Coal India: No immediate pressure from new players but outlook remains weak

Fuel supply agreements protect large chunk of its business from competition; pick up in power sector holds key for growth in FY21

The government’s nod to the ordinance, which allows other players to mine coal for open-market sales, impacted the stock of Coal India negatively on Wednesday. Despite the benchmark indices seeing good recovery at the close of the trading, the Coal India stock was down 3.7 per cent over the last couple of sessions, while the Sensex gained about 1.4 per cent.

The latest development has only worsened sentiment, with a likely negative business impact for Coal India, which has already reported dismal volumes for the first nine months of FY20 during which production and offtake reduced around 6 per cent each.

First, the good in the bad. While there is bound to be an impact in the long term, the development is unlikely to hurt Coal India anytime soon and a large part of its sales also remain protected. According to Vineeta Sharma, head (research) at Narnolia Financial Advisors: “Large portion of Coal India’s business is under long-term fuel supply agreement (FSA), which would not see much impact.” Of the total volumes of over 600 million tonnes, in FY19, over 85 per cent was under FSA.

The remaining 15 per cent and incremental volumes are the ones at risk. Further, an analyst from a domestic broking house believes that new players would take at least 5-6 years to start production.  
 

Having said that, there is nothing very encouraging about Coal India's near term outlook as production and off-take growth for FY20 as well as FY21 is expected to be dismal. Although the December month’s performance was better, the volumes (production and offtake) are unlikely to get material push unless the power sector picks up sharply, cautions Sharma. For FY20, volumes are expected to fall by 3-5 per cent. The only solace is that this lower base would make FY21 volume growth look a little better. Additional pain would stem from weak international coal prices, impacting realisations of Coal India’s e-auction business, which earns higher margin as compared to FSA-based coal supplies. Some support from non-power segment is not ruled out though.

The government’s plan to sell any stake remains an overhang for the stock. In fact, with lower tax revenue of the government, stake sale target by the government is likely to increase, say analysts.

The stock is unlikely to see a sharp upside despite attractive valuations of around 4x the enterprise value to Ebitda and a high dividend payout ratio.