Focus on import substitution and OBR
Recovery in power demand key; Negative operating leverage to kick in
To share an update on its business (in midst of the ongoing lockdown), Coal India (COAL) organized an analyst call. Key insights highlighted below:
Near-term focus on OBR with scale down in production
* COAL has reduced production given the build-up in inventories at its own mines and power plants. In turn, the company is focusing on OBR (overburden removal), which should help it improve production. OBR has increased 15% over the past two months.
* Dispatches for COAL have increased over the past one week, even as power demand recovers and factories restart operations. As demand continues to recover and given the current focus on OBR, the company believes it would be in a better position to ramp up production.
Substituting imported coal
* Of the ~170-180mt imported thermal coal in India, COAL plans to substitute ~100mt, thereby looking to improve off-take.
* ~18mt of coal has been auctioned and committed for off-take (as part of its import substitution drive). Further, e-auction is being done at the notified price for import substitution (reserve price has been cut to notified price) till Sep’20. COAL would also not charge bonus/penalties for higher than agreed off-take quantities.
Capex to continue with production target of 1b ton
* COAL has noted that it expects thermal power demand to continue at least for the next 10-15 years in the country. Accordingly, it plans to increase production to 1b ton over the next 3-5 years. For the same, COAL would continue to incur capital expenditure related to heavy engineering machinery and coal evacuation. While COAL is still finalizing its investment plan, it has set FY21 capex target at INR120b, which might increase in the coming years.
* A large part of the INR500b capex program on Coal Infrastructure announced by the Finance Ministry would be borne by COAL. However, there would be certain capex, which would be incurred by thermal plants and Railways (for railway line works). In addition, this amount includes certain loan component as well. COAL believes that projects related to these schemes could be completed over the next 3-4 years.
* Dividend policy: COAL is working on forming a dividend policy.
* Commercial mining: Land acquisition, ECs and evacuation may remain an issue for commercial coal miners as well. COAL does not expect any negative impact from commercial coal mining as it plans to be competitive. COAL believes that the new commercial coal mines would take at least 4 years to produce coal.
* Employees: COAL would reduce its net employee count by ~12,000 annually over the next 3-4 years.
* FY21 Guidance: COAL had set its FY21E production target at 710mt before the COVID-19 situation. However, the company would have to scale it down depending on how the COVID-19 situation plays out.
* Underground mines contribute ~5% of production and 50% of manpower. Currently, losses at underground mines stand at ~INR5,000/t. COAL is trying to reduce manpower at mines by trying and adjusting staff at nearby mines. Over the long term, the company may come up with a voluntary retirement service (VRS) policy.
* ‘Vivaad se Vishwas’ scheme: COAL would take a call on settlement under this scheme on a case-by-case basis. The company has listed them in contingent liabilities and believes it can win ~80% of such cases.
* Outstanding receivables have increased to ~INR170-180b. In the last 3 months, receivables have increased INR50-60b. COAL has not tried to regulate supplies despite receivables inching up. Nevertheless, the company does not face liquidity crunch with no need to raise bonds so far.
* ESG: COAL would look to reduce emissions faced during coal transportation and improve its disclosure on carbon emissions.
Valuation and view: Near-term headwinds persist as negative operating leverage kicks in
* India’s nationwide lockdown came at a time when (a) power demand was largely muted, and (b) production at COAL’s mines ramped up (post the heavy monsoon season). Accordingly, inventory at both coal mines and power plants has risen. However, power demand has been recovering, inching up ~700MUs from ~3,000MUs levels witnessed at end-Apr’20. Recovery in power demand would be the key to improve coal off-take.
* Large proportion of COAL’s costs is fixed in nature with employee costs accounting for ~50% of the company’s expenses. Further, with the company focusing on OBR removal activities, COAL would continue using contractual employees, in our view. Thus, with lower dispatches, negative operating leverage would kick in.
* Working capital could remain stretched with elevated receivables as cash issues due to lower demand materialize within the power value chain. Furthermore, inventories too remain high.
* We cut our FY21E adj. EBITDA estimates by 11% to account the lower e-auction prices. However, we expect COAL to tide over the situation in the near term given its robust cash position (Net cash: ~INR300b). The stock trades attractively at ~1.5x FY22E EV/adj. EBITDA (v/s historical average of 7x), P/E of 5x (v/s average of ~13x) and offers a dividend yield of ~7%. Maintain Buy with a target price of INR195/share.
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