Coal India: Fuelling prospects

The stock of State-owned coal major Coal India (CIL) has been on a downtrend in the last few months, hitting a two-year low last week.

This is despite robust coal production and offtake growth of 8.6 per cent and 8.8 per cent respectively in 2015-16, as against the average of about 3 per cent over the past five years. The company also paid an interim dividend of ₹27.4, 32 per cent higher than the dividend of ₹20.7 paid in 2014-15.

The stock price’s fall is possibly due to worries of an impending stake sale, tepid global coal price worries and weak demand from the power sector. The current price of ₹276 discounts CIL’s trailing 12-month earnings by 12 times, lower than its three-year historical band of 14-16 times.

Investors can buy the CIL share, given its attractive valuation, the company’s long history of high dividend payout, high profit margin and improving production.

There are a few concerns that weigh on CIL that need to be considered. One, coal prices globally have been on a downtrend and touched a decade-low late last year. Prices have increased since then and stabilised recently.

CIL’s sale price for various grades of coal is set by the company and is not automatically linked to global prices, insulating revenue to some extent. It recently cut prices of high-grade coal and its prices are cheaper than the equivalent import prices by 20-30 per cent.

Still, CIL will be able to maintain or improve its margin with inflation-linked hikes, pick-up in e-auction volumes and likely price hikes in low-grade coal.

Two, power producers have been weighed down by debt and have not increased their fuel purchase last year. Coal imports are on a downtrend even as power demand is increasing.

Demand from power companies is likely to improve as reforms initiated by the government start to yield results in a few quarters.

Three, the government has asked CIL (along with ONGC and NTPC) to adopt one urea plant (that are shut) each for revival. The government’s eagerness to dip into the cash reserves (of ₹54,000 crore as of September 2015) for purposes not beneficial to minority shareholders is a concern.

Still, the company generates ₹14,000 crore of cash every year and is capable of funding its capex needs (which has averaged about ₹5,000 crore), pay hefty dividends and support non-core investments.

Four, there is a perpetual Damocles sword of government stake sale hanging over CIL. The sale was postponed in 2015-16 due to tepid market conditions.

Given similar lukewarm environment and the government’s need to raise cash, it is likely that CIL may buy back government’s stake. This, if it happens, can be beneficial and may remove the uncertainty of stake-sale, at least for 2016-17.

CIL’s prospects, the short-term concerns notwithstanding, are bright, aided by a few factors. One, production has been on an uptrend and increased 8.6 per cent year-on-year to 536 million tonnes in 2015-16.

Output is expected to increase, aided by its expansion plans in existing and new projects as well as operational improvements, such as more machinery and better quality with coal washeries. It is also working on improving the railway network for evacuation through joint ventures.

The company has ample coal reserves — proven reserves of 52 billion tonnes and extractable reserves of 22 billion tonnes (about 44 years of life, based on current output levels of 500 million tonnes a year). Bottlenecks in coal transportation have also been easing with availability of railway rakes increasing to 212 days in 2015-16 from 194 days a year ago.

Two, the company is India’s top coal producer, with an 80 per cent share currently. While there are plans to open up coal production to private companies (a 33 per cent share of the 1.5-billion-tonne target for 2020), CIL may continue to maintain a high share, given delays in notifications and other concerns such as land acquisition in opening up the sector.

Three, its average sale price is likely to improve in the next few years, aided by higher share of coal sold through e-auctions. CIL sells nearly 90 per cent of its production to power plants on a fuel supply agreement.

The share of coal sold through auction (which are priced 30 per cent higher) is likely to increase as more linkages, especially in the non-power sector, expire in the next two years.