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Reiterate buy with target price of INR450
Looking at the 1QFY12 PAT at 64% YoY much above our and consensus estimates
and management confidence post the results explaining that, barring seasonal
issues, the company is well on course to meet its performance targets for FY12
(as well as its production targets for FY17), we came out of the meeting quite
positive and feeling reassured on initiatives for protecting shareholders’ interests.
Our revised estimates – down 7% for FY12E and up 1% for FY13E – factor in
some cushioning for upcoming wage negotiations in FY12E. Buy.
A strong Q1 performance driven by inventory draw-down
With continued partial stoppage of iron ore exports from Karnataka, the railway
rake availability was up 13% YoY and led to a 5.3% YoY jump in off-take, largely
from inventory draw-down. Coupled with a price jump of 20% YoY, at INR145bn
the top line was 2% ahead of expectations. The cost increase at cash levels up
7% YoY was also a shade lower than our expectations while net income was up
64% YoY at INR 41.4bn.
A lot of initiatives taken to protect shareholders’ interests
Apart from standing up to the planning commission proposal to import coal and
distribute at subsidized rates (at cost of higher normative prices), the company has
also communicated to the Ministry of Power that stoppage of e-auction coal
would not increase coal availability for the power sector. Also, should wage
negotiations result in a margin drop, the company would seek a price hike at the
end of year. In the long run, the mining tax could accelerate the land acquisition
process and be earnings accretive.
A follow-on offering in prospect?
Looking at the management’s business outlook and the fact that the stock is the
2nd highest in market capitalization in India today, we would not be surprised if the
government decides to go for an FPO in the 2nd half. Our valuation matrix remains
the same with a 12M target price at INR450 based on an average of life of mine
DCF and exit P/E of 18. Key downside risks are volume risk and mining tax.
Valuation and risks
Valuations
We use an average of the values derived using life-of-mine DCF and P/E of 18x FY12E to
arrive at our target price of INR450 (rounded off). In the life-of-mine DCF methodology, we
value the currently-stated extractable coal reserves of 22.3bn ton, yielding a value of
INR479/share. This excludes any potential upside from conversion of the company's
remaining c.30.1bn tons of proven reserves into extractable reserves. We assume volume
growth of 3% until FY17 and then assume volume growth of 4% until extractable reserves
become zero. We assume constant prices post FY17 and rising costs, implying diminishing
profitability. We assume a discount rate of 12.3% (beta of 0.8, a risk-free rate of 8.1% and an
equity risk premium of 5.3%). In the P/E methodology we assume an exit P/E of 18x FY12E
(vs. 16x earlier), as we believe the valuation paid for Indonesian coal mines by Indian
developers and the upcoming auction of captive mines within India warrant a premium for
Coal India's operating assets which have among the lowest cost structures. However, this
multiple is at a modest premium to international peers. We believe the premium is justified
largely on account of understated profits at CIL, a strong balance sheet with ~USD9.5bn of
net cash, and also because CIL works with negative operating assets, which results in very
high returns. Furthermore, we estimate earnings CAGR for FY11E-13E of c.26%, implying a
PEG of lower than 1, which looks reasonable.
Continues to be expensive on headline P/E and EV/EBITDA basis
Coal India’s earnings are understated to an extent of 20-29% as under Indian accounting
standards CIL charges INR20-30bn annually as additional overburden removal charges.
According to management, under the IFRS accounting standards, these charges cannot be
provided, resulting in net profit for the company being understated. Historically, we estimate
that the understatement has been to the extent of 20-29% over the past few years. Also,
thanks to high shortages of coal in the country, there is a reasonable chance that net working
capital would fall – read rising customer advances which would also drive up cash earnings –
but are not reflected in earnings.
Please see next page for global peer valuation table
Risks
Key downside risks are lower-than-expected production growth due to delays in
environmental clearance, higher-than-expected operating costs and the profit-sharing
provisions in the proposed new 'Mining Bill' leading to earnings dips (depending on when
and how the act is implemented). Our sensitivity analysis shows that if the sales volume for
FY12 is 2% lower than expected, then FY12 EPS could fall by 4%. Diversion of e-auction coal
to the power sector with a regulated price increase of less than 4% could have a negative
impact on earnings. In the event the proposed mining bill is imposed and in the adverse
scenario of the government not allowing any price hike, Coal India’s FY12E profit could be
reduced by c40%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reiterate buy with target price of INR450
Looking at the 1QFY12 PAT at 64% YoY much above our and consensus estimates
and management confidence post the results explaining that, barring seasonal
issues, the company is well on course to meet its performance targets for FY12
(as well as its production targets for FY17), we came out of the meeting quite
positive and feeling reassured on initiatives for protecting shareholders’ interests.
Our revised estimates – down 7% for FY12E and up 1% for FY13E – factor in
some cushioning for upcoming wage negotiations in FY12E. Buy.
A strong Q1 performance driven by inventory draw-down
With continued partial stoppage of iron ore exports from Karnataka, the railway
rake availability was up 13% YoY and led to a 5.3% YoY jump in off-take, largely
from inventory draw-down. Coupled with a price jump of 20% YoY, at INR145bn
the top line was 2% ahead of expectations. The cost increase at cash levels up
7% YoY was also a shade lower than our expectations while net income was up
64% YoY at INR 41.4bn.
A lot of initiatives taken to protect shareholders’ interests
Apart from standing up to the planning commission proposal to import coal and
distribute at subsidized rates (at cost of higher normative prices), the company has
also communicated to the Ministry of Power that stoppage of e-auction coal
would not increase coal availability for the power sector. Also, should wage
negotiations result in a margin drop, the company would seek a price hike at the
end of year. In the long run, the mining tax could accelerate the land acquisition
process and be earnings accretive.
A follow-on offering in prospect?
Looking at the management’s business outlook and the fact that the stock is the
2nd highest in market capitalization in India today, we would not be surprised if the
government decides to go for an FPO in the 2nd half. Our valuation matrix remains
the same with a 12M target price at INR450 based on an average of life of mine
DCF and exit P/E of 18. Key downside risks are volume risk and mining tax.
Valuation and risks
Valuations
We use an average of the values derived using life-of-mine DCF and P/E of 18x FY12E to
arrive at our target price of INR450 (rounded off). In the life-of-mine DCF methodology, we
value the currently-stated extractable coal reserves of 22.3bn ton, yielding a value of
INR479/share. This excludes any potential upside from conversion of the company's
remaining c.30.1bn tons of proven reserves into extractable reserves. We assume volume
growth of 3% until FY17 and then assume volume growth of 4% until extractable reserves
become zero. We assume constant prices post FY17 and rising costs, implying diminishing
profitability. We assume a discount rate of 12.3% (beta of 0.8, a risk-free rate of 8.1% and an
equity risk premium of 5.3%). In the P/E methodology we assume an exit P/E of 18x FY12E
(vs. 16x earlier), as we believe the valuation paid for Indonesian coal mines by Indian
developers and the upcoming auction of captive mines within India warrant a premium for
Coal India's operating assets which have among the lowest cost structures. However, this
multiple is at a modest premium to international peers. We believe the premium is justified
largely on account of understated profits at CIL, a strong balance sheet with ~USD9.5bn of
net cash, and also because CIL works with negative operating assets, which results in very
high returns. Furthermore, we estimate earnings CAGR for FY11E-13E of c.26%, implying a
PEG of lower than 1, which looks reasonable.
Continues to be expensive on headline P/E and EV/EBITDA basis
Coal India’s earnings are understated to an extent of 20-29% as under Indian accounting
standards CIL charges INR20-30bn annually as additional overburden removal charges.
According to management, under the IFRS accounting standards, these charges cannot be
provided, resulting in net profit for the company being understated. Historically, we estimate
that the understatement has been to the extent of 20-29% over the past few years. Also,
thanks to high shortages of coal in the country, there is a reasonable chance that net working
capital would fall – read rising customer advances which would also drive up cash earnings –
but are not reflected in earnings.
Please see next page for global peer valuation table
Risks
Key downside risks are lower-than-expected production growth due to delays in
environmental clearance, higher-than-expected operating costs and the profit-sharing
provisions in the proposed new 'Mining Bill' leading to earnings dips (depending on when
and how the act is implemented). Our sensitivity analysis shows that if the sales volume for
FY12 is 2% lower than expected, then FY12 EPS could fall by 4%. Diversion of e-auction coal
to the power sector with a regulated price increase of less than 4% could have a negative
impact on earnings. In the event the proposed mining bill is imposed and in the adverse
scenario of the government not allowing any price hike, Coal India’s FY12E profit could be
reduced by c40%.
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