A silver lining for Coal India's profitability

The government’s decision to auction coal linkages for non-regulated sectors is reason enough for Coal India’s investors to cheer.

The fresh auctions can lead to improved realisations for supplies to non-power sectors, which accounted for about 12% of Coal India’s FY15 production, as per analysts.

Kotak Institutional Equities’ analysts estimate that this could lead to incremental earnings of Rs 2,100-3,000 crore, resulting in an increase in their fair value estimate of Coal India by Rs 33-48/share.

However, few others like Kamlesh Bagmar at Prabhudas Lilladher believe it may be a bit early to quantify the gains. He says while the company would benefit from the auction as it will improve realisation of coal equivalent to 58 million tonne (MT), due to absence of data related to grades of coal within linkage coal, it is difficult to quantify the impact on earnings. Therefore, more clarity is likely to emerge as the process progresses.

The Street’s cheer nevertheless was reflected in Coal India share price that jumped 4.44% to Rs 405.60 on Friday and over 1% on Monday, even as broader indices were in the red. Given the consensus target price of Rs 431, as per 21 analysts polled on Bloomberg in June, it seems there is more upside left.

The latest move has also eased some concerns. In the past, as coal supplies to the power sector increased under the Fuel Supply Agreements (FSA), Coal India saw a decline in e-auction volumes that fetch higher prices, thereby impacting its profitability. The Street has been anticipating price hikes by Coal India to mitigate the same.

Analysts at Barclays said that no decision has been taken on the price hike as yet and the management feels any future price hike will depend on a combination of three factors namely international prices, company’s cost of production and marketability/demand in the domestic market. In this backdrop, the news of fresh auction to non-regulated sector is positive.

On the other hand, production and off-take are also increasing. For first two months (April-May) of FY16, Coal India’s total production/off-take stood at 82.5 MT and 87.3 MT (up 11.8 and 7.4% year-on-year, respectively).

Analysts at Nomura say, “Relative to company’s 2M’FY16 MoU-based targets, production was in-line but off-take was lower by 5%.” However, they add that the robust output growth seen in 2M’FY16 bodes well for FY16 targets.

Analysts at JM Financial are factoring in 530 MT of production (increase of 7%) and 535 MT in dispatches (9% growth) in FY16 as they expect e-auction volumes also to pick up.

Analysts at JM Financial are factoring in 530 MT of production (increase of 7%) and 535 MT in dispatches (9% growth) in FY16 as they expect e-auction volumes also to pick up.

Analysts at Centrum believe that re-rating is imminent as roadmap for increasing production has been laid out and focus on easing logistical problems provides strong volume growth visibility as they expect EBITDA/profits to grow CAGR of 18.7%/14.8% during FY15-17.