Coal India: Near-term concerns cloud earnings outlook

Firm will take earnings hit of Rs 4,000 cr if a proposal to double gratuity limit is approved

Rising costs and downgrades of its mines coupled with weak quarterly performance saw the Coal India stock hit its 52-week lows recently. The key concern for the Street is about rising employee costs due to ongoing wage negotiations. Even though Coal India has been provisioning for wage revisions, the Street feels that the actual rise may be larger. Added to this is higher cost of gratuity payments. The proposed amendment by the government towards doubling the gratuity limit to Rs 20 lakh would put an additional one-time burden of Rs 4,000 crore on the company's earnings, say Kamlesh Bagmar and Amit Khimesra at Prabhudas Lilladher. Though they add that management expects to neutralise the impact partially through reduction in leave encashment days of executives, the development adds to existing concerns on rising employee costs.

Added to all this is uncertainty on impact of mine-degradation. The company has seen grade slippages impacting overall profitability. During March quarter its operating profit fell by 39.2 percent year-on-year to Rs 3,388 crore primarily attributable to higher provisioning towards pending wage revision and for grade slippage. Analysts at Kotak Institutional Equities say that the de-grading of several coal mines since April 2017 poses new uncertainty; it is yet unclear how much this compounds the impact of grade slippages already factored in and uncertainty on this issue will likely subside only post results for June'17 quarter. Coal India management in recent analyst meets however believes that with quality control measures in place, grade slippages should not happen and management expects better grades of existing mines moving forward.

The company recently indicated that 37 unviable underground mines would be shut by 2017-18. The identified surplus manpower from these mines would be redeployed in nearby mines of areas to reduce further loss in these mines. The company's plan to shut down some unproductive mines, rationalise costs and shift employees to alternative locations while putting near term pressure is a positive.

Amid these concerns the company is likely to see better volume growth during FY18 driven by demand. For April-May 2017 the company has seen better liquidation of inventories as dispatches grew 4 per cent year-on-year. Analysts at Reliance Securities say that they expect volume and realisations to recover in FY18 and add that valuations of 12.3x FY19 earnings seem to be inexpensive.

Thus while improving volumes and inexpensive valuations coupled with dividend yield will cushion the downside, the clarity on wage revisions due on July 1, grade slippage among others will hold key to upsides.