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Coal India (COAL)
Metals & Mining
Air of uncertainty. Media reports on Government’s proposal to meet its disinvestment
targets through cross-holdings among PSUs is yet another addition to Coal India’s (CIL)
list of uncertainties ranging from mining tax to ongoing wage negotiations. We,
however, base our investment thesis on a sustained earnings growth (16% CAGR)
driven by modest volume and price increase coupled with benefits of gradual reduction
in employee headcount. Maintain our ADD rating with a revised PT of Rs380 (from
Rs420) to factor the risk of unknowns.
Stock price factoring a fairly pessimistic scenario, potential upside in store
CIL stock has corrected by 23% in the past three months weighed by investor concerns pertaining
to (1) potential impact of mining tax as and when it becomes applicable, (2) impact of nonexecutive
wage revisions due in FY2012E, (3) potential miss on volume guidance, (4) potential
diversion of e-auction sales to power sector and (5) proposal of cross-holding among PSUs to meet
Government’s divestment targets for FY2012E.
Although these concerns are valid and could weigh on sentiment in the near term, it presents an
opportunity at the CMP that seems to factor a stress-case scenario of low volumes, reduction in
e-auction sale higher wage cost and full impact of the mining tax. In our view, the potential
earnings impact could be muted (in cases such as mining tax and wage revision) or the events less
likely to pan out (diversion of e-auction sales), and we discuss each of them in detail in the
subsequent section.
Pricing remains buoyant, demand intact, wage cost contained
CIL’s realizations have improved 23% yoy, employee attrition maintained at 5% per annum
although dispatch growth has been at the receiving end of environmental concerns and lower rake
availability. Our investment thesis on CIL is based on modest volume and price increase, coupled
with benefits of a contained cost of production due to gradual reduction in employee headcount,
ensuring a steady expansion of margins coupled with sustainable earnings growth (16% CAGR)
without assuming aggressive growth in volumes (3.6% CAGR) or pricing (6% CAGR).
Maintain ADD with revised target price of Rs380/share
We maintain our ADD rating with a revised target price of Rs380/share, as we factor a lower
multiple (11X versus 12X previously) to factor risk of unknowns such as (1) potential impact of
mining tax and (2) continued uncertainty over wage revisions. Our target price is based on 11X
FY2013E EPS adjusted for overburden removal and interest income and implies an EV/EBITDA of
7.5X on FY2013E EBITDA (adjusted for overburden removal).
Disinvestment target—utilization Rs150 bn towards buyback and investments
As per media reports, CIL has offered to invest ~Rs150 bn (Rs24/share) through a
combination of buyback and/or investments in order to help the government to meet its
disinvestment targets. From an investor’s perspective, while purchase of other state-owned
entities remains a less-preferred option, a similar exercise undertaken in the late 1990s did
not erode shareholder value for the investors.
Ban on e-auction—power sector bid for only 5% of quantity allocated
Out of 4 mn tons of coal offered to the power sector, ~0.2 mn tons was bid for by the
power sector in the month of October. In our view, this will likely put to rest the demand
from the power sector for ban of e-auction sales to meet the requirements of the power
sector, and re-affirms our view that a ban on e-auction may further aggravate, rather than
ease the coal deficit.
Mining tax—3% increase in coal prices can absorb the impact of mining tax
A price increase of ~3.5% (assuming tax deductibility) will suffice to compensate the
incidence of the mining tax, as and when it is passed by the parliament. The power sector
(at large) has not seen in increase in prices of coal since October 2009 and our earnings
currently do factor any revision in prices of notified coal. We note that the full EPS impact of
mining tax without a price increase is ~13% on FY2013E assuming tax deductibility of the
contribution. Exhibit 2 below highlights the potential impact of mining tax on fair value and
FY2013E EPS. Also refer our note dated October 3, 2011 – ’Mining Bill moves ahead’.
Wage revisions—CIL has provided for a 17% increase in wage cost
Employee cost for 2QFY12 increased to Rs56.9 bn (24% yoy, 17% qoq) lending some
credence to a contained wage revision in the ongoing negotiation process. We further
highlight that welfare expenses (earlier classified as social overheads) have been significantly
reduced to Rs3.4 bn (-53% yoy, 15% qoq)—a trend seen over the last two quarters.
Media articles had previously highlighted demands of various trade unions of CIL, asking for
an increase of 100-500% in the basic wage—which translates into a less exaggerated 32%
increase in non-executive wages (excluding gratuity and other benefits).
We note that the demand for revision in basic wages should be seen in conjunction with the
reset of inflation-linked dearness allowance which currently stands at ~50% of basic wages
(see Exhibit 3). We further highlight that since the revision is restricted to non-executive
category (accounting for ~75% of total employee cost), the overall impact would be further
muted. Refer our note dated August 30, 2011 titled ’Vagaries of labor negotiations‘. We
factor a 27% increase in average wages in FY2012E on account of the revision, compared to
the 17% increase in wage bill provided for during the quarter.
Despatch growth—environmental hurdles are easing, we factor modest growth
Coal production has been impacted due to excessive rains and flooding of mines and has
raised concerns on CIL not being able to meet its volume guidance for FY2012E. We
currently factor volumes of 440 mn tons in FY2012E and note that 5% lower volumes in
FY2012E could impact our FY2012E EPS by ~10%. We also present below sensitivity of our
fair value estimate to FY2013E volumes (see Exhibit 4).
Further, few positive developments on the environmental front such as (1) Ministry of
Environment and Forest’s (MOEF) agreement to revoke the extant ’go-no go‘ categorization
of coal mining regions in the country in wake of BK Chaturvedi committee report, (2) lifting
of CEPI moratorium from selected clusters allowing CIL to proceed with development
projects and above all (3) a general recognition amongst policymakers about the gravity of
the situation and urgent need to ramp up domestic production (heightened further by the
recent coal shortage) makes us hopeful of CIL gradually ramping up its production going
into FY2013E.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Coal India (COAL)
Metals & Mining
Air of uncertainty. Media reports on Government’s proposal to meet its disinvestment
targets through cross-holdings among PSUs is yet another addition to Coal India’s (CIL)
list of uncertainties ranging from mining tax to ongoing wage negotiations. We,
however, base our investment thesis on a sustained earnings growth (16% CAGR)
driven by modest volume and price increase coupled with benefits of gradual reduction
in employee headcount. Maintain our ADD rating with a revised PT of Rs380 (from
Rs420) to factor the risk of unknowns.
Stock price factoring a fairly pessimistic scenario, potential upside in store
CIL stock has corrected by 23% in the past three months weighed by investor concerns pertaining
to (1) potential impact of mining tax as and when it becomes applicable, (2) impact of nonexecutive
wage revisions due in FY2012E, (3) potential miss on volume guidance, (4) potential
diversion of e-auction sales to power sector and (5) proposal of cross-holding among PSUs to meet
Government’s divestment targets for FY2012E.
Although these concerns are valid and could weigh on sentiment in the near term, it presents an
opportunity at the CMP that seems to factor a stress-case scenario of low volumes, reduction in
e-auction sale higher wage cost and full impact of the mining tax. In our view, the potential
earnings impact could be muted (in cases such as mining tax and wage revision) or the events less
likely to pan out (diversion of e-auction sales), and we discuss each of them in detail in the
subsequent section.
Pricing remains buoyant, demand intact, wage cost contained
CIL’s realizations have improved 23% yoy, employee attrition maintained at 5% per annum
although dispatch growth has been at the receiving end of environmental concerns and lower rake
availability. Our investment thesis on CIL is based on modest volume and price increase, coupled
with benefits of a contained cost of production due to gradual reduction in employee headcount,
ensuring a steady expansion of margins coupled with sustainable earnings growth (16% CAGR)
without assuming aggressive growth in volumes (3.6% CAGR) or pricing (6% CAGR).
Maintain ADD with revised target price of Rs380/share
We maintain our ADD rating with a revised target price of Rs380/share, as we factor a lower
multiple (11X versus 12X previously) to factor risk of unknowns such as (1) potential impact of
mining tax and (2) continued uncertainty over wage revisions. Our target price is based on 11X
FY2013E EPS adjusted for overburden removal and interest income and implies an EV/EBITDA of
7.5X on FY2013E EBITDA (adjusted for overburden removal).
Disinvestment target—utilization Rs150 bn towards buyback and investments
As per media reports, CIL has offered to invest ~Rs150 bn (Rs24/share) through a
combination of buyback and/or investments in order to help the government to meet its
disinvestment targets. From an investor’s perspective, while purchase of other state-owned
entities remains a less-preferred option, a similar exercise undertaken in the late 1990s did
not erode shareholder value for the investors.
Ban on e-auction—power sector bid for only 5% of quantity allocated
Out of 4 mn tons of coal offered to the power sector, ~0.2 mn tons was bid for by the
power sector in the month of October. In our view, this will likely put to rest the demand
from the power sector for ban of e-auction sales to meet the requirements of the power
sector, and re-affirms our view that a ban on e-auction may further aggravate, rather than
ease the coal deficit.
Mining tax—3% increase in coal prices can absorb the impact of mining tax
A price increase of ~3.5% (assuming tax deductibility) will suffice to compensate the
incidence of the mining tax, as and when it is passed by the parliament. The power sector
(at large) has not seen in increase in prices of coal since October 2009 and our earnings
currently do factor any revision in prices of notified coal. We note that the full EPS impact of
mining tax without a price increase is ~13% on FY2013E assuming tax deductibility of the
contribution. Exhibit 2 below highlights the potential impact of mining tax on fair value and
FY2013E EPS. Also refer our note dated October 3, 2011 – ’Mining Bill moves ahead’.
Wage revisions—CIL has provided for a 17% increase in wage cost
Employee cost for 2QFY12 increased to Rs56.9 bn (24% yoy, 17% qoq) lending some
credence to a contained wage revision in the ongoing negotiation process. We further
highlight that welfare expenses (earlier classified as social overheads) have been significantly
reduced to Rs3.4 bn (-53% yoy, 15% qoq)—a trend seen over the last two quarters.
Media articles had previously highlighted demands of various trade unions of CIL, asking for
an increase of 100-500% in the basic wage—which translates into a less exaggerated 32%
increase in non-executive wages (excluding gratuity and other benefits).
We note that the demand for revision in basic wages should be seen in conjunction with the
reset of inflation-linked dearness allowance which currently stands at ~50% of basic wages
(see Exhibit 3). We further highlight that since the revision is restricted to non-executive
category (accounting for ~75% of total employee cost), the overall impact would be further
muted. Refer our note dated August 30, 2011 titled ’Vagaries of labor negotiations‘. We
factor a 27% increase in average wages in FY2012E on account of the revision, compared to
the 17% increase in wage bill provided for during the quarter.
Despatch growth—environmental hurdles are easing, we factor modest growth
Coal production has been impacted due to excessive rains and flooding of mines and has
raised concerns on CIL not being able to meet its volume guidance for FY2012E. We
currently factor volumes of 440 mn tons in FY2012E and note that 5% lower volumes in
FY2012E could impact our FY2012E EPS by ~10%. We also present below sensitivity of our
fair value estimate to FY2013E volumes (see Exhibit 4).
Further, few positive developments on the environmental front such as (1) Ministry of
Environment and Forest’s (MOEF) agreement to revoke the extant ’go-no go‘ categorization
of coal mining regions in the country in wake of BK Chaturvedi committee report, (2) lifting
of CEPI moratorium from selected clusters allowing CIL to proceed with development
projects and above all (3) a general recognition amongst policymakers about the gravity of
the situation and urgent need to ramp up domestic production (heightened further by the
recent coal shortage) makes us hopeful of CIL gradually ramping up its production going
into FY2013E.
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