Coal India :GCV-based pricing switch turns EPS accretive: Nomura research

What’s new: CIL hikes notified coal prices
In its switch to a GCV-based grading and pricing mechanism for non-coking coal from
January 1, 2012, Coal India (CIL) has pushed through a hike in notified (regulated) price
of coal; the new pricing mechanism would be evaluated in the current quarter (1QCY12)
and may be tweaked thereafter. Prima facie, it appears that blended notified price could
effectively rise by 15-20% – CIL’s product mix in context of the GCV-based 17-grade
classification and realization via e-auctions (wherein the basis of setting the reserve price
has been tweaked) would determine the quantum of revenue accretion.
Analysis / implications for CIL – clearly a positive development
1) Although CIL’s transition to the new pricing mechanism from January 2012 was widely
expected, policymakers and management maintained that the switch would largely be
revenue neutral; in this context, the effective price hike as per our first-cut calculations does
appear surprising. 2) ‘Grade slippage’ may be the bogey in realizing sharply higher
revenues; broadly, a margin of safety of two coal grades is built-into the new pricing
structure 3) The base price for the lowest-grade coal (2200GCV) is 10-20% higher than the
lowest price point in the previous pricing regime; further, CIL will now start charging for
providing <3200GCV coal. 4) Ceteris paribus, a 1% increase in blended ASP can increase
CIL’s EPS by ~3%. We maintain our Buy recommendation; on our earnings forecasts for
CIL (under review), the stock trades at 11.5x FY13F P/E and 6.5x FY13F EV/EBITDA.
Negative for consumers, more so for the non-core sectors
1) Overall, notified price for erstwhile Grade C,D coal (~18% of output) has been hiked
sharply, and the price for erstwhile Grade E,F coal (~2/3rd of output) appears to
effectively been raised by at least 4-5%: by our calculations, a 1% hike in notified coal
prices would typically result in 0.25-0.4% rise in power tariff. 2) Price revisions for noncore
sectors are sharply higher for lower GCV coal; the premium over pricing for the core
sector is now 50-60%. 3) The source and GCV of the coal secured from CIL becomes
increasingly important to assess the impact on profitability; IPPs with a revenue model
wherein fuel cost is a pass-through are relatively better placed.
Grade slippage – What is the margin of safety?
While the transition from a pricing mechanism based on seven broad coal grades (from
3200GCV to >6401GCV) to 17 coal grades (from 2200GCV to >7000GCV in slabs of
300GCV) enables a better price discovery, the risk of realizing a lower price on account
of ‘grade slippage,’ i.e. lower-than expected GCV of coal, is also accentuated. A broad
glance over the new pricing structure suggests that CIL has built-in a typical margin of
safety of two coal grades
E-auction reserve price – base premium over notified price lowered
Besides the hike in notified price of non-coking coal, we understand that CIL has lowered
the ‘reserve price’ for sale of coal via the e-auction mechanism. Until 2011, the reserve
price for a particular grade of coal was based on a 30% premium over its notified price.
Going forward, the reserve price for coal grades up to 5500GCV would be based on a
20% premium over its notified price; the reserve price for >5500GCV coal would be the
notified price itself.


Pricing premium for non-core sectors sharply up for low-GCV coal
While the price for >5800GCV coal remains similar for all consumers, pricing premium
for non-core sectors (all excl. power, fertilizer & defence) for lower-GCV coal (erstwhile
Grades E-G) now ranges between 50% and 60%, compared to ~30% previously. Pricing
premium for mid-GCV coal (erstwhile Grades C,D) is marginally higher at ~33% vis-a-vis
~30% previously.

Coal India: New year, new beginnings :: Kotak Securities

Coal India (COAL)
Metals & Mining
New year, new beginnings. Coal India has transitioned to the international grosscalorific
value (GCV) based pricing mechanism—adopting a uniform pricing structure
across all subsidiaries for 17 categories of steam coal (seven previously). The revised
pricing is likely to help to improve realizations, specifically for low realization subsidiaries
such as MCL and SECL, which are expected to contribute ~52% of incremental volume
targets. Maintain ADD with a target price of Rs380.
CIL to move to GCV-based pricing, precise benefit difficult to assess though looks encouraging
The CIL board has approved the internationally accepted GCV-based pricing for coal, moving away
from the decades-old UHV pricing mechanism—furthering its aspirations to market-oriented
pricing. The range of notified prices has increased meaningfully (10% to 30%) across various
categories of coal—though a precise computation of the benefit is difficult in the absence of
company-wise product sales output.
The shift to GCV-based pricing has led to classifying non-coking coal into 17 slabs of 300 kcal
bandwidth compared with seven UHV-based categories previously. Exhibit 2 highlights the
mapping of the old (UHV-based grading) and the new system and Exhibit 4 highlights CIL’s sales
mix across different grades.
Low price, high growth entities such as SECL and MCL likely to benefit from uniform pricing
CIL has also adopted uniform pricing across subsidiaries, from which low-price but high
incremental volume subsidiaries, such as MCL and SECL, are likely to will benefit. We note that
SECL and MCL contribute about half the overall sales volumes and ~52% of incremental targets,
though prices for Grade E and Grade F for these subsidiaries were 44% and 24% respectively
below the revised prices (average across mapped GCV band). CIL also imposed an additional 6%
levy on sales from Eastern Coalfields Ltd (ECL). We note that ECL contributes 12% of total revenue.
Maintain ADD with a target price of Rs380
We maintain our ADD rating with a target price of Rs380. Our target price is based on 11X
FY2013E EPS adjusted for overburden removal and interest income and implies an EV/EBITDA of
7.5X on FY2013E EBITDA (adjusted for overburden removal).The CIL stock has corrected 23% over
the past three months, weighed down by investor concern about (1) the potential impact of the
mining tax, (2) impact of wage revisions due in FY2012, (3) CIL potentially missing on volume
guidance, (4) diversion of e-auction sales and (5) proposal of cross holdings among PSUs. These
concerns are valid and could weigh on sentiment in the near-term but the potential earnings
impact could be muted (in cases such as mining tax and wage revision) or events less likely to pan
out (diversion of e-auction sales).