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UBS Investment Research
Coal India
D owngrade—no significant catalysts ahead
Event: no major catalysts; mining tax policy uncertainty an overhang
YTD Coal India (CIL) has been one of the best performers on the MSCI India/S&P
CNX Nifty (outperformance of 25%/26%). Incrementally, we do not expect
significant positive developments over the next 6-12 months, especially on coal
price increases/coal volumes. The recent mining tax bill has created uncertainty
about the potential earnings impact on Coal India (see India Metals and Mining:
GoM approves draft mining tax bill, published 11 July 2011).
Impact: no material change in operating estimates; adjust ‘OBR charges’
We maintain our volume/ASP estimates for FY12/13 (details below). We remove
‘overburden removal’ (non cash provision in P&L) from our FY12 assumptions
(based on recent management guidance); this increases our FY12/13 EPS estimates
c14%/12%. However, we also increase our operating cost estimates due to high
inflation (largely employee expenses in FY13). We therefore increase our FY12/13
EPS estimates 6%/1%. There could be downside risk to earnings due to the
proposed new mining tax policy.
Action: downgrade to Neutral after 25% outperformance; cut PT to Rs400
We downgrade our rating from Buy to Neutral (after a 25% outperformance YTD)
and cut our price target to Rs400.00 (from Rs435.00) as we believe it will difficult
for CIL to: 1) exceed its volume guidance; and 2) raise prices before completing
wage negotiations. Uncertainty on the mining bill (CSR setoffs/price increases)
will also remain an overhang.
Valuation: lowering target multiple to factor in increasing uncertainty
We continue to value CIL on FY13E EPS but we lower our valuation multiple
from 16.5x (in line with our valuation multiple of China Shenhua) to 15x due to
removal of OBR provisions and the mining bill overhang.
Highlights (Rsm) 03/09 03/10 03/11E
No major positive catalysts
ahead
Upside to volume guidance looks difficult: CIL has been citing railway
wagon availability as a key issue hindering volume growth. We need to see
meaningful and sustained improvement in wagon availability before
increasing our volume assumptions. Historically, CIL has disappointed on
volume guidance.
Higher than expected wage hike/no accompanying price hike: Wage
negotiations for CIL (due once every five years) are expected to begin in July
2011—CIL will make wage provisions from Q1 FY12.
— We have factored in an incremental wage bill of Rs45bn (US$1bn, +25%
YoY) for FY12, but no offsetting coal price increase.
— In addition, wage negotiations may take time (the last wage negotiations
started in early 2007 and took about 2.5 years —CIL was able to raise
coal prices only after the full negotiations were complete).
Mining tax an overhang: According to media reports, the GoM has
approved the mining tax bill (please refer to our note India Metals and
Mining: GoM approves draft mining bill, dated 11 July 2011) which
proposes a 26% tax on PAT for coal mining.
— There is still no clarity on whether CIL will be allowed to set off the CSR
expenses (in FY10/11 the company spent c20% of PAT on CSR) against
this 26% profit share proposal.
— Management has been saying since the IPO that it would be able to
increase prices to offset any negative impact due to an additional mining
tax. We estimate an across the board price increase of 6-7% in FY12/13
would be sufficient to offset the potential 26% tax on PAT.
— In the worst case, if we assume CIL is not allowed any CSR setoffs and if
coal prices are not allowed to be increased, then we estimate the impact
on PAT could be -26%/-26% for FY12/13.
YTD outperformance: Coal India has been one of the best performing
stocks in India YTD, outperforming the S&P CNX Nifty/MSCI India by
26%/25%.
Valuation
We previously valued Coal India at 16.5x FY13E EPS to arrive at our price
target of Rs435.00. Our target PE multiple is broadly in line with the UBS target
multiple for China Shenhua Energy, Coal India’s largest regional peer.
We believed this was conservative, as: 1) Coal India’s accounting practices were
more conservative than peers (for example, it accounted for overburden
provision in its P&L: Rs31bn 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, for FY12/13 UBS
estimates Shenhua’s ROE at 15%/14% compared with 38%/34% for Coal India.
Some of the strong fundamentals that warranted a rich PE multiple for Coal
India are now being outweighed by concerns (mining bill uncertainty, rake
availability) discussed above. In addition, CIL is returning to normal accounting
policy from a conservative one (with regard to overburden expenses). Hence we
now believe Coal India deserves a 10% lower PE multiple, at 15x FY13E
earnings.
Table 1: Price target derivation
Valuation
EPS - March 2013 (Rs/share) 26.76
PE multiple 15.00
Target price - (Rs/share) 401*
* Rounded off to Rs400.
Source: UBS estimates
Coal India
Coal India is the largest coal company in the world (primarily thermal coal). The
government owns 90% of the company. It sells its entire output (415Mt in
FY10) in the domestic market. Coal India sells coal at a significant discount (55-
60%) to international coal prices.
Statement of Risk
Coal India is a public sector enterprise and hence may not be able to raise coal
prices in line with input costs (given inflation concerns) negatively impacting
earnings. Coal India is expanding capacity significantly; any delay in capacity.
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