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Coal India – A contrarian value play

, June 1, 2016, 0 Comments

coal-india -coal-mine-marketexpress-inPerceptions sway stock prices in the short run; however, it is the strength of a Company’s business model and the valuations that determine stock returns over a longer term. No other stock fits this better than the state run monopoly- Coal India.

Present perceptions of Coal India are largely negative; its net profit for March 2016 was flat on a y/y basis at INR42.5bn below consensus estimates of INR45.5bn as oversupply of the fuel combined with lower prices offset the 7.8% y/y increase in coal deliveries. However, a valuation of just 12.5x PE along with a dividend yield of ~7% of a company controlling close to 80% of the Indian coal market seems appealing, especially to institutional investors seeking a high margin of safety on their investments

Now let’s move ahead of basic number crunching and look into possible triggers for modest returns over the next 12-18 months.

Coal Imports on a decline
India’s coal Imports have declined by 15% y/y to 15.9 million tons (Mt) as of April 2016 which has resulted in saving an estimated INR240bn in foreign exchange, almost all of the imports is set to be replaced by Coal India which can improve deliveries going forward. Also, power producer NTPC, which initially targeted to stop coal imports by 2020, is now 4 years ahead of schedule to curb imports as supplies from Coal India has reduced its need to import the fossil fuel.

Foray into exports
Coal India is reportedly in discussions to supply coal to power companies in Bangladesh; Coal through India would be much cheaper than the ones Bangladesh currently imports from Indonesia as the logistics costs would be much lower. If the talks materialize, it would be the first time that Coal India would be exporting on a commercial basis, opening up other avenues for future growth.

Immense role to play in India’s Demographics
The current valuations don’t fully price in the immense role that Coal India has to play in India’s growing energy hungry economy; close to 52% of India’s commercial energy production is coal dependent and given the current regime’s focus on removing energy deficits across the states, a re-rating of the stock seems possible.

Reduction in Red Tape
Land clearances have witnessed massive reductions in red tape, which is evident from the fact that Coal India got clearances for more than 3,000 hectares of land during FY2016, double the clearances received during the previous year.

Scope for further price hikes
Coal India has announced to hike coal prices by an avg. 6.29% effective May 30th 2016 and this is expected to generate additional INR32.3bn in revenues; still the weighted average discount to import parity prices is ~30% currently which offers a decent margin to increase prices in the future.

Possibility of a BuyBack
As of March 2016, Coal India has net cash and cash equivalents of INR380.5bn which is 21% of the current market cap; also its high equity base makes it a potential candidate for the Government’s planned buyback program in PSU’s. The buyback seems like a realistic possibility in the near term given that the SEBI’s deadline for at-least 25% public holding in listed PSU’s is set at August 2017 (current public holding stands at 20.35% as the GOI holds a 79.65% stake)

Although near term headwinds such as volatility in coal prices and opposition by the Company’s employee unions to the machinery modernization and outsourcing programs do pose challenges for the Company, they are all priced in at the current low valuations and thus offer a high margin of safety for value investors. Consequently, the prevalent ‘negative’ perceptions that Dalal Street has placed onto the stock provides a good opportunity for long term investors to invest into the state run monopoly.

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