New mining law to hit earnings

Extent to depend on treatment of social expenses and whether profit sharing can be offset against taxes.

After a severe beating over the past couple of days, Coal India’s ranking by market capitalisation has slipped from second to fourth position. The correction in share prices (9.6 per cent) is due to concern over the impact of a new bill which proposes to tell mining companies to share 26 per cent of their net profits with people affected by dislocation.

The price fall was apparent, given that it could hit profits and cash flows in the coming years. In fact, initial estimates suggest this could reduce the company’s earnings by Rs 2.5-4.5 per share in 2011-12, depending on the final guidelines. “On the higher side, a Rs 4.5 per share impact on the earnings, along with a price multiple of about 17 times, translates to a correction of about Rs 74 per share,” says an analyst with a leading brokerage house. The stock has already corrected by about Rs 36 per share.

EARNINGS
The company says that as a part of its corporate social responsibility (CSR) policy, it spends Rs 5 per tonne or five per cent of net profit. If this is allowed to be set-off against the new norms, the actual profit sharing ratio will drop to 21 per cent from 26 per cent. The best-case scenario for the company is a set-off for its current CSR expenditure and further, if such profit sharing is tax-deductible. In this scenario, analysts estimate the impact would be only 3.5-4 per cent on net profit. On the other extreme, if a set-off is not allowed and such profit sharing is not tax-deductible, it could translate to a Rs 2,900 crore cut in estimated profit or a Rs 4.5 drop in earnings per share (EPS) in 2011-12. For the current financial year, the company is expected to report a net profit of Rs 14,500 crore and an EPS of Rs 23 per share.

The final impact is yet to be seen, which will not only depend on the final guidelines but also how the company reacts to such a development. For instance, analysts believe there is a possibility that the company passes on these charges to users and raises coal prices gradually. Its actual realisation for every tonne of coal sold is estimated at Rs 1,320 in the current year. Analysts believe even a five to seven per cent increase in the price could recoup the additional amount to be shared with those affected by the projects.

GROWTH
Though the latest developments are unfavourable, the company is on a strong wicket. While there is a risk of stock price downgrades, much of this has already been factored in its share prices. Strong industry demand, coupled with the recent rise in coal prices, both for contracts and e-auction, are positives. In fact, the company is ramping up its high-margin washed coal capacity from 39.4 million tonnes to 111 mt.
 

THE IMPACT
	Whether allowed to offset self-incurred social expenses
		Allowed	Not allowed *
Whether  profit  sharing is  tax-deductible	Considered  expenses	OPM impact: (114 bps) EPS impact: (3.6%) Case for price hike: No	OPM impact: (336 bps) EPS impact: (10.4%) Case for price hike: Yes
	Distribution  of profit	OPM impact: +444bps EPS impact: (12.3%) Case for price hike: Yes	OPM impact: +222bps EPS impact: (19.1%) Case for price hike: Yes
Source: PINC Research; Note: * Assuming self-incurred social overhead is reduced to half, EPS: Earnings per share,  OPM: Operating profit margin, bps: basis points

Additionally, with some its new projects receiving environmental clearances, production volumes should look up. Volumes are expected to grow at four to five per cent over the next two years, along with 10-14 per cent expected increase in realisations per tonne, leading to overall revenue growth of 14-18 per cent.