Recovering lost ground
We recently met the senior management of Coal India to understand the revised production targets for FY20E as their earlier target of 660mnte seems challenging since H1FY20 production was only 241mnte (down 5.6% YoY). The management stated the decline in production was mainly in August and September when some states faced excessive floods due to which most mines were shut. However, as water levels have receded now, the management is confident of achieving ~625mt (implying 11% YoY growth in H2), which although is an uphill task, not impossible. As cost checks and 1bnte target production by FY26 are in place, the company expects profitability to improve significantly, as operating leverage will improve margins. We have assumed 618mnte for FY20 in our estimates and expect dividends to improve compared to FY19. Maintain BUY.
* Production picks up post monsoons: CIL has produced 241mnte in H1FY20 and is looking to achieve ~625mnte (growth of 3.6% YoY). Lower revised target is mainly due to the impact of excessive floods in Chhattisgarh, Jharkhand, Odisha and Maharashtra. With receding water levels, production has picked up in October and is expected to significantly ramp up from November (largest SECL mine Dipka was flooded due diversion of river after overflowing; however, mining activities have been restored within seven days of shutdown). The contractual issue faced in SECL has now been resolved and although law and order situation at MCL continues to be volatile, major part of the issue has been resolved. For coal evacuation, two of the three critical rail links have commenced and are expected to become fully operational in the next 18 months. There is a good enough reason to believe that CIL, despite challenges, has the resilience to produce 35-40mnte incrementally annually going forward.
* To introduce VRS: CIL is looking to introduce VRS to reduce manpower expenses, especially in the underground mines which contribute 13% to the total production but employ 50% of the total workforce. This will improve profitability significantly, as OC mines earned PBT of Rs420bn, while UG mines incurred loss of Rs150bn in FY19.
* Blended pricing to be better YoY: FSA pricing has improved to Rs1,370/te, up 4.4% YoY in Q1FY20, as contribution of non-power FSA increased (price of which is at 25-40% premium to FSA power price). Q3FY20 may see a QoQ decline in FSA realisation as restocking in power plants takes place. However, Q4 onwards, FSA premium should continue. Despite a 25% correction in imported coal prices, Indian coal remains at a 30-35% discount to imported coal prices (at plant).
* Valuation: We remain positive on CIL over FY19-21E, with ~47% RoE trading at 6.0x PE and 4.0x EV/EBITDA on FY21E basis. As CIL was in the highest corporate tax rate bracket, the decrease in tax rate combined with volume growth will lead to 10% CAGR in EPS over FY19-21E. We expect a significant increase in dividend payout in FY20, from Rs13.1/share in FY19. Maintain BUY rating on the stock; target price Rs333/share.
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