Coal India - Ready to Fire Up The Portfolio
![]()
How many Navratnas and Maharatnas do we have in the country? Many would think the answer is Nine Navratnas but the fact is that there are 15 Navratnas and four Maharatnas, of which 13 Navratnas and four Maharatnas are already listed on the bourses. Coal India, a Navratna com-pany, would be only the second but last company (amongst Navratnas) to go public when its IPO would open in the month of October. (Hindustan Aeronautics then would be the only Navratna not listed on the bourses.)
Coal India has some of the unique features that separate it from other leading Navratnas. First it’s the world’s largest producer of coal and no other PSU company can claim “world’s largest” tag in its area of operations. Second, it has no substantial opera-tions of its own but derives its revenue mainly through its eight subsidiaries, which makes it a unique structure amongst the PSUs. Out of the eight subsidiaries, as many as six have mini Navratna status, which no other PSU companies can boast of. This gives the company a lot of management bandwidth to meet future challenges. Last, but not the least, Coal India IPO would most probably be the biggest ever IPO in the history of India with issue size in the range of Rs 14,000-16,000 crore (depending upon the price band).
The company for the year ended March 2010 reported consolidated total income of Rs 51,925 crore crore with net profit of Rs 9,829 crore, mak-ing it the third highest profit making companies amongst the PSUs and the fifth highest amongst all listed compa-nies in the country. The company saw its net profit jumping smartly from Rs 4,063 crore of FY 2009.
India has no listed players in the coal mining and hence there is not much information known to the investing community. To understand the coal business and the business dynamics of Coal India, we have looked at the critical functions of the company to understand where it stands and what the investors at large can look for-ward from Coal India IPO. Also, the company is into commodity business where demand and supply plays very important role in deciding the profit-ability. Of course, not to forget that Coal India being a PSU company even the government policies have a sub-stantial role in determining the price it can charge to end users, despite the fact that the coal price was deregulated in 2000. We all know what has happened to oil marketing PSUs when it comes to pricing of fuel for customers. Our story has looked at all these aspects to understand the valuations Coal India should command so that readers are future ready when the largest ever IPO in the history of the country hits the market. Let us start with the company’s operations as this is very critical for any company to offer returns to the investors.
Operations
Coal India operates 471 mines of which 273 are underground mines and 163 mines are open cast mines. Despite having larger number of underground mines, coal production from these mines is very low. For the FY 2010, Coal India produced 431.26 million tonnes of coal of which only 43.25 million came from underground mines accounting only for 10 per cent of the total production. In fact, this is the lowest ever production from under-ground mines in last five years (we are not able to make comment beyond this period for want of data). Due to falling production from underground mines, its share in total production fell from 13.3 per cent of FY2006 to 10 per cent in FY2010. Please note that the company deploys almost 55 per cent of the total work force in these mines as against open cast mines where it deploys 25 per cent. This is one area where the company needs to improve its efficiency. Due to the higher num-ber of employees and less production, most of the underground mines are loss making. “Nearly 250 underground mines are making losses” reveals Partha S Bhattacharyya, Chairman, Coal India. Bhattacharyya further adds that the company’s eight per cent of the production comes from loss making mines. On the other hand, open cast mines are more profitable, with only one or two mines making losses.[PAGE BREAK]
To understand poor performance of underground mines one needs to rewind the history of coal sector. When coal mining was nationalized it was mainly underground mines and they were not as efficient as one would have expected them to be. “At the time of incorporation of Coal India, we had near about 650-700 underground mines,” reveals Bhattacharyya. Over the years company reduced the num-ber of underground mines through amalgamations and, in some cases, closing down the mines through con-sensus with labour. “Every year we are closing down at least 7-8 loss making underground mines,” informs Bhattacharyya. Due to this, the num-ber of underground mines are reduc-ing. As per Ministry of Coal website, as on March 2004 the company had 295 underground mines and 144 open cast mines as against the current 273 underground mines and 163 open cast mines. The process of closing down mines that are not feasible to oper-ate would continue and this could improve the profitability for the com-pany. In fact, company needs to aggres-sively look at the same to shore up its profitability.
Pricing of Coal
Profitability in any business is a function of price you are able to com-mand. In India, demand for coal is higher than supply. Despite having almost monopoly in the business with 81 per cent share in production, Coal India continues to charge price lower than what it should be charging. We strongly believe that pricing is one area where Coal India has great scope for improvement. Despite price of coal being deregulated (sometime in 2000), the company continues to get prices lower than the market price or landed cost of coal. This is evident from the reply given by Minister of Coal Sriprakash Jaiswal to the query of Badruddin Ajmal in the parliament on August 04, 2010 when Jaiswal stated that the price being charged by Coal India is lower than the price of imported coal. He further went on to add that “Coal India does not at pres-ent have any plan for bringing parity in prices of domestic and imported coal”. He further stated “while fixing the prices of domestic coal, the interest of the end-use consumers is taken into consideration so as to minimize the impact on the national economy”.
The price of coal got deregulated from January 2000 and since then there have been four significant revi-sions in the price of coal starting from January 2001 when price of coal was increased by 8.5 per cent and the last revision being in October 2009 when the average price was increased by 11 per cent. “Whenever we have asked for an increase in price, no one has said no,” emphasizes Bhattacharyya. But Bhattacharyya candidly admits that the price of their coal is 30-60 per cent lower than what it should be as coal produced by the company is not con-sistent and not washed. “We are willing to take ‘inconsistent’ penalty”, declares Bhattacharyya.
The October 2009 price increase helped the company improve its real-izations and in turn the profits for FY2010. Please note that the average annual price increase in last one decade has been 4.5 per cent which is less than inflation rate during the same period. We believe that as we move along there could be more price increases thereby improving profitability for the company. [PAGE BREAK]
One more advantage the company would have is that it has started e-auc-tion of its coal and that is helping the company improve its realizations. The company sold 28.79 million tonnes of coal through e-auctions in the year 2007-08. But last year the volume took a marginal beating to 45.73 million tonnes as against FY09 figure of 48.87 million tonnes. The company’s realiza-tion is much better in e-auctions. “The price of raw coal sold under e-auctions is significantly higher than the price of raw coal sold under our FSA (fuel supply agreement)” reveals A K Sinha, Director-Finance, Coal India. This is evident from the fact that Coal India sold 11.6 per cent of the total vol-ume through e-auction, but the same accounted for 16.2 per cent in terms of revenue. Our estimate is that the company should be getting near about 60 per cent premium in e-auction as against the notified price. Also, note that in the last two years, average real-ization through e-auction has improved by 17.5 per cent from Rs 1,346.73 per tonne of FY08 to Rs 1,582.8 per tonne in FY10. The Planning Commission has suggested that coal sales through e-auction should be 20 per cent of the production, but it’s unlikely that Coal India would be able to sell that much through e-auctions. We believe that the company would sell near about 10-11 per cent of total production through e-auctions as there is the logistics issue of despatching the coal to the e-auction buyers. Also, there is an incentive for Coal India to sell coal through FSA to power generating companies wherein if they sell more than 100 per cent of the coal requirement to power companies they get incentive of 40 per cent on the price on incremental supply. Right now, average supply under FSA stands at 96 per cent.
E-auctions along with other mea-sures helped the company improve its average realization per tonne to Rs 1,045.26 as against Rs 841.14 in FY08. This gives CAGR hike of 11.47 per cent in its realization. With production and realization improving, the com-pany could see its financials improving going forward at a healthy clip.
At the same time, the company is selling high quality non-coking coal at better realization where the price of coal is fixed at 15 per cent discount to the imported coal (unlike other coal which is sold at discount as high as 40-60 per cent). This is another positive step that is helping the company to improve its financials. We are of the opinion that in the next few years, the company should see its average realization per tonne improving substantially as it would go more for washing of coal through beneficiation process (by which the ash content in coal is reduced and gross calorific value increases). The company is looking actively at washed coal as a part of improving realization where all plants having 2.5 million tonne capac-ity would have inbuilt washery and this would mean that in future more revenue for the company would come from washed coal than at present.
The company this year would get full benefit of the price hike in October 2009 as last year the company could get the benefit only for a part of the year. This would mean that the compa-ny should see its financials better when it would declare its FY11 numbers. We will look at our projected numbers in the later part of the story.[PAGE BREAK]
Environmental and Naxal Impact
India is fourth largest polluter in the world and hence environmental issues assume greater significance. Also, there has been larger movement to protect the environment with more and more people becoming conscious of protecting the environment. There is no doubt that coal mining and power produced through coal causes lot of damage to the environment. Finance Minister Pranab Mukherjee in its budget speech of February 2010 had stated, ”Harnessing renewable energy sources to reduce dependence on fossil fuels is now recognized as a credible strategy for combating global warming and climate change”. With this fact in mind, the government imposed Rs 50 per tonne as a clean energy tax on domes-tic as well as imported coal in the last budget. Also, the Government of India has voluntarily accepted cutting down its carbon intensity per unit of GDP by 25 per cent by 2020 from 2005 levels. Keeping these facts in mind we believe that there could be more taxes on the coal industry. Please note that Coal India would be contributing almost Rs 2,300 crore as Clean Energy Tax this year. This amount could keep increas-ing as company would be increasing its production in the coming years. Due to great shortage of coal in the country, we expect the company to pass on the cost to the end consumers.
Coal India has been doing a won-derful job for minimizing the impact on the environment. The company has increased its budget for CSR (Corporate Social Responsibility) five times. “We have increased our alloca-tion to CSR from Re one per tonne to Rs 5 per tonne or five per cent of retained earnings, whichever is high. This means that even the loss mak-ing unit has to provide for CSR,” says Bhattacharyya proudly. Coal India has also implemented satellite surveillance for land reclamation, restoration, refor-estation and rehabilitation activities. The system was introduced in FY09 to monitor open cast mines and the com-pany claims that the result of the same has been very positive. “Due to our efforts on environment, we have been able to bring in positive climate change where a place like Singrauli’s aver-age maximum temperature has come down, rainfall has improved by 10 per cent and migratory birds have started visiting the place. We have already planted 73 million trees till now”, informs Bhattacharyya. According to him, environment care priority is next only to coal production. Despite many efforts done by Coal India, more is needed to be done and we have a strong feeling that in the years to come we would see Coal India spend-ing more money on the environmen-tal related expenses with the norms on environment becoming more and more stringent.
Naxalism is another factor which could impact the company’s operations as most of the states where the com-pany has coal mining operations are Naxal-infested. In fact, the Ministry of Coal admitted in the parliament that Central Coalfields (Coal India’s 100 per cent subsidiary) operating mines in Jharkhand has seen production loss due to Naxal movement to the tune 11.50 lakh tonnes (about Rs 100 crore plus) in FY10. Our worry is that this figure is on the rise every year and in first three months of the current year same stands at 11.26 lakh tonnes, almost equal to last year’s figure. If this movement spreads, it could impact not only its subsidiary Central Coalfields, but also operations of other subsidiaries.[PAGE BREAK]
Huge Work Force
Coal India has huge labour force of 3.97 lakh as on March 2010. This would probably be the largest work force among the listed players. Due to this large labour force, its cost of employee to revenue is high as compared to the other peer players. For the year ended March 2010, the labour cost accounted for 32 per cent of the company’s revenues, but the good news is that it has declined from 43 per cent of FY09. The company had 4.26 lakh employees as on March 2008 which has come down to 3.97 lakhs now. “We have been able to reduce our work force due to natural attrition of 3 per cent every year,” informs Bhattacharyya. Presently, the average age of Coal India employees is 47-48 years. Going by the past trend, it is expected that the company would continue to see its employee numbers going down without impacting growth in production. The company, despite reducing the work force, managed to improve its production of raw coal from 379.46 million tonnes in FY08 to 431.26 million tonnes in FY10, while number of employees reduced from 4.26 lakh to 3.97 lakh. In other words, in the last two years, production of raw coal improved by almost 14 per cent despite number of employees reducing by almost seven per cent. “Our cost of production is one of the lowest in the world when it comes to open cast mining as our manpower plus machine productivity is fairly high”, says Bhattacharyya with pride. We are of the opinion that better realization and higher coal production would improve its topline, while reduced labour cost should help the company in pushing down its employee cost to sales ratio resulting in better margins. Three per-cent reduction in number of employees would mean four per cent savings in total cost, as senior people retiring have higher wages. Our calculation suggests that four per cent reduction in labour cost would mean that the company could save almost 125 basis points in its margins, assuming that the topline remains the same.
Good Reserves To Last At Least 45 Years
In the mining business, it is essential that you have good reserves as this gives good visibility to the business. As the land bank is to real estate companies and the order book position is to engi-neering companies, so are reserves for mining companies to sustain its future operations. Coal India has 64,786 mil-lion tonnes of coal reserves, of which 52,546 million tonnes are proven reserves while 10,298 million tonnes are indicated reserves and the rest are infer-ence. Based on this, the extractable coal reserves are estimated at 21,754 million tonnes. Going by the current annual production, the existing reserves should last more than 45 years of coal mining. This means that the company has good amount of visibility when it comes to reserves. Please note that the reserves figure can keep increasing based on the coal blocks the company can get from the government from time to time. Also, the company has one wholly owned subsidiary in Mozambique where it has bagged two coal blocks. It would take at least five to six years before the company starts coal mining there. Also, the com-pany is sitting on huge cash and bank balance of Rs 39,000 crore. This money may be used for acquiring mining assets within or outside India and this can help improve reserves of the compa-ny. Please note that the proposed IPO is 10 per cent divestment from Government of India and hence the company will not receive any money from the IPO.
Financials
Coal India has very limited opera-tions on its own and derive majority of its revenues from its eight subsid-iaries. Hence, instead of looking at the standalone numbers, one needs to look at the company’s consolidated revenues. The company reported con-solidated revenue of Rs 51,925 crore with net profit of Rs 9,829 crore for FY10 as against last year’s sales figure of Rs 45,930 crore and net profit of Rs 4,063 crore. The company equity capital stands at Rs 6,316 crore, giving it a healthy EPS of Rs 15.56.[PAGE BREAK]
Valuations
Coal India is coming out with an IPO of 63.16 crore shares. In fact, there is no fresh issue of equity shares as the Government of India is divest-ing 10 per cent stake in the company. Since there is no coal mining company that is listed in the country one has to look at the valuations commanded by peer players in the international market. Based on P/E being com-manded by international coal players, one can assume that P/E should be in the region of 15 times for Coal India. Another PSU player NMDC, which is into iron ore mining, is presently commanding P/E in the region of 29 times. We are expecting the company to report net profit in the region of Rs 11,800 crore. This figure has been arrived considering demand and sup-ply situation of coal in the country, price hike in coal prices since October 2009 the benefits of the same would be available for the full year FY11, reduction in number of employees, company selling good quality coal at import parity price and, last but not least, company’s projection to produce 460.5 million tonnes of coal this year. Based on P/E of 15x, the company should have market cap in the region of Rs 177,000 crore. This gives us fair price of Rs 280 per share. Since investors can look forward to a certain gain, we expect the company to price the IPO in the band of Rs 230-250 per share.
In the last one year or so, the PSU IPOs have left a sour feeling amongst investors with almost all, barring Oil India IPO, quoting below the offer price. This despite the market senti-ment improving to a great extent in recent times. We are of the opinion that Coal India should come up with attractive valuations so that the inves-tors at large can once again have faith in the PSU companies. This would help investors to come back in the primary market as most of the mega IPOs have disappointed the investors. Coal India is offering five per cent discount to the retail investors but that does not take away the need to make the issue attractively priced. We expect good sense to prevail with Coal India management and the Department of Divestment while pric-ing the IPO. Let us hope that the Coal India IPO would reenergize the dull IPO market.