Buy Coal India, target Rs 338: Motilal Oswal Securities
Time period given by the brokerage is one year when Coal India price can reach the defined target.
Investment rationale by the brokerage
Lowering volume growth expectation as production sputters: Coal India’s (COAL) coal production growth has started sputtering. It has reached a point where growth of dispatches will suffer not only in FY19E, but also in FY20E. COAL builds inventories during 2H of any financial year in order to meet demand in the 1H of the next financial year, when production is usually lower due to seasonally high heat followed by monsoons. Unfortunately, COAL’s inventories are now significantly lower than the historical levels. Our channel checks suggest that COAL is unlikely to surprise positively in the remaining three months of FY19E. SECL is struggling with production growth. Talcher coal fields have inventories but offtake is an issue, while IB valley’s mines are suffering from slow land acquisition. Various government agencies and COAL’s top management need to work on a war footing to address these issues, else production growth will suffer. Therefore, it has become inevitable that we tone down our expectations. We are reducing our sales estimates by 1 per cent/2 per cent to 612mt/645mt for FY19E/FY20E.
Power plants restocking demand squeezing high margin E-auction volumes: Low inventory level at power plants is another factor that will impact earnings of COAL because more coal will be dispatched to power plants on priority basis, which will leave behind lower tonnage for high margin E-auction. Although low inventories at power plants in FY18 was a result of voluntary destocking during FY17, the lower level in FY15 and FY19 are a result of slower-than-expected growth in domestic coal production. Coal dispatches grew 12 per cent in FY18 and continue to grow at 11 per cent so far in FY19E. Since inventories at power plants remain low, the restocking demand will continue to drive higher demand in FY20E as well. Therefore, we need to reduce E-auction volumes by 3 per cent to 79mt in FY19E and by 25 per cent to 69mt in FY20E. A scarcity of coal for non-power will ensure that E-auction prices remain high. Therefore, we are increasing E-auction realization by 10 per cent to Rs 2200/t for FY20E, which is still a decline of 12 per cent YoY.
Reducing earnings by 5-7 per cent; valuations are attractive: We are reducing adj. EBITDA estimates by 5 per cent/6 per cent to Rs 242/274b for FY19E/20E on combined impact of reduction in volumes and increase in E-auction prices as discussed above. EPS is reduced by 5 per cent/7 per cent for FY19E/20E. Stock is trading at an attractive valuation i.e. adj. EV/EBITDA of 4.6x/4.1x, P/E of 9.2x/8.3x and dividend yield of 8 per cent/9 per cent at 90 per cent payout ratio in FY19E/20E. Adjusted EBITDA is expected to increase at CAGR of 16 per cent over FY18-20E on high operating leverage driven by 5-6 per cent volume growth and cost reduction on high natural attrition. We maintain BUY and value the stock at Rs 338/share based on EV/EBTIDA of 6.5x, in line with valuation of mining stocks.