Coal India :BoD gives nod for FSAs, not on price pooling:Nomura research

What’s new: CIL Board agrees on modifications to new FSAs…
Media reports (Financial Express, Business Line) and our interaction
with the Coal India (CIL) management suggest that CIL’s Board of
Directors (BoD), in its meeting on August 31, has agreed to the proposed
modifications in the new Fuel Supply Agreements (FSAs), wherein:
 The trigger level (minimum guaranteed supply) is pegged at 80% (65%
domestic, 15% imported) of annual contracted quantity (ACQ).
 If a consumer does not opt for receiving imported coal, the trigger level
would be restricted to 65% (i.e. committed supply of domestic coal).
 Penalty structure is graded (from 1.5% to 40%) depending upon the
supply shortfall below the trigger level (details in Figure 1).
 Amendments to the ‘force majeure clause’ have broadly been agreed
upon.
We understand that the modified FSA, including the Side Agreement for
terms & conditions of supply of imported coal (work-in-progress), is
expected to be formalized at the next Board meeting, expected in mid-
September.

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…but not on coal price pooling; imports on cost-plus basis for now
The CIL Board has asked management to provide a business model for
the coal price pooling mechanism (detailing aspects related to
implementation, including invoicing, taxation and applicability of discount
to imported coal prices) for its consideration. Until the pooling price
mechanism is formalized and adopted, supply of imported coal would be
on a cost-plus basis.
‘Side Agreement’ for supply of imported coal is being formulated
In its tender for appointment of a consultant to draft the ‘side agreement’,
wherein bids were to be submitted by last weekend, the scope of work
mentioned in the notice inviting bids contains potential insights into how
CIL would go about procuring and delivering imported coal under its
FSAs. Points to note –
 Imports shall be centrally done by Coal India
 Agency is to be appointed for both 1) importing coal and 2) delivering it
to the power generating company
 Purchaser to commit accepting imported coal at a price to be declared
by CIL, which would vary upon some parameters (quality/freight/origin)
 Purchaser would need to make full advance payment to CIL
 CIL’s commitment is to supply specified quantity and quality of coal at
the powerhouse end
 Comprehensive force majeure clause protecting CIL from vagaries of
import business


Implications: Neutral for CIL, issue of coal price pooling lingers on
In our view, the outcome of CIL’s Board meeting was on expected lines.
We maintain that 1) the graded penalty structure in the new FSAs is not
prohibitive and CIL could continue to earn incentives (on a net basis) by
supplying more than the ACQ in its pre-FY10 FSAs; and 2) the coal price
pooling mechanism, whenever adopted, would be revenue neutral for
CIL. However, we note that CIL would assume the 'delivery risk' of
imported coal from the port to the power project.
In addition to CIL Board’s decision to seek a detailed business model on
the pooling price mechanism and CIL management’s insistence on a
‘sign-off’ from all constituents (particularly beneficiaries) on the same,
our recent interaction with policymakers in the Ministry of Coal (MoC)
and Ministry of Power (MoP) suggests that adoption/implementation of a
coal price pooling mechanism would potentially take at least a few more
months (i.e. earliest by end 2012), in our view.
Maintain Buy; our FY13 earnings forecast appear fairly achievable
Our FY13 earnings forecast for CIL appears fairly achievable – we build
in off-take at 460mt (vs. 433mt in FY12 and CIL’s target of 470mt for
FY13) and blended realization at INR1,463/ton (1QFY13 realization was
INR1,460/ton). On our FY13F normalized earnings (which includes the
incidence of the potential 26% profit share via the mining tax), the stock
trades at 14.2x P/E and 7.4x EV/EBITDA.