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Coal India — IPO: Invest at cut-off

Attractive valuations, a near monopoly status and a widening demand supply gap in the
domestic coal market make Coal India an offer that investors should not miss.

Unearthing value.

M. V. S. Santosh Kumar

Investors can subscribe to the initial public offer of Coal India, the only unlisted navaratna
public sector company. Coal India is the largest coal mining company in the world in terms
of reserve-base and annual production.

This is by far the largest IPO in India (Rs 15,100 crore). Coal India is a holding company for
11 subsidiaries which are engaged in the development and operation of coal mines as well as
exploration and design, making it an integrated coal mining company.

Coal India is a near monopoly with 82 per cent share of India's total coal production. Its
fundamentals are strong, given the widening demand-supply gap for coal and the company's
improving operating metrics. High return on equity (38 per cent for 2009-10), despite
significant cash balances, too bolster prospects.

At the likely cut-off price (upper end of band), after factoring in a 5 per cent discount, the
price for retail investors works out to Rs 232.75. This price values the company at a modest
10.8 times the estimated FY-12 earnings (consolidated). The EV/EBITDA for FY-12 works
out to 4.8 times. This places it at a discount to global peers such as China Shenhua Energy,
China Coal Energy, Yanzhou Coal Mining (China) and Peabody Energy (US).
According to Bloomberg estimates, the EV/EBITDA multiple for the calendar year 2011 for
these companies were in the range of 6.5-9 times. Coal India may deserve to trade at a
marginal discount to peers in light of the higher realisations of the overseas players due to
better quality reserves and market-linked prices.

The operating margins of these companies for the calendar year 2009 ranged from 18.7 per
cent to 39 per cent as against the 22 per cent (for 2009-10) of CIL.

The company has huge cash coffers of Rs 39,000 crore (around Rs 62/share) to fund future
capex and overseas mine acquisitions.

Business overview

According to SRK Consulting, a UK-based mine auditor, the current resource base of Coal
India is 64 billion tonnes with 21 billion tonnes of extractable reserves. The extractable
reserves are sufficient to sustain current levels of production for 50 years.

Coal India operates 471 mines, of which 163 are open cast mines, 273 under-ground and 35
mixed mines. More than 90 per cent of the present production comes from open cast mines,
which have a low stripping ratio. Stripping ratio is the ratio between thickness of coal seam
and above lying strata.

This reduces the time required for development and allows high mechanisation that improves
productivity. This improvement in development and operational parameters has been the key
factor underpinning Coal India's financial performance. Despite having two sick subsidiaries
(negative net worth) under its belt, it continues to be among the most profitable companies.

The sales grew at 14 per cent, compounded annually over the period FY2007-10, while the
net profit clocked a 32 per cent growth. The company's operating margins stood at 22 per
cent for the year ended March 2010, which is expected to improve on the back of rising
realisations and falling costs.

Of the 142 mines to be tapped over the next decade, 77 are being developed and have already
received environment approvals. Almost 90 per cent of the land for the projects coming up in
Eleventh Plan is also owned by the company, reducing execution risks.
Demand-supply gap

According to Ministry of Coal, the domestic demand-supply gap of coal for 2009-10, at 67
million tonnes or 11.5 per cent of demand, was bridged through coal imports.

The gap is expected to widen to over 120 million tonnes by 2012 despite domestic production
ramping up.

Coal India may see its production increase from 435 mtpa (million tonnes per annum) to 643
mtpa (a 6 per cent CAGR) over the next seven years.

Demand on the other hand is expected to grow in double digits, translating into better
realisations. According to the offer document, non-coking coal and coking coal demand are
expected to grow at a compounded rate of 11.3 per cent and 9.7 per cent up to FY-2014.

The company is looking at overseas acquisitions to augment supplies. It entered Mozambique


through its subsidiary to develop coal in that country and is exploring opportunities in
Indonesia, Australia and the US. While the majority of power projects are attempting to tap
captive coal mines, these projects are still in the drawing board stages. In the near term, they
have to turn to imports or buy in e-auction at market determined rates (from which CIL is a
beneficiary).

Realisations to go up

To improve the production and reduce costs, Coal India is reviewing legacy mines and
negotiating with buyers for higher coal prices that can ensure at least a 12 per cent return.

The proportion of expensive under-ground mines has fallen from 13.3 per cent in 2005-06 to
10 per cent as of March 2010.

The impact of this on the cost structure is quite high as the current cost of mining per tonne
from open-cast mines is at Rs 520 per tonne compared to Rs 2,145 per tonne in under-ground
mines.

Mechanised open cast mining trims employee costs for the company; the employee base is
already down 3.7 per cent over the last three years and a net reduction of 11,000 employees is
expected this year; from the current base of 4 lakh.

CIL also plans to add 111 million tonnes of coal washeries which would improve the
beneficiated coal output, which has higher calorific value.

The average price realised for beneficiated coal (Rs 2134/tonne in FY-2010) is almost double
the average price for the entire output, with only marginal addition to costs for washing.
Currently the high grade coal is sold at import parity price unlike cost plus in case of low-
grade coal.

The proportion of coal sold through e-auctions is also expected to go up to 20 per cent from
the current 13 per cent, owing to the demand-supply gap.
While the existing fuel supply agreements (FSAs) with power projects stipulate that Coal
India meet 90 per cent of its commitment or else pay a penalty to the clients, the commitment
is lower at 60 per cent for non power sectors.

New power FSAs too have a 50 per cent commitment. This allows room for Coal India to sell
larger quantities through e-auction.

Risks

Investors have to bear in mind that the coal mining business is fraught with risks, apart from
requiring long gestation periods.

Execution delays may crop up owing to regulatory, legal and environmental hurdles, land
acquisition delays, political risks and social disturbances.

Geographical concentration of resources may impose logistical problems. ECL and BCCL,
wholly owned subsidiaries, despite turning profitable recently have negative net worth of Rs
6015 crore and Rs 5400 crore respectively. These companies' contributed 36.4 per cent to the
overall employee costs but only 13.4 per cent to the revenues of the parent.

The new MMDR Bill may require Coal India to set aside 26 per cent of the profits for
resettlement and rehabilitation activities of project affected persons. However, given the
company's monopoly status and pricing power, the additional costs can be passed on to
consumers.

The accounting treatment for over-burden removal may change once IFRS accounting
principles are adopted.

This would mean charging the expense in the same accounting year, instead of spreading it
over the life of the project. There may be a dip in profits once IFRS is adopted from April
2011 and profits may also be lumpy on account of the same.

Coal India IPO Allotment News


October 29, 2010

While retail investors are waiting eagerly to know how many shares have been alloted in
Coal India IPO , the registrars are yet to make the details public and are taking their own
sweet time.

The registrar for Coal India’s IPO Link Intime is yet to update it’s website with the latest
information on the allotment given to retail investors in Coal India IPO. Once updated you
will be able to check your allotment of shares online .

Coal India IPO Allotment Delayed


The Coal India IPO Allotment could have been delayed because of the huge number of
applications that the registrar has recieved.
Some analysts revealed that more than 17.5 lakh retail applications were submitted by small
investors for Coal India’s IPO. This is more than 10% of the total number of demat account
holders in India.

Also the retail portion of Coal India’s IPO was over subscribed 2.3 times and the bulk of the

bids have come at the upper end of the price band at Rs 245. 

Allotment Ratio of shares in Coal India IPO

In book built issues like that Coal India , the basis of allotment is decided by the book
running lead managers or investment bankers within 14 days from the date of closure of the
IPO.

While the basis of allotment has not been revealed by the bankers many believe it will be in
the ratio of 1:2 for retail investors who have bid for more than 100 share of Coal India and
1:1 for those who have bid for less than 100 share in the Coal India IPO.

Read – Exclusive details of how much profits retail investors will make !

Some analysts believe that due to the huge number of applications for Coal India IPO , the
allotment of shares and refunds could take more time as the registrar of the issue would need
time to process all the applications. Even though the majority of applications are in a digital
format it would still take time as they need to be manually verified.

We would suggest you subscribe to our newsletter to stay updated about the latest news on
Coal India IPO.

What are the key challenges for Coal India


ahead?
Published on Thu, Nov 04, 2010 at 15:14   |  Updated at Thu, Nov 04, 2010 at 16:05  | 
Source : CNBC-TV18

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In an interview with CNBC-TV18's Sonia Shenoy, Suhas Harinarayanan, Co-Head of Research,


Religare Securities, spoke about the blockbuster Coal India IPO and his outlook for the company.

Below is a verbatim transcript of the interview. Also watch the video.

Excerpts from Bazaar on CNBC-TV18 Watch the full show


»

Q: Have you been amazed at how Coal India has listed?

A: I do not think anyone expected to or not too many people expected to list above Rs 300 and
probably even close to Rs 300. It has probably taken a lot of people at surprise including us.

Q: You had a fair kind of about Rs 265-315 per share it has surged beyond that as well. What is
the next step now for an investor who holds this share?

A: If I look forward there are two ways to look at it. Most analyst expectations for EPS or EBITDA for
FY11 are lower than what the management has guided for. Most analyst are expecting about 15-20%
earnings growth while the management, in their various meets, have clearly highlighted that they
could grow by almost 25% on the profit line. So that is possibly one hope we can have. Second is
over a period of next six to nine months investors would start looking at earnings beyond 2012 also.

If I look through over the next 12-months one can probably look at a price of about Rs 380 but clearly
it is not more than 10-15% upside from current levels.

Q: So if you do look at earnings beyond FY12—currently, they are sitting at a profit of about Rs
9,800 crore—the expectation is that by FY13 there would be a significant jump of about 40% in
their net profits. Do you see this happening if the company reaches parity in terms of prices or
are you at that level at this moment?
A: No. If I look earnings compounded annual growth rate probably 15-20% range over FY11-12 and
FY13. The estimates for FY12 are currently probably closer to about Rs 20-22 per share. I could
grow, if one is estimating another 15% growth, if one is possibly looking at 25 times on EPS for FY13.
That was specifically what I was trying to highlight—what next? One is when the base earnings which
is FY11 earnings itself exceed most analyst expectations. That provides a growth.

Then as we move forward over a six to nine month period investor will start looking at FY13 earnings
and if it comes 25 or higher then it could even go up 10-15% that I think it can go up from current
levels.

Q: What kind of a downside do you see on the stock or rather just to put it better what kind of
support do you see on the price and if indeed there is any kind of downside risk that you are
mapping?

A: I think the key downside risks are two folds. One is on production growth while the company has
sufficient amount of inventory to liquidate over the next 6 months or even nine months to show this
25% profit growth even if production growth does not keep pace with the general expectations or
targets I think the issue is going to be or the concern is clearly on what happens to production growth
be in FY12 because if you look at year-to-date, the production growth is only 1% on a YoY basis and
it has fallen short of targets.

We were, in our model, building in estimates which are lower than what Coal India has been guiding
and what their planned targets are. If it comes below that—that is one of the key downside risks.

Second downside risk is obviously the talk about the huge cash balance which the company has and
also how the return on equity right now for the company is. One should not forget that their largest
customers tend to be the power sector including the state electricity boards (SEB) and NTPC. The
SEBs are not generally in great shape. If you look back maybe eight-nine years back there was this
whole payment crisis where both NTPC and Coal India had receivable issues, which was all sorted
out before the IPO of NTPC.

That potentially a risk while one can build in certain pricing expectations of to be in line with inflation or
slightly lower than inflation—will the states be in a position to take that kind of an increase that is
probably one thing to bear in mind as well.

Coal India disinvestment: Will unions go along with management?

Raj Kumar Sahu, March 31, 2010 (New Delhi)

The government’s fund raising plan through divesting stake in public sector companies will
get another boost once the Coal India IPO hits the market. But it seems like worker unions
could play spoil sport.

According to Coal India management, the company is focussed on working on ways to


increase production and lower headcount.   

“The efficiency of the company will improve with new technology and will help in lowering
the headcount. In the last 10 years already the number has come down by 180,000 and in next
few years total headcount will go down to 300,000 from present 400,000 people,” said Partha
S Bhattacharyya, CMD of Coal India.

But lowering headcount may not auger well with the unions who are not convinced about the
benefits of divestment. Even though the company has secured regulatory approval for issuing
shares to workers from their seven subsidiaries.

“I had a meeting with BCCL workers and union leaders but once they will be convinced
about the benefits they will surly support it,” Bhattacharyya said.

With 63 crore shares on offering and another 6 crore shares for employees, the Coal India
IPO is going to be one of the biggest in Indian markets.

However, it remains to be seen, if the unions will go along with the management on this one.

Read more at: http://profit.ndtv.com/news/show/coal-india-disinvestment-will-unions-go-


along-with-management-33044?cp

It is a known fact that the Primary market exuberance feeds on secondary market sentiment.
And, the prevailing positive rub-off from secondary markets can be clearly sensed from the
way the corporate India is hitting markets with their public issues to latch-on to the
momentum in the liquidity wave.

Moreover, when the system is aflush with ample liquidity, a giant-sized IPO can put to test
the integrity of the markets and the prevailing market sentiment. In such a scenario, the
world’s largest coal producer, Coal India Ltd, plans to raise around $3.4 billion
(Rs.15,000 crore) through IPO by offering 631.6 million equity shares by the
government. The mega-issue will open on October 18 and will close on October 21.

Thus, the offering of the Navratna public sector company – which accounts for about 82% of
the coal output of the country – will be India’s biggest ever IPO till date. Further, when an
IPO of such huge magnitude hits the market, the secondary market remains sub-dued under
the fear that investors will liquidate shares to subscribe to the mega-sized public offering.

The Coal India IPO could go a long way in determining the success of the Indian
government’s efforts to raise billions of dollars through disinvestment this fiscal year. Last
few PSU follow-on offerings (NMDC and NTPC) of 2010 were met with cold response,
especially from the retail investors, on account of being over priced – and had to be bailed out
by big-daddy LIC.
Coming back to Coal India IPO, the government has fixed the price band of Rs.225-245
through a 100% book building process. Analysts are expecting Coal India – which is the best
bet on India’s rising coal deficit scenario – to report EPS at 15% CAGR over FY10-13. As
per the observers of the IPO market, the stock could list positively with 15-20% premium,
valuing the stock at 15-16 times the company’s FY11 earnings, which is cheaper than some
of the listed companies in the power utility sector.

Further, the government has indicated that domestic coal prices could see an increase if
profit-sharing arrangements in the proposed Mines and Minerals Development and
Regulation Act were implemented.

In my opinion, Coal India deserves to trade at a premium to global coal peers with a price
target anywhere between Rs.300 to Rs.325 on listing. The coal-major has substantial
headroom to increase prices in coming years and will provide a linear earnings trajectory and
impressive returns on the capital employed.

P.S.: Coal India will offer 5% discount on the final IPO price to the retail investors and
employees of the company and its subsidiaries. So, it looks like a safe bet !

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