Coal India: Scrambling for coal :Kotak Sec,

Coal India (COAL)
Metals & Mining
Scrambling for coal. As per media reports, a panel set up by the Ministry of Steel has
proposed de-allocation of Coal India’s (CIL) coking coal blocks in a bid to increase
availability of the raw material for the steel industry. This follows on the heels of a
similar proposal by the Ministry of Power to ban e-auction of coal to make higher
proportions available for thermal stations that has so far not fructified. Despite the
clutter of negative news flows, we remain optimistic on the medium-to-long-term
prospects of the company aided by modest volume growth, better realizations and
improving operational metrics. Maintain ADD rating with PT of Rs454 (Rs470
previously).


After Ministry of Power, steel ministry suggests radical proposals for increasing availability
As per media reports, a panel formed by the Ministry of Steel for examining infrastructure and raw
material issues for the steel sector has recommended that coking coal mines should be demerged
from CIL and either clubbed into a separate entity or auctioned off. The panel argues that coking
coal production in the country has stagnated owing to CIL’s focus on development and production
of thermal coal and CIL has limited plans to develop coking coal assets in XIIth plan as well. In our
view, the proposal reflects the continuing scramble to make additional coal available akin to the
power sector which previously argued in favor of a ban on e-auction sales. We note that such a
proposal would essentially entail demerger of BCCL which contributed 6.7% of overall production
and ~10% of total PAT in FY2011.
Labor agitation issues further weigh in on sentiments—unlikely to recede until wage settlement
Recent media articles indicate a country-wide strike called by coal unions on October 10, 2011 to
meet their demand of an annual productivity-linked bonus of Rs23,000 as against Rs17,000
offered by CIL. The strike could potentially impact CIL’s production and revenues by 1 mn tons and
Rs1.2 bn, respectively. In our view, CIL will likely continue to remain susceptible to labor agitations
in the near term till such time that the ongoing wage negotiations are conclusively settled.
Maintain ADD with a revised target price of Rs454/share
We maintain our ADD rating with a revised target price of Rs454/share (previously Rs470/share)
adjusting earnings marginally for higher cost of production and effective tax rate. CIL currently
trades at 9X FY2013E EPS (adjusted) and 6X FY2013E EBITDA (adjusted). While the spate of news
flows surrounding the wage negotiation, or proposals from the power and/or steel ministry
scrambling for higher coal availability could weigh on stock sentiment—we remain confident of
the medium-to-long-term prospects for Coal India as it continues to benefit from higher
realizations, sedate despatch growth and improving operational efficiencies that will continue to
propel the earnings growth


Key highlights of Annual Report 2011
We discuss below some other key takeaways of the annual report
􀁠 Volume miss in FY2011 spread across subsidiaries, MCL and NCL lead the pack.
Barring BCCL and to an extent SECL, all other coal-producing subsidiaries of CIL missed
their offtake targets for FY2011 by 8-10% driven by (1) environmental hurdles that
stymied new mine development, (2) infrastructure constraints and (3) law and order
problems in certain coal fields. Mahanadi Coalfields (MCL), also the largest producer,
missed its offtake target by 13% driven by lower rake availibility and law and order
problems in the region. Exhibit 2 below highlights subsidiary-wise targeted volumes and
wagon loading against actual achievement.

Exhibit 1: Our target price is based on 13X FY2012E adjusted EPS
Target price calculation of CIL
EBITDA (Rs bn) 210
OBR (Rs bn) 32
Adjusted EBITDA (Rs bn) 242
Interest income (Rs bn) 57
PAT (Rs bn) 186
Adjusted PAT (Rs bn) 168
EPS (Rs/share) 29
Adjusted EPS (Rs/share) 27
P/E on FY2013E adjusted PAT (X) 13.0
Value of coal business (Rs bn) 2,182
Cash (Rs bn) 688
Market Cap (Rs bn) 2,870
Target price 454
Notes.
(1) Adjusted EBITDA is calculated after removing the effect OBR adjustment.
(2) Adjusted PAT is calculating after removing the effect of
OBR adjustment and interest income net of taxes.
Source: Kotak Institutional Equities estimates



􀁠 E-auction premium drives FY2011 earnings. CIL’s average e-auction realization
jumped to Rs1,846/ton in FY2011 from Rs1,583/ton in FY2010 with premium over
notified prices increasing from 62% to 75% in FY2011. Sale of beneficiated coal
increased 6% yoy to 15.5 mn tons in FY2011 at an average realization of Rs2,203/ton
(Rs2,267/ton in FY2010). 8% yoy jump in raw coal realization was primarily driven by the
impact of price hike in March 2011 as well as higher realization for coal sold through
MoU.
􀁠 BCCL and MCL drive jump in profitability. BCCL and MCL registered a sharp yoy jump
of 56% and 52%, respectively in profitability (EBITDA per ton) in FY2011 driven by a
15% jump in realizations. Increase in realization for BCCL was primarily driven by increase
in price of coking coal (linked to imported prices) while MCL jump was driven by the price
hike in March 2011 which aligned MCL prices to SECL for all grades of coal. Further,
BCCL also benefitted from a strong 18% yoy growth in volumes in FY2011 while WCL
and NCL registered a negative volume growth.


􀁠 Capex and capacity addition. CIL incurred a capex of Rs25.4 bn in FY2011 as against
the original budgeted estimate of Rs38 bn. Capex miss was driven primarily by
environmental concern and more specifically the moratorium imposed by CEPI which
stalled the process of new mine development in FY2011. During the year, CIL completed
six projects aggregating to a capacity of 13.65 mtpa while another eight projects
aggregating to a capacity of 15.88 mtpa commenced contribution to production in
FY2011.

􀁠 Net attrition and improvement in productivity. Total employee count reduced from
396,342 as of March 2010 to 383,347 as of March 2011 implying a net attrition of 3%.
Correspondingly, employee productivity, output per man shift (OMS) increased 6% yoy to
4.73 tons in FY2011. We factor an average net attrition of 2.5% and 6% CAGR in
employee productivity in the FY2011-17E period. Average wages increased 14% yoy in
FY2011 primarily on account of likely inflation in variable dearness allowance linked to
inflation.

GAIL (India) – Shale gas acquisition not material:RBS

GAIL has acquired 20% stake in the Carrizo operated shale gas assets in Eagle Ford shale (US)
for US$95m. Though it’s a producing asset, due to its small size, it will not materially impact
GAIL’s prospects where we remain pessimistic due to under-utilization of new pipelines for the
lack of gas supply sources


20% stake in Eagle ford shale
􀀟 GAIL has announced that its US subsidiary has entered into a joint venture to acquire 20%
stake in Carrizo operated Eagle Ford shale at the cost of US$95m. This comprises of
US$63.65m of upfront cash payment and additional US$31.35m of drilling carry. Carrizo
expects the $31.35 million drilling carry to be fully realized in less than one year
􀀟 The acquisition would be funded through debt-equity mix of 70:30.
The assets are already under production
􀀟 The Eagle ford shale is a liquid rich play. The assets under JV are already under production
with eight horizontal wells currently producing approximately 1,700 net bopd (340bopd net to
GAIL) and 3,800 net mcfd of rich gas (760mcfd net to GAIL). In mid 2011, Carrizo has
estimated proved reserves of 13.8mmboe (2.76mmboe to GAIL) of which 2.5mmboe are
classified as proved developed (0.5 million boe net to GAIL). A drilling rig is currently in the
process of drilling a four well pad on the JV assets which is expected to be completed and
brought on production near the end of this year.
Acquisition not material for GAIL
􀀟 This acquisition is in line with GAIL’s strategy of buying oil & gas assets outside the country
and bringing equity LNG into the country to support its pipeline business. That said, given the
small size of the acquisition, it would not have any material impact of its core pipeline
business which we believe would continue to remain under pressure due to lower utilization of
the new pipelines on account of lack of gas supply sources.
􀀟 On per acre basis, cost for GAIL comes to US$23,515/acre which prima facie looks expensive
compared to other deals in the Eagle ford shale. For eg , RIL had acquired 45% stake in
Pioneer Natural Resources operated assets in Eagle Ford shale in June 2010 for

US$11,110/acre. That said, we note that per acre based cost comparison may not be most
appropriate due to heterogeneity in shale gas plays and different production profiles etc.
􀀟 We believe that the returns on this acquisition, like all other shale gas acquisitions, would
depend upon rebound of natural gas prices in US which contrary to expectations have shown
no signs of improvement.