Coal India has underperformed the benchmark indices over the last one year due to the overhang of the Government’s share sale, disappointment on volume growth, Government’s directive to reduce E-auction sales and inability to pass on the increase in costs. We believe most of the negatives are factored in the current price or have now turned positive. Production which witnessed mere 1.8% CAGR during FY10-14 increased to 7.3% yoy in 9M FY15. Since coming to power, the Narendra Modi led Government has emphasized a lot on power for all. In-line with the Government’s target of providing 24x7 power to all the power Ministry has set a target of 1bn tons of coal production from Coal India by 2019 from ~500mn tons in FY15 to meet the demand in the country.
Margin for the company is expected to improve from FY16 due to a combination of higher volumes, increase in realisations and lower diesel costs. We expect operating margins to improve from 20.8% in FY15 to 24.5% in FY16 and 27.9% in FY17. EBIDTA/ton of coal is expected to increase from Rs278/ton in FY15 to Rs403/ton in FY16. We estimate earnings CAGR of 13.7% over the period FY14-17. At the price of Rs365, the stock is available at 5.9x FY17 EV/EBIDTA, lower than its average of 7x. We believe Coal India would be a major beneficiary of the new Government’s focus on fuel security. In addition to the upside risks to our estimate if the government manages to achieve its goals in the near term, the company would witness a re-rating. We recommend a BUY on the stock with a one-year price target of Rs429 as it looks well positioned to gain from the steps being taken by the government to step-up coal volumes. A 5% discount to retail investors provides a good entry point and hence one should push for applications under the retail category. The huge size of the issue would also lead to higher allocation for retail investors.
To meet its target its target of 1bn tons by 2019 the Government has formed an Inter-Ministerial Sub-Group comprising representatives of Ministry of Power, Ministry of Coal and Ministry of Railways which would monitor coal supplies. To improve availability of coal the Government has already taken the following steps: (a) Decongestion of railways (b) Setting up new railway lines (c) Coal India to purchase 250 additional rakes to evacuate greater quantities of coal primarily to power plants expeditiously. (d) Easing environmental norms for existing mines (e) Faster clearances to boost volumes (f) Focus on exploration of coal blocks to increase and it is even planning to outsource the same. (g) CIL has agreed to provide an option to test at third party laboratories at unloading points. (h) Streamline the procedures for environmental, forestry and wildlife clearances.
Though we believe that it is a steep task for the company to meet its target, we expect Coal India volumes to witness production CAGR of 6.5% over FY14-17E. Offtake too would be higher after the decongestion of railway network. We expect coal offtake to increase from 472mn tons in FY14 to 490mn tons in FY15, 520mn tons in FY16 and 560mn tons in FY17. We believe there are upside risks to our estimates if the Government is able to achieve its goals over the next one year.
Blended realisations to improve from FY16 and FY17 on our estimate of FSA price hike in FY16. We estimate the company to announce prices hike of 7% in FY16, which would lead to an increase in FSA prices by 4% yoy in FY16 and by 5% yoy in FY17. The impact of slippages in grade due to third party sampling would offset the impact of the price rationalization exercise taken by the company in H2 FY14 and hence would keep FSA prices flat on a yoy basis in FY15. We believe that E-auction prices have formed a bottom in FY14 and prices would improve by 2% in FY15 and 4% each in FY16 & FY17. We also expect beneficiated coal prices to increase by 2% each over the period FY14-17. Blended realisations which were lower by 0.6% yoy in FY14 are further expected to decline by 1% in FY15 on account of slippages in grade. Led by our estimate of a price hike in H1 FY16 and higher market linked prices, we estimate blended realisations to increase by 3.3% yoy in FY16 and 4.7% yoy in FY17.