Coal India Target price: Rs325 Buy :: Motilal Oswal

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Dispatches up 3% YoY in 1HFY11, core business earnings robust
1HFY11 operational analysis; valuations / financial framework explained
1HFY11 operational performance mixed given heavy monsoons, signs of
improvement apparent in October: During 1HFY11, CIL's operational performance
was mixed, with production growth of 0.7% YoY and dispatch growth of 2.9% YoY.
1HFY11 production growth was impacted due to heavy monsoons (at 102% of LPA,
v/s 78% of LPA in 1HFY10). Given the seasonal nature of the business, 1H typically
accounts for 40-43% of production, and 1HFY11 production at 186m tonnes is 40% of
the FY11 target. In October 2010 (till 25 October), production growth stands at 5.7%
YoY and is already showing signs of picking up.

Raw coal dispatches in 1HFY11 at 200m tonnes are up 2.9% YoY, and account for
46% of our FY11E dispatches. Inventory at pitheads has declined by 14m tonnes in
1HFY11, as thermal plants create inventory to provide for possible wagon shortfall in
4Q. We have factored in raw coal dispatches of 436m tonnes in FY11 (up 5%) and the
residual growth required in 2HFY11 to achieve the full-year target is 6.8%. This is
achievable, in our opinion. (Note: LPA - long-period average)

1QFY11 earnings of Rs25b provide comfort on full-year earnings estimate of
Rs118b (up 20%): In 1QFY11, CIL reported net profit of Rs25b, representing 21% of
FY11E earnings. CIL's reported quarterly earnings follow a seasonal pattern in line
with the operational matrices [1QFY11 contributed just 21% of the targeted production
for FY11]. This is because of the largely fixed cost structure, with employee cost at
35% of revenue. Also, 1QFY11 revenue and profitability were boosted by 28% YoY
increase in realization from e-auctions to Rs1,748/tonne.

Earnings framework explained; core RoE at over 200%: CIL makes provisions for
overburden (OB) removal based on average stripping ratio and these provisions
constitute ~21% of PBT. We arrive at adjusted earnings by adding OB provisions to
reported earnings. The company has large cash balances, resulting in high treasury
income, which constitutes ~17% of adjusted earnings. We deduct treasury income
from adjusted earnings to arrive at core adjusted earnings. Our analysis indicates that
CIL's core adjusted earnings are just as robust as its reported earnings, with FY10
core earnings at Rs98b (EPS of Rs15.5). Adjusted RoE for FY10 was 36% v/s reported
RoE of 40%, and adjusted core business RoE was infinite, given the negative capital
employed. This was achieved despite sale of 85% of production through notified pricing,
inefficiency of legacy mines (with meaningful losses), etc, and is commendable.


Valuation framework explained; maintain Buy: We arrive at a price target of
Rs325/share, valuing Coal India at Rs2,055b based on DCF methodology. At this price
target, the stock would trade at 17.4x FY11E and 15.4x FY12E earnings, at par with
utilities like NTPC, PGCIL, etc. Adjusted for the OB removal and treasury income, at
Rs325/share, CIL would trade at 17.6x FY11E and 15.7x FY12E core business earnings.
In addition, cash and investments stand at Rs64/share as at FY10. The stock quotes
at 4.3x FY11E and 3.5x FY12E adjusted BV, with adjusted RoE at 32.6% and 29%,
respectively.