Coal India outlook gets rosier

Divestment might be less volatile than in past; better prospects, led by a rise in volumes and realisations, should help

The central government’s task of selling 14.65 per cent stake in Coal India (CIL) to meet the Securities and Exchange Board of India's recent directive of a minimum 25 per cent public shareholding in public sector undertakings (over a three-year period) is unlikely to be easy.

The previous move to divest 10 per cent stake was met by stiff opposition from the worker unions. After prolonged negotiations, the government was able to go through with only five per cent divestment, leading to a long period of uncertainty and pressure on the stock price.

This time, too, whenever the event takes place, expect some volatility. The only difference between the earlier occasion will be that market sentiment is now positive and economic recovery and better prospects for the company might support the stock price. Which, say experts, would perhaps lessen the volatility.

Nevertheless, pricing and size of the offer (Rs 35,000 crore at the current rate) will remain the crucial elements.

Meanwhile, CIL’s prospects are improving, as the government attempts at increase coal supplies in the country. The market also has high hopes of reforms that will benefit the country, as well as PSUs. Frederic Neumann, co-head of Asian economic research at HSBC, observes that CIL, producer of 80 per cent of the country’s coal, could also do with an overhaul. Like other state firms, it needs to raise its game to meet India’s challenges. The fact that the government is already helping the company get environmental clearances and boost its output is positive. With the expectations of reforms, for the coal sector and PSUs in general, the CIL stock has gained 63 per cent since the start of March.

Analysts at Nomura say preliminary feedback from Coal India officials suggest the intent is clearly to 'walk the talk' on boosting production. “Although fast-tracking build-out of trunk rail links, land acquisition and sorting law and order issues pose a bigger challenge, we are inclined to give the benefit of doubt to the government and view the stock as a long-haul story,” they add. They are building a more bullish earnings outlook for the company after 2016-17 and expect improving visibility on volume-led earnings growth.

While the company might see a gradual increase in volumes, the increasing FSA (fuel supply agreements) supplies to the beleaguered power sector could also mean lower e-auction volumes. But, a majority of analysts do not agree on e-auction volumes trending lower, while accepting these could be flat. However, to compensate for any fall in volumes, analysts believe the company will raise prices. While there is talk of 10-15 per cent price increases, this has not been confirmed by the company.

Analysts at Ambit Capital estimate a seven per cent increase in FSA realisations in 2014-15, compared to their earlier estimate of five per cent. They add that the new government’s key policy focus for the sector would improve CIL's production and efficiency.

As a result, they expect Coal India’s margins to increase from 23.2 per cent in FY14 to 26.1 per cent in FY15, versus the earlier estimate of 23 per cent. Compared to the current target of a production growth of 93 million tonnes over FY15-17, they expect growth of  75 mt as of now. But, over FY18-24, they expect production to increase at a compounded annual rise of eight per cent, versus the 4-6.5 per cent assumed earlier, due to commissioning of railway lines.

Based on these estimates, analysts at Ambit have a 12-month target price of Rs 464, meaning an upside of 16.7 per cent from the current levels of Rs 398. However, some other analysts believe the valuations are expensive. Analysts at Nomura feel though the near-term multiples are not cheap, these might well remain at the upper end of the historical range, as investors look beyond FY16. The average one-year target price of analysts polled by Bloomberg in June for the stock is Rs 398.