Coal India: Buy :: Business Line

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Coal India may be on the cusp of big growth, thanks to the Government’s backing

There are instances when investor’s macro bet on a stock does not play out. The case of Coal India (CIL) is one such. The company is a monopoly in the coal sector and demand grew at an average of 5 per cent per year during 2010-2014. Yet, the company managed to grow its output only by 2 per cent, was embroiled in quality disputes with its power plant customers and ranks low on productivity.

The stock has dropped from a high of over ₹400 reached in June 2014 and faces near-term volatility due to the planned stake sale by the Government. But investors with a long-term perspective can use these dips to buy, as many of CIL’s long standing issues are likely to be sorted out.

The company’s problems are well understood by the stakeholders; the recent initiatives from the Government and expected regulatory changes bode well. CIL’s core strengths of ample coal reserves, supply dominance, large cash reserves and robust operating margin of over 20 per cent continue to lend support. A generous dividend policy — ₹33.3 per share in 2013-14 including a special dividend, (current dividend yield of over 9 per cent) adds to the stock’s attraction. With ₹52,300 crore in cash on its books as of March 2014, dividend payouts, which averaged 3 per cent in the past, should remain healthy. At ₹356, CIL trades at 15 times its trailing 12-month earnings.

This is in line with its three-year historical band of 14-16 times. CIL’s output is expected to get a leg-up in the next three-five years. This, along with rational price hikes, could sustain earnings growth of 10 per cent per year in the long term.

Fuelling growth

CIL’s production is expected to double by 2019-20 with planned green-field and brown-field expansions and operational improvements. So far, the company faced procedural bottlenecks in ramping production.

As of August 2014, environmental clearances for 48 projects, totalling 109 million tonnes per annum (mta), were pending. But now with the Government planning to expedite clearances, a ramp up in production seems achievable.

Production will also be boosted once CIL is allocated a few of the coal blocks by the Government. Many of these mines are ready or close to starting production, adding to output.

Additionally, the company is planning to enhance underground mining with the twin benefit of quick production ramp up without land acquisition delays and higher grade output that should boost realisations.

But one issue with underground mining is that CIL achieves a very low output — 0.76 tonnes per person during an eight hour shift now.

This compares unfavourably with the 12 tonnes produced in its open cast mines and the 40 tonnes produced in underground collieries in Australia.

The poor productivity is due to lack of equipment . However, solutions are being put in place; Western Coalfields, a subsidiary of CIL, expects a 10 per cent increase in output with better equipment.

Besides local mines, CIL is also expanding in Mozambique, Africa to increase higher grade coal output. Coal India Africana expects to start operations within a year. Also, the company is a partner in the public sector joint venture, ICVL, that bought Rio Tinto’s production-ready coal assets in Mozambique.

In the past, the company's fuel quality was contested by its customers including NTPC. The recent move of third-party agents testing the fuel at the loading point, larger share of underground coal and addition of more coal washeries should improve quality.

Unearthing value

CIL’s margins could also improve in the next two-three years due to lower wage expenses and market-linked pricing. The company’s headcount of mostly unskilled labour force is expected to come down from around 3.5 lakh as of January 2014 to 2.5 lakh by 2017 due to retirements. This nearly 25 per cent reduction should aid the company’s margins, given that wage bill account for over half its operating expenses.

A more rational pricing based on market rates, should aid profits. Unlike many commodities, coal prices are not linked to global prices or local demand.

Prices are currently around 40 per cent lower than global prices, hitting profits. A more rational pricing and fuel-supply agreement policy are likely with a new coal regulator; this should benefit CIL in the long term.

Also, minority shareholders of CIL will benefit with improved liquidity after the Government reduces its stake from 90 per cent to 75 per cent to meet listing regulations. Additionally, the appointment of a new CEO and seven independent directors to the Board by the Government should inspire more shareholder confidence.