Stock Review: COAL India Limited (CIL)

 

Operating margin for CIL should firm up further due to price hikes and also from an increase in inventory despatch. But a lag in environmental approvals and lack of transportation rakes may weigh heavy

   COAL India Limited (CIL) offers an attractive buying opportunity for long term investors due to the increasing demand for coal in the country, which is seen boosting its earnings. Also, the environment ministry's softening of stance on mining is seen auguring well for the company.

BUSINESS:

Established in 1973, CIL is a subsidiary of the government of India. It is the world's largest coal producing company with a production at 431.26 million tonne in 2010. With a total reserve of 18,862.9 million tonne, it also has the largest coal reserves in the world. It produces non-coking coal and coking coal reserves of various grades. Non-coking coal represents over 90% of the total production. Its customers include thermal power generation companies, steel and cement producers and other industrial companies.

   Its operations are carried out through seven wholly-owned subsidiaries in India and one in Mozambique. Additionally, it also has a wholly owned subsidiary, CMPDIL, which carries out exploration activities of subsidiaries and provides technical and consultancy services to CIL and third-party clients as well.

GROWTH DRIVERS:

CIL will benefit from the increasing demand for coal in the coming years. In the next five years, demand for coal is expected to rise at a compounded annual growth rate of 12%, but production is estimated to grow at a CAGR of 5-6%. Coal deficit is expected to increase by 150 million tonne by FY15 which will lead to rise in demand.

   Differential pricing strategy adopted by CIL would increase the average realisation per unit. In the past month, it increased prices of coking and non-coking coal. Power utilities, fertiliser and defence sectors would be exempted from this, but sectors whose products enjoy market driven prices will face 30% price hikes. Also, the coal sold under e-auction would see a price jump of 30%. These together represent over 30-35% of the coal produced. As a result of these price increments, net sales would grow at 15-16% despite lowered volume growth guidance for FY12 of 2%. Out of the company's nine coal mining companies, two were loss making. After restructuring, both subsidiaries have turned around and going ahead, a stronger performance can be expected.

TRIGGERS:

CIL has a cash of 39,100 crore on its balance sheet. Given the shortage of coal supply in India, CIL is consistently looking for acquisitions outside. Any such acquisition would increase the earnings per share of the company. Also, softening of the government stance on mining will boost production.

FINANCIALS:

The company's net sales for the first nine months of FY11 are 35,217 crore and net profit is 6646.4 crore. We expect a growth at CAGR of 15% for another five years. Operating margin for CIL was 22% in FY10. This should improve due to price hikes and also from increase in the inventory despatch, which is very high currently due to infrastructure bottlenecks. The company is planning a wage hike in July 2011, which will partly lower the growth in    operating margins.

   The company has a strong balance sheet with a net worth of 25,800 and cash of 39,100 crore and robust operating cash flows.

VALUATIONS:

On annualising 9-month earnings, it is trading at a price-to-earning multiple of 32.8. Given the strong earnings growth estimate for another five years, strong return ratios and cash flows, we believe CIL is a good buy. However, possible delay in environment clearances and lack of transportation rakes are concerns for the company, going ahead, and can adversely impact earnings and return ratios.