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UBS Investment Research
Coal India
Upgrade to Buy post recent correction
„ Event: recent correction provides attractive risk-reward opportunity
We upgrade Coal India to Buy rating after the sharp correction of 16% in the past
one month (versus a 5% fall in the Nifty). This correction has been led by negative
newsflow on: 1) the proposed mining tax; 2) concerns about wage negotiations;
and 3) a production miss in H1. We believe that these concerns do not impact the
structural story ie: 1) strong domestic coal demand; 2) a virtual monopoly; 3) ASP
significantly lower than global prices—potential for price hikes; 4) low earnings
volatility; and 4) one of the lowest cost producers globally. Globally, thermal coal
prices have been flat over the past three months.
„ Impact: no changes to our estimates; H2 production could be higher
We forecast FY12/FY13 ASP of Rs1,344/1,400 and volumes of 452/473mt.
Though CIL missed its April-August production target of 163mt by 7% due to
heavy rains, it also sold inventory of c20mt during this period. It can increase
production in H2 post the monsoon. We have factored in an incremental wage
burden of US$1bn for FY12. Our worst-case earnings impact from the proposed
mining tax is c19% on PAT. However, there could be significant changes in the
bill before it is passed and there is no clarity on the timeline of its implementation
„ Action: upgrade to Buy, structural theme intact
We believe the recent correction outweighs the recent negative newsflow and the
structural story is very much intact.
„ Valuation: upgrade to Buy rating, maintain price target of Rs400
We continue to value CIL on 15x FY13E PE.
New mining tax bill
CIL corrected c16% in the past one month (while the Nifty was down 5%). A
large part of the correction (c10%) took place post the news of the Cabinet’s
approval of the MMDR bill (which was approved by the GoM headed by the
Finance Minister in July 2011)
As we had highlighted in our note, India Metals & Mining: Cabinet approves
draft mining bill, published on 3 October 2011, we estimate the worst-case
impact of the 26% mining tax could be a 19% cut in earnings. However,
practically –
— the draft MMDR bill could see significant changes when it reaches the
Parliamentary Standing Committee for further deliberations before being
introduced in Parliament for a vote.
— there is a possibility of the outflow due to the mining tax being treated as
an expense for tax accounting which could potentially reduce the worstcase 19% impact by one-third.
— Though our interactions with CIL management suggest that the social
expenditure CIL does every year will not be set off against the mining tax,
CIL has the flexibility to lower its social expenditure which was c20% of
PAT in FY10/FY11 as the purpose of its social expenditure largely
coincides with that of the 26% mining tax.
— CIl may pass on the burden due to the mining tax to its customers as it
does with certain state/centre imposed surcharge/cess.
— Increase prices by c5-6% to totally offset the worst-case impact of 19%
We believe most of the negative impact from the proposed mining tax is already
in the price.
Wage hike
Wage negotiations for CIL (due once every five years) are underway.
We have factored in an incremental wage bill of Rs45bn (US$1bn, +25% YoY)
for FY12, but no offsetting coal price increase. We believe a large part of the
potential incremental burden due to the wage hike is already in the price.
Production miss could be offset by inventory sale/higher
production in H2
As we highlighted in our note, Coal India: Missed YTD production target by
16mt, published on 21 September 2011, CIL missed the April-August
production target by 7% or c11mt (152mt versus 163mt target) due to heavy
rains. YTD (April – third week of September) it missed the production target by
16mt. We are approaching the end of the monsoon and we do not expect further
production target misses for the rest of the year. CIL has, however, liquidated
c20mt of its pithead inventory during this period (down from 70mt at the
beginning of April to 50mt by end-August).
Structural story intact…
The structural positives of CIL are intact and outweigh the recent concerns, in
our view:
(1) One of the world’s lowest costs of production (
favourable geological conditions
(2) A virtual monopoly in India in a highly constrained (sector regulated by
the government) and scarce resource
(3) Sells coal at a significant discount to international prices (hence room for
price hikes and margin expansion)
(4) Significant reserve base of c64 bn tonnes (proven + indicated+ inferred)
and 21.8bt of extractable reserves.
The recent price correction prices in most near-term negatives and provides an
attractive buying opportunity, in our view.
Limited correlation with global coal prices
Q Coal India sells c83% of its coal at a significant discount (c50%) to
international prices for comparable quality. However, it sells A & B grade
volumes (c6-7% of total sales volume) at international parity.
Q Additionally, it sells c11% of its volumes in e-auction. Given the significant
shortage of coal in the country, we do not expect e-auction prices to fall
significantly even if global coal prices decline.
Q Hence, we believe Coal India is at limited risk even if there is a correction in
global thermal coal prices
Thermal coal prices have remained strong
Q NewCastle (6300 GAR) thermal coal prices (FOB) have increased by 0%/3%
in the last 1 month/3 months to US$121.5/t currently
Q Indonesian Kalimantan (5900 GAR) thermal prices have increased by 1%/-
1% in the last one month/three months to US$102.5/t currently
Q Kalimantan (5000 GAR) thermal prices have increased by 1%/-2% in the
last one month/three months to US$81/t currently
Q Coal India’s average GCV is 4200 kcal.
Q 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.
Q 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 is
likely to impact earnings.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Coal India
Upgrade to Buy post recent correction
„ Event: recent correction provides attractive risk-reward opportunity
We upgrade Coal India to Buy rating after the sharp correction of 16% in the past
one month (versus a 5% fall in the Nifty). This correction has been led by negative
newsflow on: 1) the proposed mining tax; 2) concerns about wage negotiations;
and 3) a production miss in H1. We believe that these concerns do not impact the
structural story ie: 1) strong domestic coal demand; 2) a virtual monopoly; 3) ASP
significantly lower than global prices—potential for price hikes; 4) low earnings
volatility; and 4) one of the lowest cost producers globally. Globally, thermal coal
prices have been flat over the past three months.
„ Impact: no changes to our estimates; H2 production could be higher
We forecast FY12/FY13 ASP of Rs1,344/1,400 and volumes of 452/473mt.
Though CIL missed its April-August production target of 163mt by 7% due to
heavy rains, it also sold inventory of c20mt during this period. It can increase
production in H2 post the monsoon. We have factored in an incremental wage
burden of US$1bn for FY12. Our worst-case earnings impact from the proposed
mining tax is c19% on PAT. However, there could be significant changes in the
bill before it is passed and there is no clarity on the timeline of its implementation
„ Action: upgrade to Buy, structural theme intact
We believe the recent correction outweighs the recent negative newsflow and the
structural story is very much intact.
„ Valuation: upgrade to Buy rating, maintain price target of Rs400
We continue to value CIL on 15x FY13E PE.
New mining tax bill
CIL corrected c16% in the past one month (while the Nifty was down 5%). A
large part of the correction (c10%) took place post the news of the Cabinet’s
approval of the MMDR bill (which was approved by the GoM headed by the
Finance Minister in July 2011)
As we had highlighted in our note, India Metals & Mining: Cabinet approves
draft mining bill, published on 3 October 2011, we estimate the worst-case
impact of the 26% mining tax could be a 19% cut in earnings. However,
practically –
— the draft MMDR bill could see significant changes when it reaches the
Parliamentary Standing Committee for further deliberations before being
introduced in Parliament for a vote.
— there is a possibility of the outflow due to the mining tax being treated as
an expense for tax accounting which could potentially reduce the worstcase 19% impact by one-third.
— Though our interactions with CIL management suggest that the social
expenditure CIL does every year will not be set off against the mining tax,
CIL has the flexibility to lower its social expenditure which was c20% of
PAT in FY10/FY11 as the purpose of its social expenditure largely
coincides with that of the 26% mining tax.
— CIl may pass on the burden due to the mining tax to its customers as it
does with certain state/centre imposed surcharge/cess.
— Increase prices by c5-6% to totally offset the worst-case impact of 19%
We believe most of the negative impact from the proposed mining tax is already
in the price.
Wage hike
Wage negotiations for CIL (due once every five years) are underway.
We have factored in an incremental wage bill of Rs45bn (US$1bn, +25% YoY)
for FY12, but no offsetting coal price increase. We believe a large part of the
potential incremental burden due to the wage hike is already in the price.
Production miss could be offset by inventory sale/higher
production in H2
As we highlighted in our note, Coal India: Missed YTD production target by
16mt, published on 21 September 2011, CIL missed the April-August
production target by 7% or c11mt (152mt versus 163mt target) due to heavy
rains. YTD (April – third week of September) it missed the production target by
16mt. We are approaching the end of the monsoon and we do not expect further
production target misses for the rest of the year. CIL has, however, liquidated
c20mt of its pithead inventory during this period (down from 70mt at the
beginning of April to 50mt by end-August).
Structural story intact…
The structural positives of CIL are intact and outweigh the recent concerns, in
our view:
(1) One of the world’s lowest costs of production (
favourable geological conditions
(2) A virtual monopoly in India in a highly constrained (sector regulated by
the government) and scarce resource
(3) Sells coal at a significant discount to international prices (hence room for
price hikes and margin expansion)
(4) Significant reserve base of c64 bn tonnes (proven + indicated+ inferred)
and 21.8bt of extractable reserves.
The recent price correction prices in most near-term negatives and provides an
attractive buying opportunity, in our view.
Limited correlation with global coal prices
Q Coal India sells c83% of its coal at a significant discount (c50%) to
international prices for comparable quality. However, it sells A & B grade
volumes (c6-7% of total sales volume) at international parity.
Q Additionally, it sells c11% of its volumes in e-auction. Given the significant
shortage of coal in the country, we do not expect e-auction prices to fall
significantly even if global coal prices decline.
Q Hence, we believe Coal India is at limited risk even if there is a correction in
global thermal coal prices
Thermal coal prices have remained strong
Q NewCastle (6300 GAR) thermal coal prices (FOB) have increased by 0%/3%
in the last 1 month/3 months to US$121.5/t currently
Q Indonesian Kalimantan (5900 GAR) thermal prices have increased by 1%/-
1% in the last one month/three months to US$102.5/t currently
Q Kalimantan (5000 GAR) thermal prices have increased by 1%/-2% in the
last one month/three months to US$81/t currently
Q Coal India’s average GCV is 4200 kcal.
Q 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.
Q 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 is
likely to impact earnings.
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