Can Coal India crash to ₹300 per share?

The performance of Coal India as an investment has been a mixed bag, with outcomes varying significantly based on the timing of investment. For those holding the stock for nearly a decade, the returns have been less than stellar, contrasting sharply with the experiences of those who entered the market three to four years ago. This situation challenges the conventional wisdom regarding the benefits of long-term investing.

A glance at Coal India's 10-year price chart reveals a startling stagnation: the stock's price in July 2015 mirrors its current value. Despite reaching a peak of approximately ₹450 per share in mid-2015, it took nearly a decade for the stock to revisit these levels. Investors from 2015 have only recently seen their investments return to their initial values, notwithstanding the substantial dividends paid out over this period.

For investors focused on capital gains, the stock's trajectory has been disappointing, especially for those who bought in during or before 2015-16. However, the narrative shifts for investors who bought shares in the aftermath of the 2020 market crash triggered by the coronavirus pandemic. These investors have witnessed their capital quadruple in value over a span of three to four years, thanks to a robust resurgence in the stock's performance, outpacing the benchmark index.

Coal India's financial performance post-2015 played a role in its stock's underwhelming returns. After posting a profit of ₹143 billion in FY16, profits halved by FY18, significantly impacting the stock's price. 

Not surprising then that from a high of ₹440 in 2015, the price plummeted to around ₹240 by 2017, continuing to decline to a quarter of its value by 2020.

Despite a profit recovery in FY19 to ₹175 billion, investor confidence remained low, influenced by the broader skepticism towards PSUs and environmental concerns related to coal. The company found itself to be a pariah among fund managers and chief investment officers whose mandate was to invest in stocks with a high ESG score.

The stock hit rock bottom to ₹110 per share, offering a price to earnings (PE) ratio of a mouth-watering 4.8 times, but the negative sentiment around coal and its environmental impact kept many investors at bay.

A government monopoly with a teflon-coated balance sheet and a dividend yield of almost 10% was there for the taking. However, investors seemed to be busy playing, 'once bitten, twice shy.' 

However, a shift occurred as investors recognized the undervaluation of Coal India amid its financial recovery and the premature dismissal of coal's relevance. The company's EPS more than doubled in two years to ₹46 per share by FY23, buoyed by increased demand for coal, underscoring its continued importance in India's energy mix. This realization, coupled with efforts to reduce its carbon footprint, revived interest in Coal India's shares, propelling the stock price to quadruple since its 2020 lows. 

What is more, the investing community also began to realise that given India's rapidly growing thirst for power and the slow pace of capacity augmentation in renewables, thermal power plants will continue to play an important role and consequently, demand for coal will also go up.

Put differently, coal will keep playing an important role in the country's energy matrix. So, these couple of important factors combined with Coal India's own efforts at reducing its carbon footprint, has rekindled investor interest in company's shares. This has led to the company's share price going up by more than 4 times since its lows of October 2020.

And in an interesting example of how the sentiments quickly change, most brokerage houses are now positive on the stock. This is in stark contrast to the largely lacklustre reports that the very same brokerage houses used to churn out few years back.

However, there's one report that has forecast dark days ahead for the coal mining behemoth. In fact, it has argued that the company's stock could crash to ₹300 from the current levels. The report feels that there near-term pressure on the company's earnings on account of an expected drop in average realizations. It has also flagged long-term headwinds such as easing of coal prices globally, growth in renewables, greater efficiencies and private sector competition, as the key reasons behind the steep fall anticipated in the company's share price.

Please note that a lot of other brokerages are positive on the stock and have also increased their target price for Coal India.

From a personal analysis perspective, evaluating Coal India involves considering both external valuations and internal factors. Currently, the stock trades at a PE ratio of around 9 times, appearing undervalued against its historical median. The risk of a significant price crash seems low, barring a broader market downturn.

When the stock crashed from ₹450 to ₹110 over a span of five years, Coal India's PE at its peak was around 20 times.

Thus, right now, it is nowhere close to that point. In fact, it is currently trading at less than half of that. From a valuation standpoint therefore, the risk of a big crash in the company's stock price does appear to be on the lower side unless there is a crash in the entire stock market.

As far as the internal factors go, these are more difficult to analyse and they are mostly about what the earnings per share of the company will look like 1, 3 and 5 years from now.

Here, I try to follow the Warren Buffett's motto of trying to be approximately right than precisely wrong. Put differently, don't try to be too precise while trying to arrive at the company's EPS few years down the line. A broad approximation will work just fine.

So, here's what we should do. We should try to answer the following set of questions with a simple 'yes' or 'no'.

Are the company's valuations so high that a small drop in earnings can lead to a huge fall in the company's share price?

Also, are the company's valuations so low that a small rise in earnings can lead to a huge rise in the company's share price?

Well, my answer to both the questions would be a big 'no' in my opinion.

Neither are valuations too high, nor are they near the lows of 2020. Hence, the best option in such cases is to have a wait and watch approach.

One should wait for few quarters and see how the earnings pan out. If they improve a good deal, then the share price will most likely go up. And if they fall then the share price may also fall a bit.

I guess the days of easy money in Coal India seem to be behind us. But that doesn't mean one should exit the counter. A good judgement with a cool head is your best bet currently.

Happy Investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com