Coal India: Divestment concerns add to weak sentiments

While rising costs and issues related to FSAs are among reasons for the stock's under-performance, the possibility of government divesting a part of its stake is proving to be another overhang

The Coal India Ltd (CIL) stock has corrected almost 20 per cent from its 52-week high of Rs 386 on September 17, 2012, to Rs 311.65 currently. Of this, 11 per cent decline has come in the last fortnight. While increasing costs, lack of clarity on various aspects related to the fuel supply agreements (FSAs) with customers and absence of coal price increases are being attributed as reasons for the stock's decline, the recent news of CIL likely to figure in the government's FY14 divestment list has added to the weak sentiments.

Although analysts are positive on the company's medium-term prospects (Bloomberg consensus target price stands at Rs 392) due to improving volume outlook, they believe unless clarity over the possible follow on public offering (FPO) as well as FSA issue emerges, the stock will remain under pressure.

Inflationary pressures
Increasing costs are a concern as they took away some of the benefits that could have accrued due to strong volume growth and realisations reported in the December 2012 quarter. While costs have been on a rise, the company has not been able to raise prices as was anticipated by the Street.

Analysts at Deutsche Bank Market Research, after the results had observed that "despite a good set of numbers, management sounded a bit cautious in the press meeting, and highlighted that the recent impact of diesel cost increase has a high sensitivity for earnings. So, even if we were to adjust the impact of few one-offs on the cost side, the stock may not rally significantly, until investors get comfortable that the company would be able to pass this cost inflation via a price rise".

Thus, if price increases being talked about materialise, it can provide a trigger for the stock as it will not only take care of rising costs but also of any potential impact on realisations, which may be there due to FSAs with the power producers.

FSA-related issues
The lack of clarity on issues related to price-pooling of imported and domestic coal remains an overhang on the stock. Though the government has accepted price-pooling in principal for supply to power producers, there are a number of issues that require clarity.

Analysts feel there is lack of clarity on the timing of implementation as well as around certain important issues, including pricing of various grades of coal. For instance, there is no clarity on whether imported coal would be supplied only to coastal power plants or to those in the interiors of India as well. Likewise, whether plants commissioned before March 31, 2009 will only be covered under price-pooling or others will also be provided coal based on price-pooling.

While clarity is awaited, analysts at Citi expect the impact of price-pooling to be largely neutral if CIL signs back-to back contracts (covering the entire costs involved).

However, some analysts believe that since CIL also earns some revenues from e-auction of coal, where prices are market determined (leading to better profitability), increased sales based on FSA (where quantities are fixed and pricing mechanism is pre-defined) will hurt profitability.

Chetan Kapoor at IDBI Securities feels that with increase in FSA share and continued pressure to introduce price-pooling, the upsides for CIL will be limited despite better volume growth outlook. But, largely due to better volume growth outlook and higher other income contribution, Kapoor has revised his earnings estimates upwards by 2.9 per cent and 5.2 per cent for FY13 and FY14, respectively.

Improving volume outlook
Recently, CIL had revised its FY13 coal production guidance from the earlier 464 million tonnes (mt) to 452 mt (a decline of 12 mt over its earlier target) due to rains affecting production in the December quarter. Positively, with improved railway rake (wagons) availability, it expects to touch 470 mt of its targeted dispatches, by drawing from its inventories. The average rake availability has been about 215 per day in February as against 193 in February last year.

Kapoor of IDBI Securities feels 465 mt dispatches is quite achievable and would translate to 7.5 per cent year-on-year growth in FY13, which still is a significant increase from 2.6 per cent compounded annual growth achieved over FY09-12. Analysts at Citi feel CIL is relatively insulated from global price trends, with improving volumes (dispatches up eight per cent year-on-year during April 2012-January 2013 after two years of muted growth) and odds favouring faster clearances. Going forward, in FY14, analysts at Angel Broking peg the company's dispatches at a shade below 500 mt. Lastly, the company on Wednesday has invited bids to acquire coal assets from the global markets. Early success on this front should also add to the positives.