins, mine life visibility, limited risk of coal
price downside, low costs and net cash position warrant a Low Risk rating.
Downside risks that could prevent the shares from reaching our target price
include, but are not limited to: risks of restrictions imposed by regulators related
to forest clearance and environmental safeguards; difficulties in obtaining
reserves/resources; a proposed 26% profit-sharing requirement contained in
the New Mining Bill; land acquisition; logistical constraints including rail
transport bottlenecks; restricted ability to raise coal prices; disruption of
operations in politically unstable areas; auction for future reserves; and nonavailability of critical equipment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Coal India (COAL.BO)
Buy: Volumes Cut; Value Despite Conservatism
Outlook more subdued — We see Coal India (CIL) supplying much less coal
than anticipated a few quarters ago. Management guidance on volumes is
disappointing with FY11-12 growth target being cut from ~6% earlier to 0-4% –
stumbling blocks being (1) the moratorium imposed in critically polluted clusters
and (2) railways failing to meet their commitments. While we believe it’s time to be
more conservative on volume expectations and cut FY10-17 CAGR to 3.7% from
5.5%, there appears to be value in the stock (most bad news discounted). Higher
global prices should benefit e-auction and washed-coal realisation in FY12.
Volume growth: a challenge — While the MOEF will likely relax pollution norms
and some of CIL’s projects are likely to be taken up for approval, the benefit is only
likely to come by FY13 – with a continuing lag effect for subsequent approvals.
Besides production, evacuation of coal is an issue. Additional coal can be made
available only if railways increase rake availability (currently 175/day). CIL hopes
for higher rake availability in FY12. Power generation could be an alternative.
Higher realizations— CIL is in discussions with the government to hike notified
coal prices on account of expected wage revisions (July11), higher global prices
and to make some projects viable. It has also proposed market-linked prices for
consumers with unregulated end-product prices. In addition, e-auction/washed
coal realizations will rise with global prices. E-auction premium to notified prices is
80%+ vs ~60% (FY10). CIL hopes to sell 12% (Citi est 11%) via E-auction vs 10%.
Rs448). On the other hand, our 12x PE based value (40%) goes up from Rs225 to
Rs236 as we raise FY12 EPS by 5% on slightly higher realizations.
Risks — Forest/environmental/pollution clearances, 26% profit sharing, transport
constraints, auction for future reserves, restricted ability to raise prices.
Analyst Meet Takeaways
Production
Opening stock at the beginning of FY11 was 63mt. In 1HFY11, CIL had
decided to focus on growth in off-take and reduction in stock. Higher
inventory and imposition of the moratorium resulted in an 11% yoy increase
in OBR (overburden removal) in 1HFY10. Coal production + OBR removed
grew 7.6% yoy for 9MFY11.The moratorium was expected to be lifted in
Aug10 but has been extended to March11.
CIL has tried to apprise the government of the consequences of low
production. Meetings between the Environment and Coal Ministries have
resulted in softening of the MOEF’s stance. Media reports indicate that the
Environment and Forests Minister Jairam Ramesh has agreed to relax the
comprehensive environment pollution index (CEPI) that could free up 16 coal
projects currently stuck. The MOEF Minister may increase the CEPI
threshold to 75 points from the existing 70.
CIL expects some of its projects to be taken up for approval by the MOEF but
expects the impact to be felt in the later part of FY12/early FY13.
The meeting on the ‘go’ –‘no-go’ areas was scheduled for 17 Feb 2011. CIL’s
focus is ‘go’ areas and they hope the clearances are expedited in these
areas.
CIL believes that if things go in its favour, a 5-5.5% growth expectation
beyond FY12 may be conservative.
Despatches
FY10 off-take was impacted by low rake availability (production 431mt,
despatches 415mt).
The only way CIL would have been able to meet its original dispatch target of
FY11 − 460.5mt (ignoring production problems) was if the railways provided
30 rakes more per day vs FY10. The railways did not meet their
commitments.
There was a meeting between the Railway and Coal Ministries in June 2010
to discuss the improvement in the availability of rakes. While there was no
increase in availability in 1QFY11, seven additional rakes per day were
available in 9MFY11 vs 9MFY10. Despite another meeting in Jan 2011, the
number of rakes available for coal movement is unlikely to improve yoy in
4QFY11. Currently, ~175 rakes are available per day for the movement of
coal. Based on the improvement in availability of rakes and the off-take via
road, despatches in FY11 are likely to be ~12mt higher vs FY10 i.e. 427mt.
One rake transports ~3,500 tonnes of coal.
~16,000 more wagons have been ordered (14,000 net). CIL hopes for higher
rake availability in FY12.
CIL is considering an alternate plan in the absence of infrastructure capacity
supporting rail movement − to set up power plants, especially in areas where
there is lack of rail support.
Pricing
CIL has started discussions with the government for a proposed price
increase on account of wage revisions, movement in international prices and
to make some projects viable.
It has also proposed to the government that consumers whose end-product
prices are not regulated should be charged market-linked pricing.
E-auction premium to notified pricing has gone up from 56% last year to 81%
and was as high as 93% in Dec10 given the movement in global prices. CIL
hopes to enhance the proportion of e-auction volumes to ~12% (vs 10%
earlier).
Costs
The dearness component was 27.7% in FY10; this has increased to 49.9% -
resulting in a 7-8% increase in employee costs.
The next wage revision is due in July11. The first meeting to discuss wage
provisioning was held on 28 Feb 2011.
FSA (Fuel Supply Agreement)
CIL has not defaulted on its FSAs. It has been able to supply 93-94% coal on
an average and get premium pricing for its coal. No new FSAs have been
signed.
International ventures
CIL was mandated to import 6mt of coal in FY10 but could find customers for
only 0.4mt.
The target was to import 6mt in FY11 again – but CIL has been unable to
conclude terms and conditions. CIL was seeking to deliver coal at the port
but customers have not agreed to it.
It is in discussions to assessing international acquisitions and tie-ups with
coal companies.
CIL and the Shipping Corporation of India (SCI) have signed a Memorandum
of Understanding (MoU) to promote a JV company to create a
comprehensive end-to-end logistic solution ''from load port to consuming
end''.
Washeries
CIL expects to set up 20 washeries with a capacity of 111mt. The order for
the first washery has been awarded to a consortium led by HEC.
Valuation
We calculate our Rs350 target price based on two metrics:
a valuation based on DCF + 30% premium (Rs425/sh)
a 12x FY12 PE-based valuation (Rs236/sh)
…which we then combine based on a 60/40 weighting.
This method incorporates both CIL’s asset valuation and also its earnings
potential. Our DCF valuation is enhanced by 30% to account for the probable
reserves (8.3bn tonnes – an additional 78% over the proven reserves) that we
have not incorporated in our valuation. We have not taken a terminal value and
thus also use a PE-based valuation as it assumes new reserves replace the
ones exhausted. The lower weightage to PE seems justified given CIL’s limited
exposure to international prices and that the benefits of beneficiation are likely
to have a meaningful impact only after 2-3 years – thus PE alone cannot fully
capture a fair valuation. At our TP of Rs350, CIL would trade at 15.1x FY12 PE
adjusted for the overburden removal adjustment.
DCF-Based Valuation
We have modeled DCF cash flows out to FY27E based on CIL's existing
proven reserves of 10.6bn tonnes. Our DCF valuation is enhanced by 30% to
account for probable reserves (8.3bn tonnes – an additional 78% over the
proven reserves) that we have not incorporated in our valuation. We do not
account for any terminal value due to lack of visibility on future reserves. Our
WACC is 11.8% which is calculated based on a beta of 1.0 (relative to Sensex),
a risk-free rate of 8.0% and an ERP of 6%, cost of debt of 6.8% (post tax), and
a target debt-to-total-capital ratio of 30%. We enhance our DCF-based
valuation by 30% – resulting in a price of Rs425/share.
Figure 2. Target price based on DCF
WACC (%) 11.8%
EV (Rs m) 1,519,382
Net Debt (Rs m) -545,886
Market cap (Rs m) 2,065,268
No. of shares (m) 6,316
Per share (Rs) 327
Value per share at 30% premium (Rs) 425
Source: Citi Investment Research and Analysis
Figure 3. WACC Estimation
Risk free rate (%) 8%
Equity risk premium (%) 6%
Beta 1.0
Cost of equity 14.0%
Cost of debt (post tax) 6.8%
Target debt to total capital (%) 30.0%
WACC (%) 11.8%
Source: Citi Investment Research and Analysis estimates
PE-Based Valuation
Chinese and Indonesian coal companies currently trade at 7-11x PE. We value
CIL at 12x FY12 PE – at a premium to the trading range for the Indonesian and
Chinese producers. Reasons:
CIL makes a higher provision for overburden expenses than actually incurred
− FY12E EPS would rise by 17% if we were to provide for only the actual
overburden removal expenses. Most Indonesian producers under-expense
their overburden costs – thus making their PE multiples appear cheaper.
No major downside risk to coal prices given the significant discount to
international coal prices.
High visibility on CIL’s mine life based on its proven and probable reserves.
Scarcity premium – CIL is a dominant coal producer in India and is well
positioned to benefit from India’s growing coal demand.
Our PE-based valuation results in a price of Rs236/share. The derived PE at
Rs236/share would be 10.2x, if we adjust for the excess overburden removal
expenses. Again, we would not use PE on a pure standalone basis given CIL’s
limited exposure to international prices; its long mine life and that the benefits of
beneficiation are likely to have a meaningful impact only after 3-4 years
Coal India
Valuation
Our target price of Rs350 is arrived at using (1) a valuation based on DCF +
30% premium (Rs425/sh) and (2) a 12x FY12 PE based valuation (Rs236/sh),
with a 60/40 weighting. This method incorporates both CIL's asset valuation
and also its earnings potential. Our DCF valuation is enhanced by 30% to
account for the probable reserves (8.3bn tonnes - an additional 78% over the
proven reserves) that we have not incorporated in our valuation. We have not
taken a terminal value and thus also use a PE-based valuation as it assumes
new reserves replace the ones exhausted. The lower weightage to PE seems
justified given CIL's limited exposure to international prices and that the
benefits of beneficiation are likely to have a meaningful impact only after 3-4
years - thus PE alone cannot fully capture a fair valuation.
Risks
We rate Coal India shares Low Risk based on our quantitative risk rating
system. We believe CIL's stable margins, mine life visibility, limited risk of coal
price downside, low costs and net cash position warrant a Low Risk rating.
Downside risks that could prevent the shares from reaching our target price
include, but are not limited to: risks of restrictions imposed by regulators related
to forest clearance and environmental safeguards; difficulties in obtaining
reserves/resources; a proposed 26% profit-sharing requirement contained in
the New Mining Bill; land acquisition; logistical constraints including rail
transport bottlenecks; restricted ability to raise coal prices; disruption of
operations in politically unstable areas; auction for future reserves; and nonavailability of critical equipment.
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