Coal India- How bad can it get? Macquarie Research,

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Coal India
How bad can it get?
Event
 Diverting e-auction coal to power: As per press reports, the Coal Ministry
has announced that they will divert the October e-auction coal quota (about
4mt) to power companies in light of shortages. This coal will be supplied to
them at FSA prices as against the e-auction prices which were at an 80%
premium.
 This will impact Coal India's profits for October, though the company expects
to increase the e-auction quota after October and end at 10%+ for the whole
year. However, this is more negative for companies which source coal from eauction
currently and they could be hit by lack of supply in the near term.
Impact
 Production ramp up remains a concern: The Ministry of Coal, Ministry of
Power and Coal India called an emergency meeting yesterday to address the
concerns over a shortage of coal production. The company's production was
flat for FY11 after growing between 5-7% for the past 7 years due to delays in
environmental clearances and unavailability of rail rakes for despatches. This
situation was exacerbated by the Telangna stir, which stopped coal transport
in Andhra Pradesh and has resulted in a crunch for power producers.
 Agreement is biased towards power: The current agreement releases only
4mt, which is the October quota to power producers at FSA prices. However,
our concern is that if the company is unable to increase production and
despatches, this might set a precedent and impact Coal India's profitability in
the long run. A total shift of e-auction volume to FSA linked prices would have
an impact of 22% on Coal India's FY12E profits by our estimates.
 E-auction dependent companies also impacted: Various cement
producers, sponge iron producers and aluminium producers which depend on
eauction coal will also be impacted. Most impacted will be cement companies
which source 35-40% from eauction; aluminium producers like Hindalco (35%
for domestic), Nalco (40%) and Sterlite Energy (55%) could also see some
impact.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs388.00 based on a DCF methodology.
 Catalyst: Strike by workers on Oct 18-19
Action and recommendation
 Maintain Neutral, could see more downside: Coal India has corrected
sharply in the past few days. We believe there could be more negative news:
(a) production targets miss (b) strike by workers on October 18-19 and (c)
impending wage negotiations which would put the stock under pressure. We
maintain our target price and rating and would wait for a better entry point.