Coal India Ltd’s (CIL) public issue will see the government divest a 10% stake, issuing shares in the price range of Rs225-245 a share.
Investors have to cut through the euphoria of all the firsts associated with the CIL issue, to decide on whether to invest in it. The coal business and its future prospects are evident. India is a power-starved nation with large coal reserves of low quality, which are suitable for thermal power generation. The number of thermal power units being set up should ensure there is enough demand for coal for many years to come.
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India imported around 12% of its coal consumption for fiscal 2010, to meet the supply gap. The issue is not of demand, but production. CIL produced 431 million tonnes of raw coal in fiscal 2010, around 6.7% more than in the previous year. In fiscal 2011, its production is projected to rise by around 7% and by around 6% in fiscal 2012. With tight supply conditions and decontrolled prices, coal companies could theoretically get good realizations.
But CIL states in its prospectus that prices are hiked, in consultation with the government, to meet cost increases and are lower than international prices. The objective is avoid price shocks to the power sector, its main consumer, which will affect costs to end users. CIL’s margins are still good due to the relatively cheaper cost of labour and most of its production being done through open-cast mining. In fiscal 2010, for example, average price of raw coal was Rs926 a tonne, while its cost of production was Rs750 a tonne.
If the ability to hike prices is limited, then performance can improve through increasing production. CIL’s expansion projects will see its capacity rise by 48 million tonnes by the end of fiscal 2012.
That will bring in additional revenue. It is also planning to grow the share of sales of beneficiated coal, from which impurities have been removed by washing, which gets better realizations by installing facilities for the same. Since October 2009, it has also started import parity pricing for higher grade coal.
The key risks for the company are in the medium term: the effect that a proposed change in mining laws could have, especially if mining companies are required to share 26% of their profits with local populations. This would affect all mining companies, including CIL.
Wages are a key cost for the firm and its wage agreement will end in July 2011. A hike in wage costs could affect margins, unless CIL is allowed to pass on higher costs to its consumers. While a fall in international coal prices will have some impact, since its long-term contracts are already at a discount to international prices, its realizations are unlikely to come under pressure.
In fiscal 2010, CIL’s sales rose by 15% to Rs44,615 crore and its net profit rose sharply, due to one-time wage related adjustments in the previous year. In fiscal 2011, its performance will reflect the full effect of the 11% increase in coal prices from October 2009. At the higher end of the IPO price range of Rs245, the issue is valued at about 15 times its fiscal 2010 per share earnings. Sales and profit growth are likely to grow at moderate rates, till the company’s efforts to improve margins bear fruit. That is reflected in its pricing, which can be said to be fair. The issue calls for long-term investors who are keen on investing in what is essentially a steady state business. And while stock movements in the short-term are always uncertain, the fact remains that the stock will form part of the core holdings for institutional investors and also part of the main indices.
Graphic by Yogesh Kumar/Mint