BHAVIKK SHAH's BLOG: POWER

Scrip Code: 533278 / COALINDIA

CMP: Rs. 311.00; Market Cap: Rs. 1,99,660.27 Cr; 52 Week High/Low: Rs. 447.10 / Rs. 286.50

Total Shares: 631,63,64,400 shares; Promoters : 503,09,70,582 shares – 79.65 %; Total Public holding : 128,53,93,818 shares – 20.35 %; Book Value: Rs. 26.49; Face Value: Rs. 10.00; EPS: Rs. 19.03; Dividend: 207.00 % ; P/E: 16.37 times; Ind P/E: 11.54; EV/EBITDA: 7.56 times.

Total Debt: Rs. 408.32 Cr; Enterprise Value: Rs. 1,87,157.86 Cr.

COAL INDIA LIMITED: Coal India Ltd was incorporated in 1973 in Kolkata, India. It was formerly known as Coal Mines Authority Limited. Coal India Ltd is a leading public sector undertaking engaged in coal mining & selling coal fines in India and is working on establishing its footprint globally through acquisitions. The company provides Washed and Beneficiated coal for use in manufacturing of hard coke for steel making and power generation. Company operates 471 mines in 21 coalfields across 8 states in India, which includes 163 open cast mines, 273 underground mines & 35 mixed mines – open & underground mines. Coal India Ltd operates through its 9 wholly owned subsidiaries, of which 1 subsidiary is engaged in exploration and feasibility study analysis. The company came with an IPO of 63,16,36,440 equity shares of Rs. 10 each at Rs. 245.00 per share to the general public in October, 2010. The purpose of the issue was to achieve the governments disinvestment target & to achieve benefits of listing on the exchanges. It got listed on November 04, 2010 at Rs. 291.00 per share making a high of Rs. 344.90 on listing day. Its subsidiaries include Eastern Coalfields Ltd, Bharat Coking Coal India Ltd, Central Coalfields Ltd, Northern Coalfields Ltd, Western Coalfields Ltd and South Eastern Coalfields Ltd. Coal India Ltd has total reserves of 64.3 billion tons and proved reserves of 52.4 billion tons, of which extractable reserves stands at 21.7 billion tons. The company offers coking coal primarily for use in steel making & metallurgical industries, and for hard coke manufacturing, semi coking coal for use as blend able coal steel making, merchant coke manufacturing, it also provides middlings used by fuel plants, brick manufacturing units, cement plants, industrial plants, as well as for power generation. Coal India Ltd coal fines/coke fines are used in industrial furnaces, as well as for domestic purposes. It serves primarily power, steel, cement, and fertilizer industries. Coal India is compared with Banpu Public Company Ltd of Thailand; Blackgold International Holdings Ltd of China; Agritrade Resources Ltd of Hongkong; PT Sumber Energi Andalan Tbk of Indonesia, Siberian Mining Group Company Ltd & Mongolia Energy Corporation Ltd of Hong Kong.

Investment Rationale:

Coal India, a ‘Navratna’ company, is the largest coal producing company in the world, based on its raw coal production. The company is also the largest coal reserve holder in the world, based on its reserve base. Coal India Ltd is well positioned to capitalize the widening gap of demand & supply as it controls 80 % of the coal supply in India and around 66% of India’s power generation is coal based. More than 90 % of Coal India's extractable reserves are easy-to-mine, low-cost, opencast mines that produce mainly Low-quality thermal coal, primarily consumed by power utilities. Coal India has also set up high-margin coal beneficiation plants; the increased use of the high-priced e-auction platform sales, and gradually bringing its prices in line with global market prices should boost the company's margins and generate high returns. The underlying mines in India are of high quality and are of high-margin, as reflected in high double-digit returns on invested capital. Coal India is heavily regulated and the government compels Coal India to supply utilities contracted coal at below global market rates. This dynamic carries the potential to squeeze margins and returns. Recent union budget has increased clean cess from Rs. 200 per tonne on Coal to Rs. 400 per tonne and Coal India would be able to offset any increase in mining costs with commensurate price increases, and it has proved this with its track record of doing so. While transportation costs, primarily from railways, account for about 40 % of total mining costs, the majority of the Indian coal power plants still find it more economical to burn domestic coal relative to other types of energy, given its abundance and low production costs. The Indian Electricity production is expected to grow at a 6 % average annually and in tandem with gross domestic product growth. The Coal demand is expected to remain strong, as it is expected that coal to still constitute about 58 % of the power generation over next few years. This should benefit Coal India, as it holds about 80 % market share in Indian coal production. Coal India should continue to reward shareholders with increased dividends or share repurchases, as it continues to generate strong free cash flow that exceeds capital expenditure requirements. Overall, Coal India offers investors high-quality exposure to a low-cost miner with a dominant share of coal supply in the Indian market and this is where Coal India enjoys a narrow economic moat. Extensive coal reserves, long mine life, legal barriers to entry for private domestic coal producers, and low production costs coupled with low mine acquisition costs makes a relatively strong case of competitive advantage. Coal India’s strategic value lies in the fact that it cheaply meets more than half of India's energy demands, primarily the demands of power utilities. For this reason, the Indian government has ensured that Coal India holds a significant portion of the nation’s total coal reserves. Also coal India’s 18 billion tons of extractable reserves represent about 33 % of India’s total. Based on the 2015 production rate, the estimated reserve life for coal India is about 40 years. During the five-year period leading up to 2015, return on invested Capital, or ROIC, was on an average of 41 % annually. The attractive returns reflect the low-cost nature of Coal India's mines, and the low historical acquisition costs for mines and reserves. Mines and reserves are allocated by the government and current assets benefits from low-cost acquisitions from the government. The company derives about 10 % of its revenue by selling some of its coal through e-auction at higher prices, which more closely reflect underlying Supply and demand. However, about 85 % of the revenue is derived from contracted domestic coal supply, which is under the yoke of price controls. Coal India has considerable advantages over other domestic coal producers and has about 70 % market share of India’s total coal demand, and accounts for 80 % of domestic production. While private companies are allowed to mine for coal, eligibility is restricted to only iron and steel, cement, and power generation companies for their own captive use, and is prohibited under Indian national law from selling coal in the open market. This creates a significant entry barrier for private coal producers. Coal India Currently holds at least 15 years’ worth of low-cost coal reserves, even if one assumes 10 % average annual production growth. This assumption appears aggressive against the comparable trailing 10-year figure of 4.5 %, and low cost reserve depletion will likely to take much longer than 15 years once slower production growth and probable reserve replacement are taken into account. The government’s stance encouraging competition is unlikely to dilute Coal India’s returns below its cost of capital in the medium-term, since competitors will need to bid for generally inferior quality coal blocks at a higher price than Coal India has acquired its reserves. This will dictate poorer margins and returns for competitors. In the past, initiatives such as this allocating coal blocks to private players for captive consumption have failed to deliver the intended results, especially given land acquisition, forest and environment clearances, lack of business expertise, and various other issues. Coal India's primary focus is the domestic Indian market, especially power utilities, which account for more than 70 % of its sales volume. Sales to power utilities are around 50 % below international prices, yet Coal India still earns attractive returns, a testament to its cost advantage. During the next five years, it is projected that Coal India’s ROIC to average 31 % annually, consistent with its trailing four-year average of 41 %. Additional high-margin avenues such as e-auctioning of coal, and selling washed and beneficiated coal, to continue to help Coal India sustain its profitability. Coal power plants continue to be the cheapest and Coal amongst the dominant source of power to meet the rising demand for electricity; low-cost, opencast mines should help to weather any downturn in coal prices and help in sustaining ROICs of COAL INDIA above the cost of capital. COAL INDIA’s rich cash pile, coupled with lower Capital expenditure, could result in higher Shareholder returns in the form buybacks or bonus Issue in coming few years.

Outlook and Valuation:

Coal India (CIL) is largest coal producing company. CIL is well positioned to capitalize the widening gap of demand & supply as it controls 80 % of the coal supply in India and around 66 % of India’s power generation is coal based. More than 90 % of Coal India's extractable reserves are easy-to-mine, low-cost, opencast mines that produce mainly Low-quality thermal coal, primarily consumed by power utilities. The recent union budget 2016 proposed a Clean Environment cess of Rs. 400 per ton on coal instead of Rs. 200 per ton. This could increase the coal prices from COAL INDIA by 20 %. The average notified coal price from Coal India is Rs. 1000 to Rs. 1100 per ton and increase of Rs. 200 per ton translates into almost 20 % increase in prices. COAL India sells almost one third of its coal output in grades 10 to 13 and the same is priced at about Rs. 700 and Rs. 800 per ton respectively. The higher grade coal prices goes up to Rs. 3500 a ton from Coal India in which impact would be less, but would have negative impact in terms of power tariff as this additional levy will jack up the coal prices by as high as 25 % and power tariff will be more for south India power plants that procure mostly low grade coal which is priced at Rs. 700 – Rs. 800 per ton from Mahanadi Coalfields. Coal India operates in narrow moat situation whereas its peers operates in wide moat, Coal India enjoys competitive advantage from the fact that cost of replacing reserves in coming days will trend higher than historical costs, and future mines are also likely to have higher mining costs coupled with the need to dig deeper compared to very attractive mostly opencast mining at present. The current estimated reserve life with respect to growth in coal demand is short of the 20 years, and one can be confident that Coal India will still generate excess returns. Also, the government intends to gradually open the market to free pricing in the future years, it is unlikely the generous mine acquisition terms from the government will continue longer-term. Therefore, Coal India warrants a narrow economic moat versus wide, as new mines will likely deliver less attractive returns on invested capital. Its proven from the past on COAL’s ability, that it passes on the impact of escalation in cost associated with hike in wages of non-executive employees and it is believed that 6 % price hike in power segment and higher scale of 10 % + increase in volumes would off-set the impact well. With smart rail logistics management, improved turnaround time aided by addition of sidings and the gradual addition of rakes by railways helped Coal India’s volumes to grow by 10 % YoY in Apr-Jan’16. The growth trajectory would be sustained in the range of 9 % + for next couple of years on the back of lower congestion and improved availability of rakes. The trajectory would ascend to 10 %, driven by commissioning of Eastern DFC, 3rd line between Howrah-Wardha and Talcher-Cuttack, Jharsuguda-Barpali Rail link, Bhupdeopur-Korba rail link and the high loading capacity wagons sourced by Coal India. Total off-take for the quarter grew by 13.5 % YoY to 138 million tonnes. Fule Supply Agreement (FSA) volumes were largely flat at 117 mn tons which are 85 % of sales and E-auction sales were up 171 % YoY to 15 mn. E-auction sales were abnormally low last year at 6 mn tonnes due to shift of E-auction volumes to FSA due to recommendations from the Ministry of Coal to fulfill the requirements of power sector first at regulated price and consider them as priority over E-auction. Now, with overall demand being low, E-auction volume has again inched up to 15 mn tonnes level. FSA realisations decreased 1.6 % YoY to Rs. 1277 per ton due to change in grade mix. E-auction realization declined 40.4 % YoY but was up 4.5 % QoQ. Coal India may find it difficult to increase the price of e-auction coal as it is available from overseas at competitive prices. Also, acceptability of higher grade coal of Coal India is low because of its high price vis-à-vis market price. Coal India’s EBITDA margins increased by 1.27 % to 29.6 % and EBITDA grew by 10.0 % to Rs. 6,200 Cr led by cost control. Employee cost and Raw material cost as a % of sales declined 3.39 % YoY and 1.30 % YoY to 37.5 % and 6.2 % respectively. Its Contractual costs increased 2.64 % to 15.1 % of sales. Coal India Ltd currently requires 234 rakes per day whereas it is getting 220 rakes per day. Out of the 3 critical railway lines, Chattisgarh and Orissa railway lines are likely to come up by June 2016 and June 2017 respectively whereas Tori-Shivpur line will be ready by 2018. GoI's target of 910 mn tonne coal production from Coal India by 2020 is achievable only if required infrastructure for evacuation is set up. Coal India, in coordination with the Central & State governments, is successfully resolving key issues in coal production which can be seen from the growth of 6.9 % & 9.0 % in coal production in FY15 & YTD respectively a average. 1.8 % CAGR between FY11-14. While these measures will result in top line growth, Coal India Ltd must keep its cost in check to maintain profitability. It is expected that in FY17 Coal production could be of 577 million tonnes which would be a CAGR growth of 8 % from FY15 to FY17E & Offtake could be 598 mn tonnes a growth CAGR of 10.7 %during the same period. It is expected that the topline & bottomline of Coal India could grow at a CAGR of 7.8 % & 9.9 % between FY15-17E. And driven by the attractive valuation of 7 times the EV/EBITDA the stock looks strong with rich dividend yield. At the current market price of Rs. 311.00, the stock is trading at a PE of 13.77 x FY16E and 11.85 x FY17E respectively. The company can post Earnings per share (EPS) of Rs. 22.58 in FY16E and Rs. 26.23 in FY17E. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also.

KEY FINANCIALS	FY14	FY15	FY16E	FY17E
SALES (₹ Crs)	70,607.50	74,120.10	77,053.80	86,064.20
NET PROFIT (₹ Cr)	15,099.00	13,720.40	14,260.80	16,570.20
EPS (₹)	23.90	21.72	22.58	26.23
PE (x)	12.04	16.68	13.82	11.89
P/BV (x)	4.29	5.67	5.18	5.29
EV/EBITDA (x)	5.20	7.37	6.22	5.22
ROE (%)	33.23	33.16	36.39	44.03
ROCE (%)	32.81	32.95	36.29	44.13

As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of 8 % on every purchase. (Why Strict stop loss of 8 % ?) -

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*As the author of this blog I disclose that I do not hold COAL INDIA Ltd in my any of the portfolios.

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This is a personal blog and presents entirely personal views on stock market. Any statement made in this blog is merely an expression of my personal opinion. These informations are sourced from publicly available data. By using/reading this blog you agree to (i) not to take any investment decision or any other important decisions based on any information, opinion, suggestion, expressions or experience mentioned or presented in this blog (ii) Any investment decisions taken if any would be his/hers sole responsibility. (iii) the author of this blog is not responsible.

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