Coal India : Market-linked volumes, lower tax to drive earnings :Motilal Oswal

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Market-linked volumes, lower tax to drive earnings
Operating leverage a double-edged sword, inflation remains high
We expect Coal India (CIL) to report robust earnings CAGR of 27% till FY13, driven by
'market-linked' sales and lower tax rates. CIL is strongly leveraged to international
prices and 'market-linked' sales will contribute 22% of volumes, 40% of revenues and
higher proportion of earnings in FY12. Accumulated losses in BCCL and ECL will lead to
a decline in tax rate from 34% in FY11 to 30% in FY13. Operating leverage, however, is a
double-edged sword, as staff costs and contractual expenses constitute ~64% of total
costs. These are largely fixed and linked to inflation - any volume disappointments will
impact earnings. While FY11 production has been flat, incremental developments have
been positive. Buy with a DCF-based (11.5% WACC) target price of Rs447.
Expect earnings CAGR of 27% over FY11-13
We expect CIL to report robust earnings CAGR of 27% till FY13. Reported earnings
for FY12 are contingent on the quantum and timing of price increases. We have
factored in 30% wage increase for non-executive staff with effect from July 2011 and a
commensurate offset through a price increase only in April 2012. If CIL is able to raise
prices in July 2011, FY12E earnings will increase from Rs22.1/share to Rs25.1/share.
An offsetting price increase in July 2011 will be a very strong signal, reinforcing CIL's
underlying pricing power. The key drivers of CIL's earnings growth will be:
 Increase in coal sales at market-linked prices from ~92m tons in FY11 to ~104m
tons in FY12. CIL is strongly leveraged to international coal prices and marketlinked
sales will contribute 22% of volumes, 40% of revenues and higher proportion
of earnings in FY12.
 Tax breaks available at BCCL and ECL due to accumulated losses. We expect
consolidated tax/PBT ratio for CIL to decline from 34% in FY11 to 32% in FY12
and further to 30% in FY13.
Volume growth challenges persist, but incremental developments positive
In FY11, CIL's dispatches were 423m tons (up 2%) and production was flat at 431m
tons. Growth in dispatches is being impacted partly by constraints in rail wagon
availability and partly by impediments in production due to environmental issues, law
and order problems, land acquisition constraints, etc. We understand that ~42% of
production faces constraints in evacuation infrastructure. Steps have been taken to
address these through the formation of the Group of Ministers and relaxation of the
comprehensive environment pollution index (CEPI) for certain mines.
Operating leverage - a double-edged sword
Staff costs and contractual expenses contribute ~62% of CIL's total costs. In 1HFY11,
while total costs were up 4.7% YoY, staff costs and contractual expenses grew 19.4%
YoY, accounting for almost the entire cost increase. A large part of this increase has
been due to higher dearness allowances, led by higher inflation. We believe that staff
costs and contractual expenses are largely fixed in nature. Robust volume growth
could lead to strong operating leverage. However, in FY11, volume growth was modest,
with dispatches up 2%, necessitating a price increase in February 2011. Inflation
remains above the comfort zone and any volume disappointment will need to be
absorbed by internal accruals; the surplus of Rs30b-35b from the price hike in
February 2011 will be adjusted against future cost increases.