IPO Review: Coal India

 

 

IPO details

Company Name: Coal India Ltd

Issue Size: 14,000-15,200 cr

Price Band: 225-245

Issue Date: Oct 18-Oct 21


STATE-OWNED Coal India (CIL) plans to hit the capital markets with an offering of 63.16 crore equity shares in the price band of 225-245. The company has proposed a discount of 5% to retail investors and its employees who are eligible to subscribe to the offering. The sale of shares is aimed at divesting 10% of the government's stake which would mean that the proceeds from the issue would flow to the government. After the initial public offering or IPO, the government's stake would come down to 90%.

   At the offer price, the price-to-earnings, or PE, ratio of the company works out to 13.7-14.9 times for retail investors, based on FY10 financials. In the local market, the broad peer group could include Sesa Goa, mainly an iron ore mining company, which trades at a P/E of about 11 times FY10 earnings. While the scale of operations of CIL is much bigger than Sesa Goa, the comparison does give an indication that the pricing is not cheap, despite all the hype surrounding the issue.

   That aside, the company has a business with low commercial risk, huge prospects and is attractive from a long erm holding perspective. Investors may subscribe to the issue taking these factors into account.

BUSINESS & FINANCIALS:

Coal India is the largest coal producer in the world with a production capacity of 431 million tonne in FY10. It has also the largest reserves at 10.6 billion tonne of proved and about 8 billion tonne of probable reserves. It is currently undertaking 25 mine development projects, which would add nearly 47.5 million tonne of new capacity by the end of FY12. The reserves are enough to produce coal for 20 years, with an average annual increase of 6% in production. The company carries out mining operations through its seven subsidiaries, which offer some flexibility in operations.

   Nearly 90% of its production is through open cast mines, which are cheaper to produce but with a higher environmental impact. The company has stated the need to explore more under-ground options, where the production cost is almost five times that of open cast mines, as a longterm strategy and given other compulsions such as land scarcity and environmental pressures. It may be noted that mining is predominantly under-ground globally.

   Coal India has recorded nearly 12% annualised growth in sales between FY06 and FY10 and 14% in FY10. Employee costs, which form nearly 43% of the total cost of production, rose at a higher rate of 14% during the four year period, due to wage revision undertaken during this period. However, other costs grew at a lower rate leading to more than two percentage

   point increase in operating margin. A key feature of the company's operation is high free cash-flow generation, which has led to accumulated cash reserve of nearly 38,000, which alone works to nearly 60 per share, or about one-fourth of the offer price.

OUTLOOK:

The company is constrained by the fact that it has been unable to scale up its operations and managed less than 6% CAGR growth in production during FY06-10, despite a huge demand- supply gap. Sales and profits could grow at about 12% during the period, mainly due to higher realisation. This has been achieved through a combination of price increases, which averaged less than 7% annually between FY06 and FY10, and increasing sales through e-auction, where the price is a rough reflection of the market price. While the company has the right to revise the sale price, it has to do it in consultation with the government, which puts a cap on price revision. Since 2000, the state-owned company has undertaken only four price revisions and the current price is at nearly 50-60% discount to the global prices.At the same time, there is no scope to increase the share of sale through eauction due to the company's obligation to sell according to the government-proposed allocations. It now sells around 10% of its total volumes through e-auctions realising a price of around 50-60% more than on its rest 90% of sales, which are governed by long-term sale contracts.

   There is a significant scope for value addition through beneficiation, or washing of coal, which improves the burning quality of fuel apart from easing the transportation. However, none of this is going to come on stream before FY14. The company is developing 20 beneficiation facilities with a capacity of 111 million tonne annually which would take the share of beneficiated coal to 10% from 4% now by FY15. Washed coal is sold at nearly double the raw coal price and cost increase of about 30%, going by the current cost structure, offering huge improvement in margin expansion.

   A proposal which is now doing the rounds that 26% of the profits of mining companies be set aside for those displaced due to their projects could be a dampener. If implemented, this will hamper the profitability of CIL, unless it is able to pass on the impact to the final consumer.

RECOMMENDATION:

The stock is a good long-term bet with steady cash flows and limited risk to profitability. It may also turn out to be a high dividend paying stock, with huge cash reserves, minimal debt and limited cash requirement for its expansion plans for the next few years. However, the company's ability to accelerate earnings until FY14 is limited and it may not be able to record profit growth beyond the previous four years' average of 12-13%. The offer price factors in the growth expectation, leaving not much room for short-term appreciation. Investors can subscribe to the issue keeping these factors in mind.