Apr 19, 2017 02:03 PM IST | Source:

Why Motilal Oswal upgraded Coal India to buy and sees 20% potential upside

Despite reducing volume estimates by 24 million tonne, Motilal Oswal expects 6.7 percent CAGR in volumes, 21 percent CAGR in adjusted EBITDA and 15 percent CAGR in EPS over two years.

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Motilal Oswal has upgraded Coal India, the country's largest coal mining company, to buy with increased target price at Rs 335 (implying 20 percent upside), citing strong earnings growth and attractive dividend yield.

The potential upside in stock price is in addition to around 6 percent dividend yield and is very attractive compared to its cost of equity.

Despite reducing volume estimates by 24 million tonne, the brokerage house expects 6.7 percent CAGR in volumes, 21 percent CAGR in adjusted EBITDA and 15 percent CAGR in EPS over two years on operating leverage and upgraded in e-auction prices while keeping fuel supply agreement (FSA) prices unchanged.

Motilal Oswal noted that Coal India's dispatches will increase by 6.8 percent to 580 million tonne in FY18 and by 6.6 percent to 618 million tonne in FY19, driven by end of destocking and substitution of coal and pet coke imports, despite a rising share of renewable energy in power generation.

Coal India deserves a premium over other metal and mining stocks due to its dominant position in the Indian markets and its current coal pricing being very competitive, which has virtually no downside risk, the research firm feels.

After a modest 1.6 percent growth in volumes in FY17, Motilal Oswal expects growth to accelerate to around 7 percent in FY18/19 aided by an end to the destocking cycle and import substitution.

Despite a 6.9 percent price hike, fuel supply agreement net sales realisation (NSR) was flat in Q2/Q3 FY17 suggesting impact of grade slippage is already behind. The recent re-grading of coal mines is primarily a formalisation of the grade adjustments, according to the brokerage house.

Coal India has re-evaluated grades of its coal mines, resulting in downward revision in grades of 177 of its 400 odd mines. Based on analysis of data of individual subsidiaries, Motilal Oswal estimates the impact is Rs 1,500-2,500 crore. This, according to the research house, is already reflected in the FSA NSR of the past few quarters.

It says average NSR is expected to increase by 2.8 percent in FY18 on higher e-auction coal prices, even as there are no further price hikes.

The brokerage house believes Coal India will be able to negotiate an 18 percent wage hike in view of low inflation, high existing wages and pressure from power consumers to keep coal prices low. Its wages have increased 405 percent in 12 years, the highest among the metal and mining companies.

The research firm expects employee cost to increase by less than 2 percent in FY18 after rising 14 percent in FY17 due to 3-4 percent natural net attrition. However, cost of mining will still decline on operating leverage.

At 12:29 hours IST, the stock was quoting at Rs 281.95, up Rs 2.85, or 1.02 percent on the BSE.

Posted by Sunil Shankar Matkar
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