Coal India has been facing headwinds for the last six months on account uncertainty on quantum of wage hikes to workers and fears of the Government trying to use the company’s huge cash for fulfilling its divestment objectives. While Coal India’s recent decision to shift to a new pricing policy based on Gross Calorific Value (GCV) of fuel provided some respite, it had to roll it back due to pressure. The measure would have helped Coal India mitigate the impact of wage hikes among others. And if these weren’t enough, Wednesday’s announcement wherein Coal India has been asked by the committee of secretaries under the PMO (Prime Minister’s Office) to sign Fuel Supply agreement (FSA) with power companies only adds to the bad news. In fact, the move has offset the positive sentiment post a good set of December 2011 quarter performance reported on Monday.
With more supplies to be made at FSA prices (regulated) as well as with wage revisions due, clarity on price hikes to be undertaken during first quarter of FY13 is crucial for profitability. The other option for Coal India will be to substantially raise production which will help offset any shortfall in output. Until clarity emerges, the stock may remain under pressure or at best range-bound, reckon analysts. Currently, at Rs 320 (down nearly 6% on Thursday), it is trading 20% lower than its six-months high (closing price) of Rs 397.85.
Proposed FSA will hurt earnings
Coal India had last signed FSAs in March 2009 for 304.85 million tonnes (MT) of coal with 90% penalty trigger. However, after that, new power capacities have been added for which Coal India does not have any compulsion on supplies. As per the announcement, Coal India will have sign FSA for supply of a minimum annual quantity of 80% (penalty trigger level) for all power plants commissioned up to December 2011. It will also have to sign FSAs for power plants commissioning up to March 2015. Given the production issues, analysts say that the company is unlikely to supply these quantities and hence, the move is likely to impact Coal India's profitability.
Analysts at CLSA observe that if implemented this would increase the risk for Coal India’s earnings as there might be a requirement to shift some volume of coal from e-auctions for supply under FSAs which again would be detrimental. Analysts at Emkay Global estimate that about 123 MT additional coal will have to be supplied in FY13 by Coal India to the power sector at 80% penalty trigger. At existing production levels analysts feel that Coal India can spare 30 MT while another 20 MT cane be met from a 5% ramp up in production during FY13. The balance 73 MT will thus have to be met through imports which may cost Coal India dear.
An analyst at Indian brokerage house expects Coal India’s operating profits to get impacted by 12%, in an optimum scenario, if one-third of e-auction quantity is diverted to meet FSA commitments and 4% price hikes. However, higher price hikes for the power sector can help reduce the impact (last hike for power sector was 10% taken in October 2009). Thus, he adds that a price hike of 7.5% may help mitigate the losses.
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Price hikes crucial
The clarity on price hikes remains crucial for Coal India’s profitability looking at the proposed FSA’s and wage hikes. The company though has been making provisions of around Rs 780 crore towards wage arrears during previous two quarters, which is sufficient for a 24% increase in wage costs. However, analysts at Motilal Oswal Securities feel that wage costs will rise by 31%. They are estimating a wage increase of Rs 5,000 crore for FY13; wage provision of Rs 1,200 crore (versus Rs 800 crore by the management) for March 2012 quarter. Analysts at Citi observe that a 1% change in wage costs impacts Coal India’s profit after tax by 1.3%.
The other option is to significantly increase coal production. However, such a measure will take time to materialise even after assuming the company gets all clearances to do so.
Q3: Good performance
Meanwhile, Coal India saw coal production and dispatches almost in the flat terrain during December 2011 quarter (Q3’ FY12). Production of 114.62 MT was just up 0.68% higher on a year-on-year basis, while dispatches of 110.27 MT were down 0.23%. This means that Coal India will have to reach a run rate of 9.9% growth in dispatches during fourth quarter (125 MT) to achieve its target of 436 MT. Analysts though differ on whether it is achievable. Analysts at Citi estimate dispatches at 430 MT as they believe rake availability will not be a problem looking at the fact that around 200 rakes per day are available currently against 185 rakes a day required to reach the target.
The price hikes undertaken by Coal India during February 2011 as well as lower proportion of e-auctions with power sector not being able to lift most of the e-auction quantities (4MT) in October 2011 at FSA rates helped realisations in the quarter improve 21 year-on-year to Rs 1,392 a tonne, and boosted overall revenues and profits.
While December quarter performance was helped by better realisations, the price hike will be crucial moving forward too. Analysts at CLSA observe that recent flip-flop in pricing while shifting to GCV based pricing regime has raised question marks about Coal India’s freedom to determine prices. Thus, the price hike in FY13 could be a key determinant of valuations of the stock. Till then, it could remain range-bound.