Coal India: production high but valuations low as stake sale looms

This year, so far, has been evidently better for Coal India Ltd (CIL) as far as production and offtake volumes are concerned. For instance, production and offtake (or sales volume) for the first six months of FY16 increased 8.9% and 9.3%, respectively, reasonably higher than the past two years’ growth rates for the same period. In fact, September offtake improved by an impressive 15%, which is the best monthly growth in recent years.

CIL’s September production increased 6.6%, faster than the previous two months, albeit slower than the June quarter.

But investors don’t seem to be impressed. After outperforming the Sensex for most part of this year, more recently, CIL shares have underperformed substantially. The stock is down about one-fifth from its high in August. The proposed government stake sale is one of the key worries.

As Jefferies Research says, the government’s plan to divest 10% stake in CIL has contributed to the sharp correction in the share price in August due to the expectation that it would divest its stake at a discount to market price. While the stake sale could be deferred/ postponed given the sharp fall in the share price, this could remain an overhang on the stock.

Moreover, lack of price hikes on volumes sold through fuel supply agreements (FSA) and decreasing e-auction prices are also playing spoilsport. “Our analysis of India’s coal consumption suggests that the decline in e-auction realization is not only a factor of lower global thermal coal prices, but could equally be due to the fall in domestic coal consumption,” said a Motilal Oswal Securities Ltd report on 5 October. Some analysts expect normalization post-monsoon and recovery in domestic industrial activity to boost demand and thus help e-auction realizations (which fetch far higher realizations than FSA volumes).

The silver lining, however, is that valuations are undemanding. Currently, the stock trades at 12 times estimated earnings for FY17. “It now appears attractive on valuation—enterprise value/ Ebitda (ex. overburden removal expenses) is now at 7.5 times (versus last 12 months avg. of 8.9 times and long-term avg. of 7.6 times),” points out a Credit Suisse report on 5 October when the CIL shares closed at Rs.330 apiece. Ebitda is earnings before interest, taxes, depreciation and amortization.

After robust volume growth in the first half of the year, investors must watch out whether the performance momentum continues for the second half, as the base will be higher. Rake availability is another important factor. Price hikes, if and when they happen, are a trigger too.