Coal India: FSAs will be inked, with a 'penalty' of 0.01% :: Kotak Securities PDF link

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Coal India (COAL)
Metals & Mining
FSAs will be inked, with a ‘penalty’ of 0.01%. As per media reports, the board of
Coal India (CIL) has agreed to sign fuel supply agreements (FSAs) at 80% commitment,
though with a meager penalty of 0.01% (with no penalty in the first three years) of the
value of shortfall. As we highlighted previously, an insufficient penalty clause reduces
the efficacy of an FSA, making it lopsided in favor of CIL. We maintain our positive
stance on CIL and believe the board decision will augur well for investor sentiment
clouded by uncertainty surrounding committed fuel supply agreements.
FSAs with low penalties reduce their efficacy
According to media reports, the board of CIL has agreed to sign fuel supply agreements at 80%
commitment levels, though with a penalty clause of 0.01% (Rs0.12/ton). The penalty will be
applicable after three years with no penalty for the first three years. As we highlighted previously,
fixing of low to no penalties reduces the efficacy of an FSA, given the current demand-supply gap,
and has little or no bearing on CIL’s earnings. In our view, the move to reduce penalties will
significantly improve investor sentiment and partly address concerns raised by minority
shareholders.
Watch out for revaluation of gratuities and other retirement-linked benefits in 4QFY12
We expect a sharp one-off spike in employee costs, driven by realignment of actuarial liabilities
following the conclusion of wage negotiations in January 2012. We note that the revised wage
structure implies an effective revision of 30-32% for the non-executive category, translating into
~Rs60 bn of recurring incremental annual wage bills. We however factor an incremental Rs11 bn
(over and above the recurring impact of wage revisions) to account for (1) potential impact of
realignment of actuarial liabilities and (2) under provision in 9MFY12. We note that last wage
revisions (in FY2009) entailed an impact of Rs31 bn due to actuarial liabilities (see Exhibit 3).
Clarity on FSAs will significantly improve sentiment, maintain ADD
We maintain our ADD rating with a target price of Rs380. In our view, addressing emerging clarity
on FSAs will help to clear uncertainty over its potential financial implications, reducing the risk
perception of earnings. Our target price is based on 11X FY2013E EPS adjusted for overburden
removal and interest income and implies an EV/EBITDA of 7.7X on FY2013E EBITDA (adjusted for
overburden removal). We will review our estimates after clarity emerges on the impact of wage
revision and change in pricing structure.