Coal India's FSA obligations worrisome: Edelweiss

Prasad Baji, senior vice president, Edelweiss believes the penalty slapped by the Competition Commission of India (CCI) to Coal India is not a need for worrying wrinkles. On the contrary, its fuel supply agreement (FSA) obligations are, he adds.

Speaking to CNBC-TV18, Baji says the company will contest this penalty legally, though it is likely to be a long-drawn battle. However, Baji is more concerned about FSAs that the company has signed for 71000 MW.
“Even when we take 65 percent of that, there will certainly be a need to divert coal from the existing FSAs as well as a little bit from the e-auction coal which will mean that the incentive of Rs 1,300 crore that the company is earning, will go away. There will also be some dent in profitability due to lower e-auction coal and there is a risk of penalty as well. So, all that put together we expect around 13 percent decline in earnings over FY13 in FY15,” he adds. Below is the edited transcript of Baji’s interview to CNBC-TV18. Q: What is your view on the Competition Commission of India (CCI) penalty that has been given to Coal India?
A: I think the penalty is not really material, it is coming to only around Rs 3 per share. So, it is not going to impact Coal India's financials or the market cap too much. Even otherwise, we believe that Coal India will contest this legally and it will be a long-drawn battle. We have seen in the case of cement companies that even more than 1.5 years after the CCI imposed penalty, the legal contest continues and cement companies have neither provided for it in their financials and have only paid around 10 percent as deposit. So, we do not expect this to be very material. Q: If not this then what are the real downside risks that Coal India faces?
A: The larger concerns are the obligations imposed by the new Fuel Supply Agreements (FSA). Led by the presidential directive, Coal India has already signed FSAs for 71000 MW odd and will be signing some more to do a total of 78000 MW. We expect that in FY15 they will be required to meet Annual Contracted Quantity (ACQ) demand of 211 million tonne for these new FSAs.
Even when we take 65 percent of that, there will certainly be a need to divert coal from the existing FSAs as well as a little bit from the e-auction coal which will mean that the incentive of Rs 1,300 crore that the company is earning, will go away. There will also be some dent in profitability due to lower e-auction coal and there is a risk of penalty as well. So, all that put together we expect around 13 percent decline in earnings over FY13 in FY15. Q: On the flipside, what is the kicker for Coal India going ahead?
A: The positive is the fact that dividend yield is high for the stock at current levels. The stock in general has corrected. So, at around Rs 285, the dividend yield is 5 percent based on FY13 dividend which is expected to be maintained and in addition special dividend and one-time dividend of Rs 18-20 maybe paid. No decision has been taken on that, but the possibility is there considering that the government is looking to get much as possible from the PSU companies. So, that definitely will give further support. I see that as a one-off positive. It is coming from the existing cash of the company which we have already accounted for in our valuation. Hence, in that sense, this is not an incremental driver. Q: Ferrous counters for the likes of Tata Steel, Jindal Steel & Power (JSPL), JSW, all of them have managed to run up a fair bit in the past few trading sessions. Do you think that this run can possibly be extended?
A: The big move is over. In some of these companies, like in Tata and JSW, we have seen the better performance. They have almost doubled or more from their near-term bottom in August. So, that big move is over.
I think we will see more grinding up of around 15 percent annually, maybe not so much in the near-term, but more on a one-year perspective. That would be led by the volume growth and the fact that there will be slight uptick in margins. I think the margin downside is behind us. We should see small uptick in margins. So, that should help the stocks move up, but this would be an annual 15 percent kind of move.