A case of misplaced valuations
Attractively valued at ~3x EV/EBITDA
FY19 turned out to be a standout year for Coal India (COAL), with its adj. EBITDA increasing 48% YoY led by higher realizations. The company’s ability to hike FSA prices and increase evacuation charges is a reflection of its dominant position in the industry, in our view. Moreover, even after the price hike, FSA prices are 30-40% lower than the eauction rates (i.e., market rates). This indicates that there is still significant pricing power left with the company.
Despite the robust performance, COAL’s stock price is down ~30% since end-Mar’18 (v/s BSE Sensex: +11%), with valuations at ~50% discount to its long-term average. While continuing government divestment has exerted some pressure, we note that the decline in COAL’s valuation coincides with a fall in valuations of coal mining companies globally. Recent announcements of mining companies to cap/exit coal production have raised questions on the sustainability of coal.
In this report, we highlight India’s divergence from other major coal-consuming economies (US, China) in terms of coal consumption. In our view, from India’s standpoint, coal is here to stay, despite increasing renewable generation (unless storage technology develops). At current price, COAL’s market cap = 12 years of its discounted FCF. We reiterate our Buy rating with a TP of INR264 (36% upside).
Valuations have de-rated for coal companies
Over the last 18 months, valuation multiples for coal mining companies have derated (Exhibit 1). While local factors (such as regulations in Indonesia and China) may have played a part, the de-rating comes at a time when questions over sustainability of thermal coal have heightened. Thermal coal consumption in the US (the third largest consumer) is now at less than two thirds of its 2010 levels, while consumption growth in China (largest consumer) has been subdued (Exhibit 2). Against this backdrop and the increasing pressure to arrest fossil fuel consumption, large global mining companies have been moving away from coal (Rio Tinto has exited, Glencore has capped production and BHP Billiton is looking to divest).
India is a different case in point
Coal consumption CAGR in India, however, has been 5% over FY10-18 (v/s China: +1%; US: -6% CAGR). Despite the increased focus on renewables, we do not expect coal demand to be impacted in the country due to the following reasons:
(1) Per capita electricity consumption in India remains low (1/16th of US; 1/5th of China and 1/3rd of world average), implying significant room for coal and renewables to coexist and grow (refer here).
(2) A look at the US electricity market indicates that coal-based generation has largely been displaced by gas (Exhibit 3) on the back of favorable economics for gas-based plants. Given the lack of domestic gas supply in India, we do not foresee such a situation in the country.
(3) Other conventional
sources are not in a position to displace coal. Construction of new hydro projects are marred with delays due to lengthy approval process and rehabilitation/settlementrelated issues. Besides, even if India were to realize its true potential of ~150GW of hydro, this would imply incremental generation (at 40% PLF) of just 390BU – which is not sufficient to even meet incremental demand over the next five years. Nuclear generation is still at a nascent stage and accounts for ~3% of overall demand. Thus, we believe India will continue depending on coal to meet its electricity needs. Our demand-supply model for thermal coal implies demand CAGR of 6% over FY19-24 to reach 1.2bt (Exhibit 6).
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