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Coal India (COAL)
Metals & Mining
Improved volumes and the benefit of leverage. Coal India (CIL) reported an
improved operational performance, with operating margins expanding by 10% on a
10% sequential increase in dispatch volumes, demonstrating the high operating
leverage in its business model. Margins expansion was also supported by a modest
improvement in blended realizations, and although we concede the risk to volume
growth from environmental hurdles, recent reports of a resolution of issues is
encouraging. Maintain ADD rating and target price of Rs345/share.
Operational performance beats estimates on better volumes and realization
CIL reported net sales of Rs126.9 bn (14% qoq), operating profit of Rs33.8 bn (81% qoq) and net
income of Rs26.4 bn (56% qoq) against our estimate of Rs122.6 bn, Rs35.8 bn and Rs28.2 bn,
respectively. Higher-than-estimated revenues were primarily on account of (1) higher volumes of
110.5 mn tons (against our estimate of 109 mn tons) and (2) marginally higher-than-estimated
average realization of Rs1,148/ton (against our estimate of 1,125/ton). Higher-than-estimated
employee cost of Rs45 bn (against our estimate of Rs44 bn) was likely on account of increase in
dearness allowance (linked to WPI). Operating margins improved from 17% in 2QFY11 to 27% in
3QFY11 as benefits of operating leverage accrued on higher volumes. Net income miss was
primarily on account of higher effective tax rate of 37.4% against our estimate of 31%.
Environmental hurdles could play spoilsport—though signs of a resolution visible
Environmental hurdles have continued to plague production growth through the current fiscal,
though signs of thawing in the standoff between the Ministry of Environment and Forest (MoEF)
and Ministry of Coal (MoC) are encouraging. We note that our current volume estimates of 436
mn tons in FY2011E are aligned to the managements guidance, though we continue to build
moderately higher coal sales of 458 mn tons—implying target miss of 29 mn tons compared to 39
mn tons miss guided by the management.
Maintain ADD rating and target price of Rs345/share
We maintain our ADD rating and target price of Rs345/share. Our target price is based on 12.7 X
FY2012E EPS adjusted for overburden removal and interest income and implies an EV/EBITDA of
9.3X on FY2012E EBITDA (adjusted for overburden removal). CIL currently trades at 14X FY2012E
EPS (reported) and 9.1X FY2012E EBITDA (reported). In our view, CIL will likely continue to
command premium multiples to account for (1) expectations of narrowing discount to global coal
prices, and (2) constantly improving employee efficiency metrics that will further propel margin
expansion. We have marginally revised our FY2011E EPS estimate to Rs17/share (previously
Rs18/share) to account for lower volumes in FY2011E.
Analysis of 3QFY11 results
We analyze below key highlights of 3QFY11 results:
Volumes – CIL’s volumes grew to 110.5 mn tons (12% qoq, 3% yoy). Sequential jump in
volumes was on account of seasonal jump in mining activities post monsoons. However a
general slowdown and delays in capacity ramp up due to environmental hurdles led to a
muted yoy volume growth.
Realization – CIL’s average blended realization was Rs1,148/ton (2.6% qoq). Marginal
sequential improvement in realization could be attributed to better realizations in sale of
high grade coal (pricing for which is more aligned to market driven rates).
Employee cost – Employee cost for 3QFY11 was Rs45 bn (-6% qoq). Sequential decline
was due to provisioning for gratuity in 2QFY11. However, Social Overhead increased 13
sequentially to Rs5.6 bn.
OBR and OBR adjustment – CIL’s estimated OBR removal was 195 mcum during
3QFY11 at an assumed average strip ratio of 1.9X. A sharp sequential jump of 101% in
OBR adjustment was likely on account of higher-than-average stripping done in low
production period of 1HFY11 which led to lower stripping in 3QFY11 and hence higher
OBR adjustment.
Contractual expense – Estimated contractual expense reduced from Rs53/ton in
2QFY11 to Rs45.5/ton in 3QFY11.
Power and fuel cost – Estimated power and fuel cost reduced from Rs21/ton in 2QFY11
to Rs18.4/ton in 3QFY11.
Effective tax rate – Effective tax rate increased from 35.7% in 2QFY11 to 37.4% in
3QFY11 (31.4% in FY2010).
Price hike likely in CY2011E could boost realizations and offset lower volumes
CIL will likely increase its notified prices across all the grades in CY2011E to offset the nonexecutive
wage revision due in FY2012E. Management has indicated that the level of price
increase in FY2012E will be a function the of wage increase. We highlight that 10% higher
blended realization could add Rs84/share to our fair value estimate of CIL. The price hike
would also signal CIL’s ability to take price hikes to (1) narrow the gap between parity prices,
(2) offset cost escalations, and (3) compensate for lower volume growth.
Environmental hurdles – a risk to volumes and profitability
CIL’s continues to be plagued by environmental hurdles with the latest being
Comprehensive Environment Pollution Index (CEPI) that has resulted in management revising
downwards its production targets for FY2011E and FY2012E by 16 mn tons and 39 mn tons
respectively. Along with CEPI, the on going uncertainty over no-go mining areas and
possible imposition of mining tax continue to be a key risk for CIL’s volume growth and
profitability.
Comprehensive Environment Pollution Index (CEPI) - CEPI was introduced by Ministry
of Environment and Forest (MoEF) in 2009 to assess the environmental quality of industrial
clusters in India. In January 2010, MoEF imposed a temporary moratorium on development
projects in 43 clusters which also includes seven coalfields of CIL. The moratorium was put in
place till August 2010 but was further extended by MOEF (in October 2010) till March 2011
thus further delaying the award of environmental clearance for these projects. CEPI affected
clusters include seven coalfields of CIL including Chandrapur, Korba, Jharia, Talcher,
Singrauli, Raniganj and IB Valley. The directly affected CIL subsidiaries are ECL (Raniganj),
BCCL (Jharia), SECL (Korba), NCL (Singrauli) and MCL (Talcher and IB Valley). CIL’s coalfields
identified as critical under CEPI, contributed 295 mn tons or 68% of FY2010 production and
account for ~66% of CIL’s total extractable reserves of 21.75 bn tons (see Exhibit 4).
‘No go’ mining areas - Pursuant to a proposal dated July 8, 2010, MoEF introduced
initiatives for the identification of environmentally sensitive areas classified as ‘No-Go’ where
coal mining activities would not be permitted. ‘No-go' areas for mining have been defined
as those that have over 30 per cent gross forest cover or over 10 per cent weighted forest
cover. Several significant coal fields where CIL is currently carrying on mining activities have
been classified as ‘No-go’ including large mines such as North Karanpura in Jharkhand, Ib
Valley in Orissa and Chhattisgarh, Singrauli Coalfield in Madhya Pradesh and Uttar Pradesh
and Talcher coalfield in Orissa.
Mining tax – The imposition of mining tax (26% of mining profit) could erode 19% of CIL’s
FY2012E earnings in absence of a set-off against expenses on CSR already incurred by CIL.
The draft of Mines and Minerals (Development and Regulations) Act, 2010 imposes the
allotment of free shares equal to 26%, or an annuity equal to 26% of profit (post tax) in
favor of persons holding occupation or usufruct or traditional rights of the surface of the
land over which the mining lease has been granted.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Coal India (COAL)
Metals & Mining
Improved volumes and the benefit of leverage. Coal India (CIL) reported an
improved operational performance, with operating margins expanding by 10% on a
10% sequential increase in dispatch volumes, demonstrating the high operating
leverage in its business model. Margins expansion was also supported by a modest
improvement in blended realizations, and although we concede the risk to volume
growth from environmental hurdles, recent reports of a resolution of issues is
encouraging. Maintain ADD rating and target price of Rs345/share.
Operational performance beats estimates on better volumes and realization
CIL reported net sales of Rs126.9 bn (14% qoq), operating profit of Rs33.8 bn (81% qoq) and net
income of Rs26.4 bn (56% qoq) against our estimate of Rs122.6 bn, Rs35.8 bn and Rs28.2 bn,
respectively. Higher-than-estimated revenues were primarily on account of (1) higher volumes of
110.5 mn tons (against our estimate of 109 mn tons) and (2) marginally higher-than-estimated
average realization of Rs1,148/ton (against our estimate of 1,125/ton). Higher-than-estimated
employee cost of Rs45 bn (against our estimate of Rs44 bn) was likely on account of increase in
dearness allowance (linked to WPI). Operating margins improved from 17% in 2QFY11 to 27% in
3QFY11 as benefits of operating leverage accrued on higher volumes. Net income miss was
primarily on account of higher effective tax rate of 37.4% against our estimate of 31%.
Environmental hurdles could play spoilsport—though signs of a resolution visible
Environmental hurdles have continued to plague production growth through the current fiscal,
though signs of thawing in the standoff between the Ministry of Environment and Forest (MoEF)
and Ministry of Coal (MoC) are encouraging. We note that our current volume estimates of 436
mn tons in FY2011E are aligned to the managements guidance, though we continue to build
moderately higher coal sales of 458 mn tons—implying target miss of 29 mn tons compared to 39
mn tons miss guided by the management.
Maintain ADD rating and target price of Rs345/share
We maintain our ADD rating and target price of Rs345/share. Our target price is based on 12.7 X
FY2012E EPS adjusted for overburden removal and interest income and implies an EV/EBITDA of
9.3X on FY2012E EBITDA (adjusted for overburden removal). CIL currently trades at 14X FY2012E
EPS (reported) and 9.1X FY2012E EBITDA (reported). In our view, CIL will likely continue to
command premium multiples to account for (1) expectations of narrowing discount to global coal
prices, and (2) constantly improving employee efficiency metrics that will further propel margin
expansion. We have marginally revised our FY2011E EPS estimate to Rs17/share (previously
Rs18/share) to account for lower volumes in FY2011E.
Analysis of 3QFY11 results
We analyze below key highlights of 3QFY11 results:
Volumes – CIL’s volumes grew to 110.5 mn tons (12% qoq, 3% yoy). Sequential jump in
volumes was on account of seasonal jump in mining activities post monsoons. However a
general slowdown and delays in capacity ramp up due to environmental hurdles led to a
muted yoy volume growth.
Realization – CIL’s average blended realization was Rs1,148/ton (2.6% qoq). Marginal
sequential improvement in realization could be attributed to better realizations in sale of
high grade coal (pricing for which is more aligned to market driven rates).
Employee cost – Employee cost for 3QFY11 was Rs45 bn (-6% qoq). Sequential decline
was due to provisioning for gratuity in 2QFY11. However, Social Overhead increased 13
sequentially to Rs5.6 bn.
OBR and OBR adjustment – CIL’s estimated OBR removal was 195 mcum during
3QFY11 at an assumed average strip ratio of 1.9X. A sharp sequential jump of 101% in
OBR adjustment was likely on account of higher-than-average stripping done in low
production period of 1HFY11 which led to lower stripping in 3QFY11 and hence higher
OBR adjustment.
Contractual expense – Estimated contractual expense reduced from Rs53/ton in
2QFY11 to Rs45.5/ton in 3QFY11.
Power and fuel cost – Estimated power and fuel cost reduced from Rs21/ton in 2QFY11
to Rs18.4/ton in 3QFY11.
Effective tax rate – Effective tax rate increased from 35.7% in 2QFY11 to 37.4% in
3QFY11 (31.4% in FY2010).
Price hike likely in CY2011E could boost realizations and offset lower volumes
CIL will likely increase its notified prices across all the grades in CY2011E to offset the nonexecutive
wage revision due in FY2012E. Management has indicated that the level of price
increase in FY2012E will be a function the of wage increase. We highlight that 10% higher
blended realization could add Rs84/share to our fair value estimate of CIL. The price hike
would also signal CIL’s ability to take price hikes to (1) narrow the gap between parity prices,
(2) offset cost escalations, and (3) compensate for lower volume growth.
Environmental hurdles – a risk to volumes and profitability
CIL’s continues to be plagued by environmental hurdles with the latest being
Comprehensive Environment Pollution Index (CEPI) that has resulted in management revising
downwards its production targets for FY2011E and FY2012E by 16 mn tons and 39 mn tons
respectively. Along with CEPI, the on going uncertainty over no-go mining areas and
possible imposition of mining tax continue to be a key risk for CIL’s volume growth and
profitability.
Comprehensive Environment Pollution Index (CEPI) - CEPI was introduced by Ministry
of Environment and Forest (MoEF) in 2009 to assess the environmental quality of industrial
clusters in India. In January 2010, MoEF imposed a temporary moratorium on development
projects in 43 clusters which also includes seven coalfields of CIL. The moratorium was put in
place till August 2010 but was further extended by MOEF (in October 2010) till March 2011
thus further delaying the award of environmental clearance for these projects. CEPI affected
clusters include seven coalfields of CIL including Chandrapur, Korba, Jharia, Talcher,
Singrauli, Raniganj and IB Valley. The directly affected CIL subsidiaries are ECL (Raniganj),
BCCL (Jharia), SECL (Korba), NCL (Singrauli) and MCL (Talcher and IB Valley). CIL’s coalfields
identified as critical under CEPI, contributed 295 mn tons or 68% of FY2010 production and
account for ~66% of CIL’s total extractable reserves of 21.75 bn tons (see Exhibit 4).
‘No go’ mining areas - Pursuant to a proposal dated July 8, 2010, MoEF introduced
initiatives for the identification of environmentally sensitive areas classified as ‘No-Go’ where
coal mining activities would not be permitted. ‘No-go' areas for mining have been defined
as those that have over 30 per cent gross forest cover or over 10 per cent weighted forest
cover. Several significant coal fields where CIL is currently carrying on mining activities have
been classified as ‘No-go’ including large mines such as North Karanpura in Jharkhand, Ib
Valley in Orissa and Chhattisgarh, Singrauli Coalfield in Madhya Pradesh and Uttar Pradesh
and Talcher coalfield in Orissa.
Mining tax – The imposition of mining tax (26% of mining profit) could erode 19% of CIL’s
FY2012E earnings in absence of a set-off against expenses on CSR already incurred by CIL.
The draft of Mines and Minerals (Development and Regulations) Act, 2010 imposes the
allotment of free shares equal to 26%, or an annuity equal to 26% of profit (post tax) in
favor of persons holding occupation or usufruct or traditional rights of the surface of the
land over which the mining lease has been granted.
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