Coal India Limited All Drivers Falling into Place: Remain Overweight :: Morgan Stanley Research

Solid progress on volume growth enhancement,
recent demonstration of improving pricing power,
and likelihood of further augmentation of cash keep
us positive on the stock. Our recent analysis of the
Indian coal industry has reinforced our stance here.
Estimate changes: 1) We lower our F14-F15 dispatch
estimates by 0.2% and 0.7% mainly due to trends seen
so far in FY14. We raise our dispatch forecast by 1.3%
for F16. 2) After the recent price hike we assume CIL
raises notified prices for the non-power sector by 12% in
4QF14. 3) We reduce washed coal sales volume by
19% and 24% for F14 and F15 due to delays in CIL’s
washery projects. 4) We now think mining tax is likely to
be applied as a percentage of royalties; previously we
assumed a percentage of PAT. This is one of the main
reasons for our EPS estimate increases of 3% and 8% in
F14 and F15. We introduce F16e EPS at Rs55.2.
Investment thesis
1) With some improvement in the clearance process
for brownfield expansions, CIL is on track to post
healthy production growth starting 2HF14. We
estimate a production CAGR of 6.8% in F13-F16.
2) Recently CIL raised FSA prices for the power sector
after a gap of almost three years. We expect this to
raise investor confidence in CIL’s ongoing ability to
lift prices. We expect average realizations to rise by
5.3% in F14 and 6.4% in F15.
3) F13 cash balance is US$11.4bn (33% of market
cap) and post-capex net cash generation is about
US$4.3bn in F14e. This should prompt CIL to
increase its dividend per share from Rs14 in F2013
to Rs25 in F14e, translating into yield of 8.4%.
F14E adjusted EV/EBITDA is 3.9x – the 39% discount to
global peers seems harsh. In our view, it ignores an
EBITDA CAGR of 25% for F13-16E, with low risk.

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Remain OW
 With about 45mt in expansion projects
lined up, we expect CIL to post healthy
production growth starting in F14. We
expect this to boost investor sentiment.
We estimate a production CAGR of
6.8% in F13-F16.
 After a gap of three years, CIL has
raised FSA prices for the power sector.
We expect this to increase investor
confidence in CIL’s ability to raise
prices. We expect average realizations
to increase by 5.3% in F14e and 6.4%
in F15e.
 F13 cash balance is US$11.4bn (33%
of market cap) and post-capex net cash
generation is ~US$4.3bn in F14e.
 We thus expect CIL to raise its
dividend per share of Rs10 in F2012
and Rs14 in F13 to Rs25.2 in F14e. An
F2014e dividend yield of 8.4% looks
attractive.
 F14E adjusted EV/EBITDA is 3.9x, a
39% discount to its global peer group.
We think investors are overly
pessimistic and are ignoring CIL’s low
exposure to global coal pricing,
sizeable mine reserves, large cash
pile, and EBITDA CAGR of 25% in
F13-16e.
Key Value Drivers
 Average price increase of 12% for the
non-power sector in 4QF13
 Sales mix moving up the value
chain: We expect market-linked sales
volume to rise to 25% in F16 from 23%
in F13.
 Production growth: We forecast a
6.8% CAGR in F13-16.
Risks
 CIL is unable to raise FSA prices over
the next 12-18 months.
 Production growth slips in the next 6-8
quarters.
 Mining tax is imposed at 26% of PAT

Why Our Forecasts Have Changed
Prices: Our average realizations for CIL change by -0.4% and
0.1% to Rs1,550/t and Rs1650/t for F14 and F15, respectively.
This is because we now expect CIL to raise notified coal prices
(FSA) by 12% in 4QF14 for the non-power sector.
Volumes: We decrease our production and sales volume
estimates marginally for F14 and F15, largely to bring them in
line with CIL management’s targets and the trends witnessed
so far in FY14
CIL has 45-50 mt in brownfield projects slated to be
commissioned over the next 12-18 months which gives us
confidence in its ongoing ability to deliver production growth.
Our production estimates change by -1.1% and -0.4% for
F2014-15, respectively, based on the above while our dispatch
estimates fall marginally by 0.2% and 0.7%.
Our other income has increased by 3.8bn and 8.7bn due to
higher cash balance.
In addition, we now assume that the new minerals tax will be
postponed to September 2014 instead of September 2013.
More importantly, we now assume that this tax will be linked to
royalties, which means that CIL can pass this through to its
customers as it does for all other taxes and levies. Previously,
we assumed that this tax would be linked to PAT, which would
have made it difficult for CIL to pass on to customers.
Our stance change on this has been necessitated by
1) Continued deliberation and hence delay of the proposed
new mining bill, and
2) Our fresh assessment after talking to industry participants,
who indicated that in the new proposals coal will be treated
on par with other minerals and hence will be taxed as a
percentage of royalties and not PAT.
Though our price and volume forecasts have fallen slightly for
F14 and F15, we now have higher confidence in our forecasts,
especially having analyzed the Indian coal market in detail

Valuation and Price Target
We increase our price target from Rs381 to Rs413
At current price levels, CIL trades at EV/EBITDA of 3.9x
(adjusted) based on our F14 estimates. We find this unjustified
given CIL’s robust long-term positives and EBITDA CAGR of
25% from F2013-16e.
Our price target is derived based on 75%, 20%, and 5%
weightings on our base, bear, and bull cases, respectively.
These weightings are unchanged. Our 5% bull weighting
reflects the possibility that the government imposes no pricing
restrictions on CIL. We maintain a 20% weighting for our bear
case to reflect our view that CIL sells about 23% of its output at
prices that are somewhat linked to global prices, so it is
exposed to a drop in global coal prices to that extent. Also the
risk that a mining tax at 26% of PAT is imposed on CIL is
included our bear case.
Our base, bear and bull cases are derived from a two-phase
DCF model with an explicit phase of five years and a terminal
growth rate of 3%. We derive a WACC of 13.0% for the
company, with a risk-free rate of 7.9% (10-year government
bond yield) and a market-risk premium of 6.5%, in line with the
recommendations of our regional strategy team. These
assumptions are unchanged.
Our bull and base case values increase by 9% each, mainly
reflecting our assumption that the mining tax will be linked to
royalties, which means that CIL can pass this through to its
customers. In our bear case (scenario value up just 5%), we
assume that the mining Tax will be levied at 26% of PAT.