Back in action

Tete in Mozambique has proved to be quite unlucky for the world’s biggest coal miner and India’s most prized public sector undertaking, Coal India. About six years ago, the PSU had won a five-year licence for exploration and development in the north-western province of the African nation. After spending over ₹500 crore for exploration in the past few years, more than two-thirds of the 224 sq km leasehold mined was a futile exercise in moving mud. As a result, Coal India Africana, a 100% subsidiary, will now retain just 54 sq km of land and relinquish the rest. 

But coal secretary Anil Swarup, a career bureaucrat who PM Narendra Modi has entrusted with the task of reviving the coal sector, is not a worried man. The government has ensured that enough land and more will be available for the state-owned miner back home to address its chronic low output problem. “Coal India acquired more than 2,000 hectare of land last year. It has got 41 environment clearances and as a consequence of these clearances and acquisitions of land and the effort that has been put in by the people in Coal India, production has gone up,” Swarup said during a recent media interaction.

The results are already showing. After missing its production target for the last fiscal, Coal India managed to clock a 7% growth at 494 million tonne (MT) in FY15 — its highest growth output in about two decades. The PSU, which still enjoys a monopoly in coal mining, has set a production target of 550 MT for the current fiscal and an ambitious 1 billion tonne for FY20.

More importantly, the lifting of curbs on e-auctions and a proposal to allow Coal India to sell its coal to non-priority sectors at the market-linked price have also come as a whiff of fresh air. Both these categories account for almost 20% of Coal India’s offtake and could actually fetch double the money on a per tonne basis, compared with supplying coal to the regulated power sector at a discounted price. The change in fortunes has reflected in the stock price, which has gained 20% year-to-date, with a 10% spike coming in just under a month.

Now, contrast the development to the scenario that was seen at the beginning of 2015. There were hardly any takers for Coal India’s follow-on public offering at ₹343 in January, as a result of which the issue was undersubscribed. Later, those very same shares were allotted in the high net worth individuals (HNI) category. At ₹343, the stock was valued at about 8X earnings and offered a dividend yield of close to 6%. That time, investors had very little hope about the prospects of the company, which were marred by falling earnings, low RoE, lower production and offtake and the curbs on e-auction in September 2014. 

Ambareesh Baliga, an independent market expert, believes that the weak sentiment was not without reason. “I think people were ignoring this stock for no obvious reason, expecting that volumes and realisations will never grow. However, that is changing with the renewed focus of the government and the impact of this is already visible in its volumes. I don’t think that this time the government can afford to lose out on the coal front, if it is keen to ignite the Make in India programme. That will not be possible without Coal India supplying 80% of the power sector’s requirement,” points out Baliga.

Whiff of fresh air

Over the past two years, despite marginal growth in revenue, Coal India’s earnings per share has fallen from ₹27.5 in FY13 to ₹21.7 in FY15, as a result of a cap on e-auction and higher operating costs. Because of the decline in e-auction sales contribution from 11.5% in FY14 to 9.6% in FY15, the blended realisation from sales fell from ₹1,482 per tonne to ₹1,475 a tonne. 

Some of these worries are now reversing and the Street is expecting better realisations and strong earnings growth. To put this in perspective, on an average, the realisations on sales done through e-auction add up to about ₹2,450 a tonne, which is almost 80% higher compared with current blended realisations of ₹1,475 per tonne, which includes sales done through fuel supply agreements (FSA) with power producers and in the non-regulated space with cement, steel and other sectors, where Coal India is obliged to supply coal at discounted prices. Internationally, the price per tonne of the same kind of coal (5,000 KCal/per kg) that the company supplies to power plants at around ₹2,200-2,300 per tonne is about ₹4,600 per tonne. 

Due to the restriction on e-auctions and the market-linked price for unregulated sectors, the company was losing both in terms of earnings and growth. Earlier last year, the ministry had put in place a cap on e-auctions, limiting the figure to 7% of sales, which is why volumes from e-auctions fell from 58 million tonne or 12.3% of sales in FY14 to 46.9 million tonne or 9.5% of sales in FY15. The cap has now been removed. 

Under the old system, Coal India was allowed to hold an e-auction only after fulfilling the FSA signed with the power sector. This development comes at a time when volumes are increasing, hence increasing the probability of higher volumes for the e-auction even after fulfilling the demand of power sector. Analysts suggest that with the 1% rise in blended realisations, the company typically has a 3% impact on earnings per share. With coal auctions to unregulated linkage-based plants and the lift of the curb on e-auctions, realisations should be strong.

Sachin Shah, a portfolio manager with Emkay Global Financial Services, says, “The volumes growth is going to be higher. The company is hoping to double its production by 2020, which is about 15% CAGR growth. There is reason to believe this figure as the supply side bottleneck — like the availability of rakes — is easing. As volumes grow, we could see operating leverage starting to kick in and costs will come down as a percentage of sales. Also, the fact that there is a significant number of people who are going to retire in the coming year should add to its profitability. As a result, we could actually see profitability growing faster than revenue growth.” 

In FY15, the company dispatched 488 million tonne of coal. Of this, 384 million was given to linkage-based power plants and another 58.3 million tonne (12% of total dispatch) to non-power plants such as steel, cement and fertiliser factories and the rest was sold through e-auction. The new notification allows for auction of coal linkages or issuing of letter of assurances to unregulated sectors through competitive bidding.

In the proposal document, the coal ministry mentioned, “In the unregulated sector, there is no justification of providing coal at a price less than the market price because the market is not regulated and the price of the final product is determined by market forces. This also provides a non-level playing field within the unregulated sector, in favour of those having linkages, vis-a-vis those who don’t have them.”

Anirudh Gangadhar, who tracks the stock at Nomura, says, “We believe the proposed methodology clearly implies that the price discovery mechanism will boost realisation. Theoretically, the discount between Coal India’s ex-mine price of linkage coal for the unregulated sector and the export CIF price of 3,800-4,200 gross calorific value, Indonesian coal would be a potential indicator of the magnitude of the uptick in realisation.” Currently, the difference between the linkage-based coal to the unregulated sector and the Indonesian coal is about 20-25%, which for all practical purposes will get bridged, boosting realisations for 12% of the volumes. 

After a very long period, the Street’s expectations about volumes and pricing are seeing a positive shift. The general feeling among analysts was that Coal India had traditionally grown its volumes in the range of 4-5% and pricing by 6-7% (matching inflation), thus a cumulative earnings growth in the range of 10-12% was a given. But the new developments signify that some of the old assumptions will change. 

A new way out

There are reasons behind why volume growth — which was restricted because of issues related to production and offtake — is coming back. Besides environmental clearances, the other factor that limited the offtake was the worry around the evacuation of coal. This is now getting resolved gradually with the availability of rakes. 

For instance, over the past two years, production had grown to 494 million tonne in FY15 while offtake grew just 2%, as availability of railway rakes moved up very marginally from 187 rakes per day in FY13 to 194 rakes per day in FY15. Thus, the miner missed its offtake target of 520 million tonne in FY15 by 6%. Due to logistics issues, pithead inventories piled up to 53.6 million tonne in FY15, compared with 48.6 million tonnes in FY14.

 However, this is changing. In the March 2015 quarter, the company witnessed the highest rake availability of 209 per day, which is also the reason that the production growth is now starting to show up. With the availability of rakes improving, the company witnessed 11% production growth in April 2015, followed by 13% production growth in May 2015. In fact, for the first quarter of FY15, the company reported 12% growth in production to 121 million tonne. The company is looking to add 200 new rakes over the next four years through its own internal accruals and has already placed orders for 34 rakes. 

With rake availability improving and the commissioning of a new railway line at its Odisha mine (Jharsuguda-Barpalli) by June 2016, offtake numbers should look better. Besides Odisha, the ministry of coal is trying to facilitate faster evacuation of coal from two mines by constructing two new railway lines (Tori-Shivpur-Kathautia and Bhupdeopur-Raigur-Mand) in Chhattisgarh. Cumulatively, all three projects can evacuate about 250 million tonne of coal, or about half the current production of Coal India, which will help it reach the 1 billion target by 2020, marking an annual growth of over 15%, compared with the current 7%. 

That apart, the issues from the supply side are also easing. Over the past nine months, the company has been able to acquire 2,000 hectare of land and has got 41 environment and forest clearances, which is a positive indication for expediting the production. The Chhattisgarh-based South Eastern Coalfields and Odisha-based Mahanadi Coalfields have already received green clearances for five blocks each in FY15.

Full steam ahead

Though most analysts believe growth should be higher and better than in the past few years, it may not be very high or in line with the company’s targets (15% CAGR till 2020).

“These are tall targets. Achieving these targets is going to be difficult because now the company will have to move deeper into underground mines and will need to incur higher capex,” says Jigar Shah of Kim Eng Securities. However, considering that the company is generating over ₹14,000 crore in profit and has cash reserves of ₹53,000 crore, capex should not be a constraint. 

For underground mining, the miner is looking to engage with private contractors under its Mine Developers and Operators model. The management is considering changing the way it currently tenders contracts from a piecemeal approach to a complete turnkey basis.

In other words, the contract will cover the entire process chain from production to the transportation of the coal till the loading point. Even if the company is able to move up its volumes at half the targeted volumes, it will be a huge bonanza for its shareholders in terms of the implications on earnings and cash flows, thus leading to higher dividends. 

“We expect Coal India to register a 10% annual growth in volume over FY15-FY20. I think with the volume growth accelerating, there will be some gains on account of operating leverage in addition to higher realisations, which can come as a result of market-linked pricing for the unregulated FSAs,” says Sanjay Jain of Motilal Oswal Securities.

Jain explains that as a result, his company expects operating profit to double by the end of FY20. Even if volumes go up by 60% till FY20 (as against the company’s plan to double it), operating profits will go up by a similar growth or 60%, without accounting for the higher realisations and cost per tonne. What it also means is that there will be a positive impact on return on equity (RoE), which is expected to go up to 38% in FY17, compared with 32% in FY15.

Currently, the government owns a substantial stake (79.65%) in the company, as a result of which the free float is minuscule. Further, considering Coal India’s business monopoly, the stock has attracted long-term institutional investors, including insurance, mutual funds and FIIs, all of which hold close to 18%.

Consequently, retail or individual investors hold less than one lakh shares or just 1.23% of the total capital. Incidentally, 70% (34 out of 50) analysts tracking the company have a ‘buy’ rating on the company. But given that the stock is already up 20% for the year and is close to approaching its 12-month consensus target of ₹436, entry at current levels would mean investors will have to tone down their near-term return expectation.