Subscribe to Coal India IPO

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1 Subscribe to Coal India IPO ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 1

2 Subscribe to Coal India IPO The biggest ever Initial Public Offer opens today and the company in question is the largest coal producer of the world - Coal India Ltd or CIL. With markets gallopping towards new highs, amid short setbacks, investors are in two minds whether to go in for the IPO. Speaking to CNBC-TV18's managing editor Udayan Mukherjee, two experts Abhineet Anand of Antique Stock Broking and Suhas Harinarayanan, of Religare Securities gave thumbs up to the IPO. Sounding optimistic about the paper, Suhas Harinarayanan of Religare said one should subscribe to the Coal India IPO as the issue price is attractive and the company is best positioned to meet the widening coal deficit. He views CIL as "a proxy to the Indian power sector in the country" and sees its profit growth at 15%-18%. Antique's Anand said the broking house has put a "subscribe" rating to the IPO, and he believes the fair value of the stock would be at Rs per share. Below is a verbatim transcript of their exclusive interview with CNBC-TV18. For the complete interview watch the accompanying video. Q: What are you telling your clients, subscribe or not? Harinarayanan: We are recommending investors to subscribe to the issue. Q: Take us through why? Harinarayanan: Coal India is the dominant player in coal supply in the country. We have derived demand-supply situation for coal in the country over the next five-six years and the deficit is only going to widen. We think Coal India is one of the better ways to play the emerging coal deficit in the country. Despite all the stories of the coal demand-supply situation, the bottomline is - the issue is attractively priced. When I look at the issue fundamentals, we are expecting the bottomline for Coal India to grow between 15-18% compound annual growth rate (CAGR) over the next two years. On the back of partly improved production, our production estimates are lower than what Coal India is guiding for. However we do think production could grow by about 3-5% per year over the next three years. We are looking at certain pricing increases partly also to compensate the likely employee cost increases. We are looking at employee efficiencies coming in from some of the loss making subsidiaries. We are also looking at some of the existing inventories to be cleared. We do think a profit growth could be in 15-18% range over the next two years on an annual basis. On the back of this, based on both the EV/EBITDA and possibly on PE basis, the issue is attractively priced. The issue at Rs 245 for example is priced at about seven times EV/EBITDA on FY12 which is towards the lower end of the trading band for global peers. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 2

3 Q: That s an interesting thought, the parallel that you draw with a utility company. Where should the valuation be then for Coal India? Would it be somewhere between a commodity stock and a utility stock? Anand: What we have done is instead of looking at EV/EBITDA or a PE which is the way commodity companies are looked into, we have looked into it by the discounted cash flow (DCF) methodology, the same way utilities have been looked into because you have some view of the production that might happen. So 5-7% would be a production increase in the next six-seven years and then we have brought it down to 4%. That is the reason we have valued it not on EV/EBITDA basis, we have valued it totally on DCF basis. Q: What is your assessment of fair value of Coal India? Harinarayanan: We have a pricing range of Rs 265 to Rs 315. The stock will obviously list with some gains but our fair value range is Rs running across various scenarios. Q: If you did get the stock post-listing at Rs 270, is it a stock you would flip or would you continue to own it because of earnings growth visibility over the next two years? Harinarayanan: I would continue to own it. It depends on various investor interests but it s a stock worth owning and I would also agree that it is also a proxy to the whole power story. Q: What is your call - Is it a buy and own kind of stock over the next two-three years or would you flip it if you got your price of close to Rs 300? Anand: It s a long-term story because of the fact that coal demand-supply is going to be skewed and utilities might not have 90% or 100% of coal. But Coal India is there to supply. All of the off-take will be taken. It s a long-term story, there is no point flipping it over. Coal India is worth 30% more, say research firms NEW DELHI: Global and domestic securities research firms such as CLSA and Religare have valued the world s largest coal miner Coal India, at $45 billion, at least a 30% premium to what the government has priced, indicating potential gains for investors. Analysts at these broking firms valued the miner s shares between Rs 265 and Rs 324 a piece, giving an equity value of around Rs 2,00,000 crore. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 3

4 The empowered group of ministers, headed by finance minister Pranab Mukherjee, fixed the price band at Rs per share, paving the way for investor interest in the largest initial public offer in the history of the Indian capital market. The government is selling a 10% equity, or crore equity shares. At this price band, the government will raise Rs 14,000-15,210 crore, after adjusting 5% discount to retail investors for whom 35% of the offer is reserved. This would also make another history of the largest market cap of over Rs 150,000 crore on the debut date by any company. Coal India is the world s largest coal company by reserves and production. It sells coal at a big discount to global prices, but enjoys high margins due to low production costs, said CLSA s report. We believe that Coal India deserves to trade at premium to global coal prices in supplydeficit environment. Our one-year forward value for Coal India is Rs (market cap of $43-45 billion), the report says. Coal India commands a dominant 82% market share in India and hence offers the best play on the rising coal deficit in the country, says a report from broking firm Religare. Over the next three years, we expect Coal India to register a substantial expansion in operating margins from 22% in FY10 to 30% in FY13 led by improved labour efficiency, focus on beneficiated coal and technology upgrades, it says. According to a Religare report before the official pricing, Coal India s stock should be priced in the range of Rs , giving a market cap of Rs 1,99,300 crore at the upper end of the band. In FY10, the blended average selling price (ASP) of Coal India was 57% lower than global coal prices. ASPs have risen at just 6.6% compounded annual growth rate (CAGR) over FY06-10 despite a much bigger increase in global prices. There have been just four price hikes in the past 11 years by Coal India since coal prices were deregulated in January Coal India s blended ASP for FY10 was Rs 1,031 per tonne against a landed price of Rs 2,398 per tonne for the graded coal, CLSA says. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 4

5 In the hypothetical scenario that Coal India increases its prices to global coal price parity levels, our earning per share (EPS) will rise 323% to Rs 84.2 (net profit $11.8 billion) from Rs 19.9 (net profit $2.8 billion) currently. In this scenario, our valuation for Coal India rises to Rs 1,019 per share and market capitalisation to $143 billion equivalent to Rs 6,36,350 crore, says the report. According to Religare, Coal India merits valuation of 7-9 times of EV/EBIDTA based on earning estimates of FY12, translating to a price band of Rs per share. Overseas coal players are trading in the range of 5-13 times EV/EBIDTA on CY more-say-research-firms/articleshow/ cms About the company - Coal India was incorporated in 1973 as Coal Mines Authority Limited pursuant to the nationalisation of coal mines. The company underwent a corporate reorganisation wherein Bharat Coking Coal, Central Coalfield Limited, Coal Mines Planning and Development Institute, Eastern Coalfields limited and Western Coalfield Limited became its subsidiaries. Post the reorganisation, the company was freshly incorporated in 1975 and the name was changed to Coal India Limited. The company was conferred Navratna status by the GoI (Government of India) in October 2008, which provides it with certain operational and financial autonomy. It is the largest coal producing company in the world with 81% market share in domestic market. Around 90% of coal is produced from open cast mines and the balance from underground mines. Investment rationale Increasing power capacity to boost the demand for coal Coal is the primary source of energy, accounting for nearly 53% of the total energy consumption in India. Currently the total installed power generation capacity in India is 162 GW out of which the total installed thermal power generation capacity is 104 GW of which coal, gas and diesel based power generation capacity 86 GW, 17 GW, 11.9 GW respectively. The total capacity addition in the power sector during the next five years is expected to be ~66 GW of which coal based capacity are expected to be ~52 GW. This is expected to take the total capacity of coal based power plants to 130 GM. This indicated huge demand for CIL as 80% of demand for coal comes from power sector. Overseas Acquisition to increase its assets base Considering the coal supply shortage in India, CIL is exploring the acquisition of overseas coal assets. In this regard it has taken three key initiatives: 1) CIL has acquired prospecting licences for two coal blocks in Mozambique in It has plans to enter into strategic JVs for development of the same over a period of five years (CIAL set up to carry on mining activities). 2) Formed a JV called ICVL (international coal venture private ltd) (28.7% stake) with SAIL, NTPC, NMDC and RINL (Rashtriya ISpat Nigam ltd) for acquiring coal assets outside India. 3) Also scouting for strategic partnerships for the acquisition of coal assets in Australia, the US, and Indonesia with a sum of Rs 60bn earmarked for the same. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 5

6 These initiatives would open up access to additional coal resources and enhance CIL s value. Largest producer of coal as well as lowest cost producer in the world,: Coal India is the largest producer of coal in the world. It owns 48% of India s proven reserves and contributes over 81% of the total coal production in India. Given India s abundant coal reserves and the absence of other sustainable fuel sources, the company plays a strategic role in meeting India s energy requirements. Coal India is estimated to contribute 80% of the Indian coal production in FY12 and, thus, maintain its dominant position. Nearly 90% of the company s production is from open cast mines. Moreover most of these open cast mines have a low stripping ratio, which provides the company with a significant cost advantage. Coal beneficiation will lead to improvement in the margins Currently company sells raw coal in the market which yields lower realizations as compared to beneficiated coal. Beneficiation increases the quality and gross calorific value (GCV) of coal so that it is comparable with imports. CIL currently has 17 coal beneficiation facilities with a total capacity of 39.4mt. The management expects to add 20 new facilities in the 12th plan, raising its capacity to 111mt at a total expenditure of Rs 23bn. Hence going forward increased sale of beneficiated coal will enabling margin improvement going forward. Also CIL has plans to equip all new open-cast mining projects with coal production capacities greater than 2.5mtpa (not linked to pithead customers) with dedicated coal beneficiation facilities. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 6

7 Our View The demand for coal is expected to increase at 11.2% in coming four years on the back of thermal power plants being set up in the country. CIL has a dominant position in the Indian coal industry, it caters to 53% of India s coal requirement. CIL enjoys low cost competitive advantage as compared to its peers since most of its mines are open cast mines and have low stripping ratios. Along with strong cash generation and low cost advantage and strong financials, the company is all set to tap the growing demand for coal. On the back of strong fundamentals and healthy growth prospects recommend a SUBSCRIBE for the IPO. Company Background:- Coal India (CIL) was incorporated in 1973 and is wholly owned by the Government of India. It is the world s largest coal company by production as well as reserves, having total coal production of million tons per annum (as of 1 April 2010) and reserves of billion tonnes. As of March 31, 2010, it has its operations spread across 471 mines in 21 major coalfields across eight states in India, of which 163 are open cast mines, 273 are underground mines and 35 are mixed mines (which include both open cast and underground mines). Most of the coal is produced from open cast mines; hence it has the lowest cost of production. The company has plans to undertake 45 projects comprising 22 capacity expansion projects for existing mines and 23 new mine projects. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 7

8 Objects of the issue:- The objective of the issue is to divest 10% of GoI Equity shares of CIL. Financial Performance:- Coal India s revenues grew at a two-year CAGR of 17.0% to Rs 467 bn in FY10 primarily on account of 5.5% CAGR in sales volumes and 10.8% CAGR in average realisations over FY The increase in notified prices and sale of coal under market-linked prices through E- Auction and MoUs has resulted in increase in the average realisation. The company had announced an average rise of 10% and 11% in December 2007 and October 2009, respectively, for the notified prices. It has sold 8.1%, 12.9% and 11.6% of its total sales volumes in FY08, FY09 and FY10, respectively, at market-linked prices through E-Auctions. The company s EBITDA margins dipped to 15.7% in FY09 as a result of increase in employee costs. The upward revision in wages under National Coal Wage Agreement VIII and the executive pay revision led to a 51.7% increase in overall employee cost in FY09. The increase in prices in October 2009 to offset the rise in costs and, higher sales at market linked prices resulted in margin increase to 27.6% in FY10. The EPS of the company grew at a two-year CAGR of 51% to Rs 15.6 in FY10. The RoE increased to 38.0% in FY10, in line with higher profitability. As on FY10, the company has cash and bank balance of Rs 390 bn and net worth of Rs 258 bn. Since this is an offer for sale by GoI, the company would not receive any proceeds from the IPO and there would be no change in equity of the company. CRISIL has assigned a CRISIL IPO Grade 5/5 to the proposed initial public offer (IPO) of Coal India Ltd (Coal India). The grade indicates that the fundamentals of the IPO are strong relative to the other listed equity securities in India. Also, the grade should not be based to price the issues or purchase or sell or hold decisions. CRISIL Narration: The assigned grade reflects Coal India s dominant position (81% market share) in the Indian coal industry, catering to 53% of the country s energy requirement. The demand for coal is expected to increase at an annual rate of 11.2% over the next four years on the back of increase in thermal power plants being set up in the country. Coal India enjoys cost ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 8

9 competitive advantage over international players since nearly 90% of its production is from open cast mines and have low stripping ratios. As a result, the notified prices of Coal India are significantly lower than imported coal prices adjusted for calorific value. The grade also takes into account the de-controlled pricing regime and Coal India s ability to increase coal prices in the past. Further, the company has been gradually increasing its mix of market-linked price sales, which has further boosted its profitability. As of March 2010, the company has a cash and bank balance of Rs 390 bn. We believe this, together with its strong cash generation and very low gearing, would enable the company to pursue growth opportunities globally and also comfortably fund its capital expenditure plans of Rs 84.5 bn over the next two years. However, ability of the management to deploy the surplus cash in productive assets would have a bearing on its return on equity. The grade also factors in a highly experienced management, credited with the successful launch of market-linked sales and turning around loss-making subsidiaries. However, several socio-political factors limit CIL s operating flexibility. Delays in regulatory approvals, such as forest clearance, are an industry-wide concern and also remain a challenge for the company. Any adverse change in the regulatory regime on pricing regulation and restriction on mining area could have a material impact on our grade and remains a key monitorable. Summary - Government of India-owned Coal India produces and sells coal in the country. It is the largest producer of coal in the world and has the largest resources of 64.8 bn tonnes. In FY10, it produced 431 mn tonnes of coal, which accounted for 81% of the coal production in India. The company owns and operates 471 coal mines 163 are open cast, 273 are underground and the rest are mixed. Coal production is carried out by the seven subsidiaries of the company. Another subsidiary Central Mine Planning and Design Institute Limited (CMPDIL) carries out mine exploration and development works for the coal-producing subsidiaries. In , the company reported turnover of Rs bn and net profit of Rs 98 bn. It posted EPS of Rs 15.6 during the same period. Coal India s RoE for the year was 38%. Through the IPO, GoI plans to dilute 10% of its holding. Being an offer for sale, the corpus from the IPO would go to the government. ETHICAL WEALTH CITY INVESTMENT SERVICE PVT LTD, 12/27, MADDOX STREET, CHOOLAI, CHENNAI-112 Page 9

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