Coal India fair value at Rs 316 per share: Edelweiss

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Coal India fair value at Rs 316 per share: Edelweiss

In an interview to CNBC-TV18, Prasad Baji of Edelweiss Securities said that the market needs to treat CIL as an utility play. According to him, CIL’s fair value is at Rs 316 per share as coal prices is unlikely to come down in India.

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Excerpts from Bazaar on CNBC-TV18 Watch the full show » RELATED NEWS Coal India IPO to see strong retail demand: Raamdeo Agrawal Travesty, if retailers shy away from Coal India IPO: Udayan Demand for Coal India issue unprecedented: Enam Subscribe to Coal India IPO: Hem Securities Coal India IPO subscribed 11.9x, sees $ 35 bn demand

Coal India initial public offering (IPO) has seen a blockbuster response from qualified institutional bidders (QIB) as it got subscribed 24.7 times. As retail and high networth individuals (HNIs) bidding closes today, experts say the CIL IPO will see a strong demand from that side too.

In an interview to CNBC-TV18, Prasad Baji of Edelweiss Securities said that the market needs to treat CIL as an utility play. According to him, CIL's fair value is at Rs 316 per share as coal prices are unlikely to come down in India.

However, Paresh Jain of Angel Broking differs. According to Jain, CIL's fair value is at Rs 294 per share.

Below is a verbatim transcript of their interview with CNBC-TV18's managing editor Udayan Mukherjee. For the complete show watch the accompanying videos.

Q: What is your assessment of fair value for Coal India? How much do you think has been left on the table?

Baji: Our assessment of fair value is Rs 316 based on a DCF valuation. Even on EV/EBITDA basis we are getting at Rs 300 price so there is some amount left on the table in this issue.

Q: On an EV/EBITDA basis what kind of levels are you willing to give it even on price earnings (PE) multiple compared to global peers? Can you take us through the rational to arriving at Rs 300 there?

Baji: One has to look at the business model to arrive at the right number of valuation. Coal India business model is not like a commodity company at all. If you see coal prices have virtually never declined in India over the last ten years. Even going forward, we do not expect any price cut.

On the volume front, volumes will be constrained by Coal India's production challenges rather than demand. We have a demand deficit in India of thermal coal of around 50 million tonne or so currently. Therefore the cyclicality in earnings that commodities stocks have is virtually absent in the case of Coal India.

If you look at the multiples, it is closer to a utility company rather than a commodity company. Coal commodity companies globally are trading between 6-7 times one year forward EV/EBITDA. If you take utility companies in India, they are around 11 times one year forward EV/EBITDA. We think 9 times multiple is fair enough for Coal India. It is still at a discount to the utility multiple but it has to be at a significant premium to the coal companies globally.

Q: What is your assessment of fair value there?

Jain: Our fair value assessment to be precise is Rs 294 that is based on the DCF valuation methodology. We are telling our investors to subscribe to the issue largely because we feel that the downside from the issue price is capped. There are no anchor investors in this particular issue. Most of the long only issue funds that need a good chunk of the stock would have to come and purchase it from the open market. That would give a boost to your stock price.

Q: If you do get a listing in the first part of November, around Rs 280 plus, would you take profits there or can you see a clean earnings trajectory which would lead you to advice a long-term or medium-term hold on that stock?

Jain: I would advice investors to hold on to the stock because clearly our country is deficit in coal. Going forward as you see the washeries coming in, you will see earnings growth much faster 2013 onwards.

Q: These washeries the management says will start FY14 onwards. Just for the next couple of years, do you think they could add 1-2 percentage in terms of higher volumes execution, could there be any kind of margin improvement that you can model in?

Baji: Volumes are unlikely to surprise on the upside. If you beneficiate the coal then typically you have a 20% yield loss. I would not look at any kind of volume upside. Margins can definitely improve if beneficiation happens. It is a three-year kind of story to look at. Realizations can go up by 35% on a blended basis. If that happens then margins can easily more than double if that scenario pans out.

Q: What are the key risks on investing? There might not be a price risk now because valuations have been good, but in terms of a business or earnings risk what can you highlight for the next year or two?

Jain: The first risk would be whether Coal India will be able to grow its volumes or not. We are expecting a 5% compound annual growth rate (CAGR) over the next five-years.

Secondly, a lot has been said about the 26% mining tax. Although Coal India is spending roughly around 16% of its PBT in terms of social activities, still if the tax comes through that could reduce the earnings to a certain extent.

The third risk would be its ability to price on the increase in the staff cost as and when that happens in terms of price increases to the sensitive power sector.

Q: Do you see this 26% mining profit share as a hangover on the stock going forward?

Baji: I think it is a key risk, not just for Coal India but for the entire mining space. In case of Coal India, there are certain mitigating factors. They spend 4% of their revenues on social activity. There is some case here that the management has been speaking to set it off against any kind of distribution of profits.