A silver lining for Coal India's profitability

Linkage auctions for non-regulated sectors will help in higher realisation for 12% of capacity, boosting the growth in earnings

The government’s decision to auction coal linkages for the non-regulated sectors is reason enough for Coal India (CIL) investors to cheer. The fresh auctions can lead to improved realisation for supply to non-power sectors, about 12 per cent of CIL’s FY15 production.

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

However, some like Kamlesh Bagmar at Prabhudas Lilladher believe it might be a bit early to quantify the gains. He agrees the company would benefit from the auction, as it would improve the realisation of coal equivalent to 58 million tonnes (mt). However, due to absence of data on grades within linkage coal, it is difficult to quantify the impact on earnings. Therefore, more clarity is likely to emerge only as it progresses.

Still, the Street’s cheer was reflected in Coal India share prices. The stock trades about three per cent higher now at Rs 400 levels, even as the broader indices have lost 3.7 per cent since Thursday. Given the consensus target price of Rs 431, of 21 analysts polled on Bloomberg in June, it seems there is more upside.

The latest move has also eased some concerns. In the past, as supplies to the power sector increased under the fuel supply agreements, the company saw a decline in e-auction volumes that fetch higher prices, impacting its profitability. The Street has been anticipating price rises  to mitigate these. Analysts at Barclays said no decision had been taken on this and the management feels any future increase would depend on a combination of international prices, cost of production and demand in the home market. In this backdrop, the news of fresh auctions to the non-regulated sector is positive.

On the other hand, production and offtake are also increasing. During April-May, total production/offtake was 82.5 mt and 87.3 mt (up 11.8 and 7.4 per cent year-on-year, respectively). Analysts at Nomura say the robust output growth seen in these first two months of FY16 bodes well for the year's targets. JM Financial is factoring in 530 mt of production (a rise of seven per cent) and 535 mt in dispatches (nine per cent growth) in FY16, as they expect e-auction volumes to also pick up.

Further, with the company and government working to address supply bottlenecks issues, including railway evacuation facilities, analysts at Centrum believe a re-rating of the stock is imminent. For, a road map for raising the production has been laid out and the focus on easing of logistical problems provides strong volume growth visibility. They expect operating earnings and profits to grow at a compounded annual rate of 18.7 per cent and 14.8 per cent during FY15-17.