Jitendra Kumar Gupta Moneycontrol Research
Markets are in a state of frenzy, but one high quality name that has completely missed the bull run is Coal India. The stock has given no returns in the past one year as against the 21 percent rise seen in Nifty.
Will Coal India go out of business? This is the widespread doomsday scenario, fueled by government’s increasing focus on renewable energy, slump in demand from both power and non-power segments and downgrading of its mines.
Thanks to the prevailing uncertainty, its valuation has turned quite attractive. At its current market price of Rs 279 the stock is trading at 13 times its FY18 estimated earnings and offers a dividend yield of close to 6 percent. Is Coal India a good contrarian bet? We feel so and here are the reasons why.
The market may be reacting irrationally. As Warren Buffett says you only find bargains when others are fearful. Coal India is actually trading below its intrinsic value. Today, it has a market capitalisation of close to Rs 1.7 lakh crore. If one adjusts for the cash in the books of close to Rs 40,000 crore, the company is available for Rs 1.3 lakh crore. Coal India generates close to Rs 10,000 crore annual free cash flow, which gives a cash yield of 8 percent. This is attractive seen in the context that Coal India is a monopoly, has no debt and promoter risk.
There could be upside if in future the company is able to ramp up volumes or increase prices. “If next year or after that coal prices and volumes see a spurt, it will straight away reflect in profitability and higher cash flows leading to higher valuation multiples," said Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital.
Threat of Substitute
Economies like India, which are expected to grow at 7-8 percent, will require higher power generation capacity. During the year 2003-2009, India’s power demand grew by 8 percent, annually. Even at a 6 percent generation growth, India will require additional annual power generation capacity of about 20,000 MW – at least 50 percent of it will be fueled by coal.
“We are all hoping for Chinese growth in the next three years. If the India's nominal GDP grows at double-digit, say, 14 to 15 percent, you will require similar growth in coal demand to fuel the energy requirements," said Vikas Gupta.
"Although renewable energy is growing at a fast pace, it still accounts for a minuscule share of the overall power generation mix. Even if solar grows 20 percent, Coal India will still grow at 8 to 10 percent. Building huge capacity of renewables, which can immediately replace coal-based power is only an aspiration. It might happen, but will take time, may be another 10 to 15 years or so. A nation as huge as India cannot be immediately run on renewal resources. The market is worrying too much and too early. Remember, if there is any threat of a substitute, it will first impact coal imports because as a nation we still import a large quantity of coal putting pressure on our import bill," said Vikas Gupta.
In March 2017, import of thermal coal was down by 2.1 million tonnes to 13 million tonnes. Recently, the government has expressed its intention to bring down the PSU import of coal to almost zero in FY18 and gradually convince the private sector as well to reduce dependence on imported coal. The plan is to meet the demand through domestic resources. By cutting down on PSU coal imports, the government aims to bring down its import bill by about Rs 17,000 crore.
Even after factoring in the increasing share of renewable energy, there is very little threat at least in the near term. "Despite factoring in the increase in the share of renewable energy generation in India’s electricity mix from 6.7 percent in FY17 to 11 percent by FY20, we estimate Coal India’s annual volume growth to be 6.6 percent over FY17-20, driven by the end of the destocking cycle, substitution of imports and demand growth,” said Sanjay Jain, who is tracking the company at Motilal Oswal Securities.
Thankfully, demand has seen some uptick. Demand from the power sector is the biggest contributor to Coal India. As against a surplus of 3.6 percent in FY15, India has once again slipped into a deficit of 0.7 percent in FY17 and 0.3 percent in March 2017. Compared to last year, all India power generation grew at its fastest pace in the recent past at 5.9 percent in March 2017 as against 1.5 percent in February and 4.8 percent in January 2017.
This is also reflected in Coal India’s dispatches, which on a year-on-year basis grew by 7 percent to 45 million tonnes in April 2017 as against 6 percent growth in March and 5 percent in February 2017. If the trend continues it will post decent volume growth in FY18.
In FY17, the company was targeted to dispatch 598 million tonnes but actually dispatched only 543 million tonnes, which was almost 9 percent lower than the target and barely 1.6 percent higher than the FY16 number. However, this year, the Street is expecting volumes to be higher. "We estimate 6.8 percent year-on-year growth in off-take in FY18, led by an end to the destocking cycle, acceleration in import substitution and demand growth," said Sanjay Jain.
It is noteworthy that the current thermal power PLF (plant loan factor) stands at its historical low of 60 percent as against a peak of almost 80 percent in 2008, indicating that there is more room for existing plants to generate higher demand for coal as the growth picks up largely driven by industrial recovery.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!