Your success is our success

Earnings headwinds unlikely to recede

n CILs profitability to be impaired due to: a) mix changing in

June 04, 2013

Rating Reduce CMP Rs326

Target Price change (%) Nifty Sensex

favour of low-margin power, b) declining spot coal prices for its market-linked segment and c) waning incentives possibility for further price given the elections and 2) CIL to fall short of power sector trigger levels even at 7% dispatch growth, removing possibility of increased e-auction volumes

n Not many options with CIL to offset this, as 1) We see limited

Target Price Rs320

NA/NA NA 5,939 19,610

EPS Chg FY14E/FY15E (%)

n EPS CAGR of 4.5% in FY13-15E vs 25% in FY11-13. Third party

sampling which might bring in negative surprises leading to lower average realizations to be another pricing blow for CIL of meaningful earnings revival catalyst, stock is unlikely to see reversal of this de-rating. Initiate with Reduce TP Rs320

Price Performance
(%) Absolute Rel. to Nifty
Source: Bloomberg

n While stocks de-rating partially factors in concerns, absence 3M 4 0 6M 12M -11 -12 1 -17

1M 2 2

CILs high-margin profitability to be impaired

We expect CILs current high-margin profitability structure to be impaired led by: a) higher allocation to the least-margin power sector (76% FY15 vs.72% in FY12), b) declining prices for its market-linked segment (contributes ~60% to EBITDA) & c) waning out of volume-linked incentives due to shortage & necessity to honor post-FY09 FSAs.

Relative price chart

400 Rs % 10 370 2

340

-6

310

-14

Pricing outlook for CIL deteriorating despite recent price hike

The pricing outlook for CIL, we believe, is deteriorating, despite the recent 5% price hike, which would be just enough to offset the cost rise. The company could face multiple headwinds in form of: a) increased allocation to power sector, leading to stagnation in realizations, b) minimal chances of a second consecutive FSA price hike in FY14E/H1FY15 because of 2014 general/state elections, c) minimal chances of a substantial price hike for non-power given weak economy, d) 1/3rd revenue is already linked to global prices that have been declining and e) power sector trigger levels & shortage even at 7% dispatch growth to ensure stagnancy in e-auction volumes.

280

-22

250 Jun-12

Aug-12

Oct-12 Coal India (LHS)

Dec-12

Feb-13

Apr-13

-30 Jun-13

Rel to Nifty (RHS)

Source: Bloomber g

Stock Details
Sector
Bloomberg Equity Capital (Rs mn) Face Value(Rs) No of shares o/s (mn) 52 Week H/L

Metals & Mining COAL IB 63,164 10 6,316 386/ 289 2,441,086 13.4

CIL heading for structurally lower-margin trajectory; EPS CAGR of 4.5%

In the absence of a substantive price hike, we believe, CIL is headed for a structurally lower-margin trajectory. As per our estimate of allocation to power and another optimistic 5% price hike for the non-power sector in FY15E, we see CILs EBIDTA/t remaining stagnating at Rs385 in FY15E (FY13 EBIDTA/t of Rs388). Further, we are yet to factor any impact of likely third party independent sampling which might bring in negative surprises leading to lower realizations . Thus, CIL, we believe, would be unable to overcome these hurdles, and hence expect a muted EPS CAGR of 4.5% over FY13-15E vs. 25% over FY11-13 (consensus FY13-15E EPS CAGR of 8.5%).

Market Cap (Rs bn/USD mn) 2,060/ 36,314 Daily Avg Volume (No of sh) Daily Avg Turnover (US$mn)

Shareholding Pattern (%)

Mar'13 Dec'12 Sep'12 Promoters FII/NRI Institutions Private Corp Public
Source: Bloomberg

90.0 5.4 2.0 1.2 1.3

90.0 5.6 1.7 1.3 1.4

90.0 5.5 1.8 1.3 1.4

Stock de-rating unlikely to reverse; Initiate with a Reduce target of Rs320

CIL caught in a conundrum of addressing fuel supply issues of power sector and its own deteriorating profitability. Although the stocks de-rating over past 1yr partially factors in our concerns, in the absence of meaningful earnings revival triggers, the stock is unlikely to see a reversal of this de-rating. We initiate coverage with a Reduce rating and a target price of Rs320. We value CIL at 6x EV/E, which is at par with its global peers, as low earnings growth trajectory vis--vis peers offsets the monopoly premium. Financial Snapshot (Consolidated)
YEMar FY12A FY13A FY14E FY15E Net Sales EBITDA (Core) (%) APAT 25.1 146,971 26.5 173,495 25.9 176,341 25.9 189,211 EPS 23.3 27.5 27.9 30.0 EPS 34.5 18.0 1.6 7.3 RoE (%) 39.8 39.0 34.2 32.5 P/E 14.0 11.9 11.7 10.9 EV/ EBITDA 7.7 7.3 6.9 6.1 P/BV 5.1 4.3 3.8 3.3 (Rs) % chg

Ajit Motwani ajit.motwani@emkayglobal.com +91-22-66121255 Amit Golchha amit.golchha@emkayglobal.com +91-22-66242408 Nitin Arora nitin.arora@emkayglobal.com +91-22-66121491

(Rsmn)

624,155 156,513 683,027 180,836 714,333 185,216 763,008 197,534

Emkay Global Financial Services Ltd.

Initiating Coverage

Emkay

Coal India

Coal India

Initiating Coverage

CILs profitability to face multiple hurdles; FY13-15E EPS CAGR of 4.5%

Our comprehensive analysis of Coal India Ltd.s (CIL) segment-level profitability and the governments policy initiative aimed at stepping up coal supply to the problem -ridden power sector suggest that the companys profitability is likely to encounter several hurdles. We expect CILs current high-margin profitability structure to become impaired because of: a) the companys signing of a new power FSA (fuel supply agreement), which would mean a higher allocation to the least-margin power sector, leading to a structural decline in profitability, b) declining spot coal prices for its market-linked segment (contributing around 54% of FY13 EBIDTA), intens ifying margin headwinds, and c) surplus coal supply to preFY09 thermal power plants to decline, as CIL strives to honor post-FY09 FSA, which would wane incentives. We believe that these multiple headwinds would lead to a fairly muted EPS (CAGR) of 4.5% over FY13-15E compared with an EPS (CAGR) of 25% over FY1113. We believe that consensus estimates are factoring in optimistic offtake and pricing scenario for CIL, resulting in FY13-15E EPS growth (CAGR) of 8.5% as against our EPS growth (CAGR) of 4.5%. Given the twin headwinds of increasing the share of allocation to the power sector and the structurally low-margin in coal supply to the sector, we see a significant negative surprise with regard to the consensus earnings estimate. Further, note that we have not factored in any possible impact on realizations due to thirdparty sampling, which might have a meaningful impact on CILs realizations and earnings.
Exhibit 1: Emkay vs. Consensus estimates FY14E Rs bn Sales EBITDA EBITDA Margin (%) PAT EPS
Source: Emkay Research, Bloomberg

FY15E Var (%) (3) (4) (4) Emkay Consensus 763 216 28 190 30.0 797 234 29 204 32.35 (7.2) (7.4) Var (%) (4.3) (7.9) 733 210 29 184

Emkay Consensus 714 202 28 176 27.9

29.1

We have elaborated our arguments on this low profitability structure in the section below.

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

CIL generates least profit from supply to the power sector

Our analysis of CILs sectoral margin suggests that it makes least margins on its supplies to the power sector, besides its profitability is highly skewed in favour of supplies to nonpower (cement, steel and other industries) and e-auction segments. CILs last notified price hike for all consumers was in October 2009, which contributed around Rs150 to FSA realizations. However, we notice that CILs overall realizations have improved by Rs 570/t, clearly indicating that the major part of the realization improvement has come by its hiking of prices for its non-power consumers.
Exhibit 2: Garners the lowest margins from the power segment Particulars Power Volume (MT) % of total Revenue % of total EBITDA % of total EBITDA/t EBITDA Margin (%) Non-Power Volume(MT) % of total Revenue % of total EBITDA % of total EBITDA/t EBITDA Margin (%) A&B Volume (MT) % of total Revenue % of total EBITDA % of total EBITDA/t EBITDA Margin (%) E-auction Volume(MT) % of total Revenue % of total EBITDA % of total EBITDA/t EBITDA Margin (%) Washed coal Volume(MT) % of total Revenue % of total EBITDA % of total EBITDA/t EBITDA Margin (%)
Source: Emkay Research, company

FY12 312.2 72.2 302,666 49.3 36,737 20.0 118 12.1% 20.89 4.8 26,325 4.3 8,533 4.7 409 32.4% 29 6.70 108,103 17.6 21,157 11.5 730 20% 51 11.8 132,279 21.5 88,931 48.5 1,748 67% 19.59 4.5 44,781 7.3 28,095 15.3 1,434 73

FY13 344.0 74.0 358,829 53.6 57,724 28.9 168 16.1% 25.36 5.5 35,709 5.3 13,513 6.8 533 37.8% 29 6.23 108,170 16.1 19,741 9.9 681 18% 49 10.6 125,030 18.7 82,018 41.0 1,669 66% 17.63 3.8 42,290 6.3 26,858 13.4 1,523 86

FY14E 365.1 74.7 411,268 57.3 89,787 39.8 246 21.8% 25.36 5.2 38,566 5.4 16,235 7.2 640 42.1% 29 5.94 99,516 13.9 11,243 5.0 388 11% 49 10.1 118,902 16.6 75,584 33.5 1,537 64% 19.77 4.0 50,021 7.0 32,613 14.5 1,650 83

FY15E 388.3 75.7 437,433 57.3 88,168 37.0 227 20.2% 25.36 4.9 40,494 5.3 17,685 7.4 697 43.7% 29 5.66 104,492 13.7 14,986 6.3 517 14% 49 9.5 123,818 16.2 79,936 33.5 1,639 65% 21.37 4.2 56,770 7.4 37,551 15.8 1,757 82

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

Hence, we see that CILs blended realizations for non-power consumers at Rs2600/t are 2.5x that of notified power FSA realizations. Given the fact that the company has already de-regulated prices for A&B grade coal and e-auction/non-power FSA coal prices by 110% and 35%, respectively, which are higher than power FSA realizations, we estimate that the power sectors contribution to CILs EBITDA is a mere 29%, despite the sector getting a whopping 74% share in coal volumes. This implies a power FSA EBITDA/t (ex-overburden) of Rs168 vis--vis Rs1,173/t made by other segments put together. Clearly, with the power segments profitability being a mere 1/7 th of other segments, CILs profit growth is evidently linked inherently to the proportion of coal supply to the non-power sector.

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

Policy direction favours higher allocation to the power sector

Although CIL makes the least margin in its coal supply to the power sector, the policy direction embarked upon by the Government of India has been in favour of higher allocation of fuel to the problem -ridden power sector. Thus, CIL has been asked to sign FSAs with those power plants that have been commissioned post-2009. Under these new FSAs, the company has agreed for a minimum supply of 65% of Annual Contracted Quantity (ACQ) to these power plants for the first 3 years and 80% of ACQ after 3 years. Supply below 65% would entail paying a penalty by CIL to power producers. We estimate that under the new FSA, CIL will have to supply 134mnt of coal to power plants commissioned post-2009. In FY12, CIL supplied 344mt to the power sector, accounting for 74% of the volume. The supplies to h t e power sector have increased at a CAGR of just 3.8% over FY09-13 compared to total dispatches growth of 3.8%. As the company begins to honour the new FSA with those power plants commissioned post-FY09, the allocation to the power sector will increase at a higher pace. For example, as mentioned earlier, as per our calculations, CIL will have to supply 134mnt of coal under the new FSA till FY15. Hence, 93% of incremental production (post-collieries consumption) will have to be supplied to power plants. Hence, it is amply evident from our calculations that dispatches to the power sector will increase at a CAGR of 6.5% over FY12-15E compared to overall dispatches growth of 3.7%, leading to the sector accounting 75.7% of overall volumes in FY15E as against 74% in FY12. Consequently, contributions from e-auction are expected to decline 9.5% FY15E as against 11.8% in FY12.
Exhibit 3: CIL production for power FY12 Linkage -based capacity addition Production Availability for power Availability for post-FY09 Cumulative availability for post-FY09 Stock Liquidation Cumulative reqt. for post-2009 Cumulative reqt. for projects without PPA Shortage for post-FY09 (mt) Shortage for post-FY09 (%) Shortage Imp for coal terms
Source: Emkay Research

FY13E 12,835.00 452.0 344.00 15.00 66.00 13 91 7.3 -17.7 (21.2) (14.1)

FY14E 10,845.00 475.7 365.07 22.07 87.06 12 116 11.3 -17.6 (16.8) (11.2)

FY15E 11,127.00 500.7 388.29 23.23 110.29 12 134 13.8 -9.9 (8.2) (5.5)

25271* 435.8 312 38 38 0 61 4.9 -18.1 (32.3) (21.5)

Exhibit 4: Coal demand-supply matrix Particulars Assumed electricity Base deficit Assumed electricity demand gr. Coal demand Coal availability CIL SCCL Lignite Captive Cheaper imported contracts Spot Imported Coal
Source: Emkay research

FY09

FY10 FY11 FY12P FY13E FY14E FY15E FY16E FY17E -8.3% 8.6% 478 433 346 37 23 27 8 37 -8.9% 6.2% 525 470 378 38 25 29 16 39 -8.4% 9.0% 569 516 406 40 29 41 21 33 -5.1% 6.3% 619 567 434 41 31 61 23 29 -2.5% 6.5% 667 622 452 42 32 97 23 22 0.1% 6.5% 726 689 482 43 32 131 23 14

-11.0% -10.1% -8.5% 5.4% 414 398 326 32 18 22 0 16 6.7% 3.8% 437 414 332 36 19 26 1 23 451 421 338 37 20 25 4 27

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

Incentives to wane out as volumes increase for new power FSAs

CIL has earned incentives worth Rs7bn, Rs10bn and Rs13bn in FY11, FY12 and FY13, respectively, on account of supplies made in excess of the trigger level of 90% to those power plants that were commissioned before 2009. Now considering that the extension of supply commitments would increase materially in the future, we can infer that 65% requirements of post-FY09 plants are unlikely to be met, despite 93% of incremental production being supplied to power and stock liquidation. Therefore, we expect the excess supplies (higher than 90% trigger levels) to shift from preFY09 plants to post-FY09 plants. However, given the shortfall, we believe, these excess supplies would shift to post-FY09 plants, thereby wiping out the incentives completely.
Exhibit 5: Slab-wise penalty and incentive structure in new FSAs Source Level of delivery FY13-15 Trigger level for supply to power plants Maximum proportion of imported coal Penalties Imported + Domestic Applicable for imported coal 75-80% 70-75% 65%-70% Applicable for domestic coal 70-75% 65%-70% 60%-65% 55%-60% 50-55% Below 50% Incentives 90%-95% 95%-100% Above 100%
Source: Emkay Research, Co mpany

FY16 72% 10%

FY17 80% 5%

65% 15%

80-100% of ACQ

Nil 1.50% 1.50% 1.5%

Nil 1.5% 1.50%

Nil 1.5%

5% 5% 5% 10% 20% 40% 10% 20% 40% 40% 10% 15% 40% 40% 40%

10% 20% 40%

10% 20% 40%

10% 20% 40%

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

Pricing outlook for CIL deteriorates, despite recent price hike

Over the last 5 years CILs EBITDA/t improved substantially from Rs161 in FY08 to Rs388 in FY12, yielding a CAGR of 19%. A major part of this development has actually come from improvement in realizations, which have increased at a CAGR of 11%, led by CIL taking a price hike through multiple modes such as: a) an 11% Increase in FSA prices in October 2009, b) a 150% rise in notified prices for high-grade coal (A&B) in February 2011 by linking it to a 15% discount to import parity prices, and c) around 30% higher notified prices for consumers other than that for power consumers. This has lead to CIL registering a robust CAGR of 24.6% in its EBIDTA over FY08-13. As CILs profitability is highly leveraged to its coal realizations (a 1% increase in coal realization improves EBIDTA/t by 3%), sustained and frequent price hikes are extremely critical for the companys profit growth. However, we believe that the pricing outlook for CIL is deteriorating, despite the recent price which implies blended coal price increase of 5% (cuts G3 and G4 grade prices by 12.5% and increases prices by ~10% for grade G5-G17). We believe further price hike by the company face multiple headwinds in the form of: a) b) c) d) Increased allocation to the power sector, which means stagnation in blended realizations. Minimal chances of a second consecutive FSA price hike in FY14E/H1FY15 because of 2014 general/state elections. Minimal chances of a substantial price hike for non-power consumers given the weak economic conditions. One-third revenue is already linked to global prices, which have been in a decline.

Exhibit 6: Realization/t to stagnate

1600 1400 1200 1000 800 600 400 200 0 1441 977 1074 1187 1468 1463 1488

FY09

FY10

FY11

FY12 Realisation/t

FY13E

FY14E

FY15E

Source: Emkay research, Company

a) Increased allocation to power sector to mean stagnating blended realizations

As mentioned earlier, CIL realizations under power FSA at Rs1043/t are 40% lower than the blended realizations for non-power consumer at Rs2560/t. Hence, the increased allocation of coal to the power sector would mean stagnating/declining blended realizations for CIL. For example, despite assuming a regular 5% price hike for non-power consumers, A&B grade and higher E-auction prices in FY14, we see blended realizations remaining stagnant in FY14/15E at Rs1471/t &1488/t due to change in mix.

b) Minimal chances of consecutive FSA price hike in the wake of 2014 general elections
CIL has not implemented a price hike in the power segment since October 2009. However, in the wake of increasing cost and with rising volume allocations to the power segment (which garners the lowest realizations ), it became imperative for the company to implement a price hike, particularly in the power segment in order to sustain its EBITDA margin. As per our estimation, the company has to implement a price hike of 5% in the power sector to further improve its EBITDA margin (we have assumed improvement across the segment with the exception of the power FSA segment in FY15E) However, we believe, it would be extremely difficult for CIL to undertake second consecutive FSA price hike in

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

FY14E/H1FY15 because of 2014 general/state elections and CIL is still the most profitable company in the complete power value-chain, while majority of others have been reporting losses, resulting in political pressure not to increase prices
Exhibit 7: Price hike taken by CIL Date Price increase (%) Elections 15-Jun-04 12-Dec-07 16-Oct-09 26-Feb-11
Source: Emkay Research, company

16.2 April20th-May10th 2004 10 11 16th April -13th May2009 10 Differential pricing

c) Minimal chances of substantial price hike for non-power consumers in the wake of weak economic conditions
In the absence of limited possibility of a consecutive price hike for the power FSA to expand its margins to around 26%, CIL would have to entirely shift volumes of its nonpower FSA consumers to the e-auction segment. This would entail a staggering price hike of around 70% for the non-power FSA consumers. Given the fact that non-power consumers already pay 30-35% higher prices compared to power consumers and also in the backdrop of weak economic conditions such a big coal price hike would be extremely difficult to implement. In fact, with more than a 30% hike already effected in railway freight rates over the last 15 months, we believe that it would be impossible for CIL to take such a sharp price hike for non-power FSA consumers. Moreover such a sharp price hike would be extremely inflationary in nature, which could de-rail the governments anti-inflationary agenda.

d) One-third revenue, already linked to global coal prices, has been in a declining trend, intensify CILs pricing headwinds
CIL garners about a third of its revenue from e -auction and A&B grade coal, where realizations are largely linked to global coal prices. These two segments together contribute around 51% to the companys FY13 EBIDTA, despite contributing only 17% to volumes, clearly indicating the importance of these two segments to its overall profitability. With increasing allocation to the power sector under the new power FSA, we expect the proportion of A&B grade coal and the e-auction segment to decline to 16% by FY15. Hence, in a scenario of declining proportion of this segment, increasing prices for these customers would be imperative for CIL to protect its margins. However, global coal prices have been in a decline, with prices correcting 18.5% in USD term and 15% in INR term, which, in turn, has further intensified profitability headwinds for CIL.
Exhibit 8: Softening of global coal prices
120 90 USD/t 60 30 0 May-13 Apr-13 FY03 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 6000 4500 3000 1500 0 INR/t

Coal price USD

Source: Emkay Research, Bloomberg

Coal Price INR

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

Recent price hikes just enough to cover increased cost With its recent price hike CIL would be able to garner additional revenues worth Rs21.1bn for the remaining period in FY14. We believe that these hikes are just enough to offset recent cost escalations in the form of higher diesel prices and rise in wages for contractual labor to the tune of Rs12.5bn (hike of Rs10/litre in diesel price) and Rs2.5bn, respectively, aggregating to over Rs15bn. In fact our checks suggest that post the derogation of bulk diesel prices, prices of diesel for bulk user has now gone up by Rs20/litre (over earlier regulated diesel prices) which in turn would mean total cost increase of Rs25 bn on diesel alone.

Impact of third-party sampling yet to be factored in

Since CILs shift to the GVC-based system, power producers have constantly been complaining about the quality of coal it supplies. A case in point is the contentious issue between NTPC and CIL, where the former has not signed an FSA with CIL citing quality-led issues of coal supplied by the latter. NTCP, along with other power producers, has been demanding a third-party quality-check on coal supplied by CIL.

Impact analysis
Exhibit 9: Impact due to change in grade level % Avg. Impact on FY14E blended realization Impact on FY14E blended realization (Rs/t) Impact on FY14E revenue Impact on FY14E EPS
Source: Emkay Research

5.49 79 38,781 4.3

Further, it should be noted that we have not factored in any possible impact on realizations as a result of the third-party sampling, which might have a meaningful impact on CILs realizations and earnings.

Emkay Research

June 04, 2013

Coal India

Initiating Coverage

CIL is heading for structurally lower-margin trajectory

We believe that CIL is headed for a structurally lower-margin trajectory, as it increases allocation to the low-margin/low-realization power sector. With allocation to the power sector increasing from 72% to 75.7%, and even after factoring in a 5% price hike for the non-power sector/e-auction/wash coal in FY15E, our calculations suggest that CIL EBIDTA/t would still decrease from Rs388 in FY13 to Rs385 in FY15, causing the EBIDTA margin to decline by 60bps from 26.3% in FY13 to 25.9% in FY15. Our sensitivity analysis in the event of a nil price hike indicates that CILs EBIDTA/t would dip from Rs386 in FY13 to Rs355/t in FY15, leading to an EBIDTA decline of 2% (CAGR).
Exhibit 10: CIL EBIDTA/t margin in a structural lower trajectory Per tonne details Realisation Total Operating Expenses Internal consumption of coal Consumption of stores & spares Accretion in stock Employees' remuneration & benefits Power & fuel Social overhead Repairs Contractual expenses Miscellaneous expenses Overburden removal adjustment Finance charges/Commitment charges Provision/Write-off EBITDA Recovery of Trans & Loading Coal Adj. EBIDTA
Source: Emkay research, company

FY12 1441.2 1079.8 0.0 127.1 -8.8 583.1 46.5 33.5 14.9 113.2 50.7 85.3 0.4 33.9 361.4 31.8 393.2

FY13 1468.5 1079.7 0.0 130.3 10.6 587.4 50.2 13.4 17.7 124.7 56.6 68.8 0.0 19.9 388.8 32.0 420.8

FY14E 1462.6 1083.4 0.0 142.6 -5.0 536.8 61.5 41.0 16.7 143.9 52.5 74.3 0.0 19.0 379.2 33.6 412.8

FY15E 1487.9 1102.7 0.0 149.7 -5.0 529.6 65.1 43.0 17.6 151.1 53.9 79.5 0.0 18.1 385.2 35.3 420.5

Emkay Research

June 04, 2013

10

Coal India

Initiating Coverage

CIL remains most profitable in power value-chain, while most others are bleeding
Over the past few months , end-consumers have been witnessing a substantial rise in coal prices, largely due to an increase in diesel prices, leading to a hike in freight rates. With implementation of price-pooling, the cost is expected to increase even further, straining the power value-chain. CIL is estimated to earn a profit after tax of Rs169bn in FY13E as against the rest of the power value-chain that makes a loss of Rs 360bn (add up all the losses of SEBs in FY13, and add losses/profits of IPPs and generation PSUs and PGCIL). Cash on CILs books currently stands at Rs582bn, which again is higher than the sum total of the complete value-chain. Further, in the value-chain, CIL does not require any significant capex for its growth, while generators, especially distribution companies, require a significant capex to improve their performance and cater to electricity demand growth.
Exhibit 11: CIL remains most profitable in the power value -chain INR Bn FY11 FY12 FY13E PAT Coal India Private IPPs PSUs SEB losses Cash Coal India Private IPPs PSUs Capex Coal India Private IPPs PSUs Gross debt Coal India Private IPPs PSUs
Source: Emkay Res earch, PFC, Companies

FY14E 162 62 152 (428)

FY15E 179 87 168 (426)

109 60 117 (591)

148 33 121 (646)

171 14 140 (514)

459 207 342

582 228 319

701 192 305

785 186 329

898 184 313

17718 604 316

20472 708 367

27902 306 371

41159 395 422

41159 360 454

15536 1176 1005

15274 1875 1189

15274 2090 1383

15274 2372 1589

15274 2549 1819

Emkay Research

June 04, 2013

11

Coal India

Initiating Coverage

Profit growth to remain muted FY13-15E EPS CAGR of 4.5%

Led by multiple profitability headwinds such as: a) higher allocation to low-margin power sector, b) decline in international coal prices impacting realizations of CILs market-linked coal offtake, c) inability to implement two consecutive price hikes during elections, and d) shortfall in meeting new power FSA commitments , leading to the waning of incentives, we expect CILs current high-margin profitability structure to become impaired. We believe that these multiple headwinds would lead to a fairly good EPS (CAGR) of 4.5% over FY13-15E compared with an EPS (CAGR) of 25% over FY11-13. We do not see EBITDA/t expanding in the light of the shift in mix accompanied by the high inflation scenario resulting from a wage and diesel price increase, which would keep EBITDA/t at Rs379/t (USD6.8/t) and Rs385/t (USD 7/t) in FY14E/15E.
Exhibit 12: Realization/t to stagnate
1600 1400 1200 1000 800 600 400 200 0 FY09 FY10 FY11 FY12 Realisation/t
Source: Company, Emkay Research

Exhibit 13: EBITDA margin unlikely to expand

1468 1463 1488 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% FY13E FY14E FY15E 0.0% FY09 FY10 FY11 FY12 FY13E FY14E FY15E 26.4% 22.0% 25.6% 25.1% 26.5% 25.9% 25.9%

1441 977 1074 1187

Source: Company, Emkay Research

Exhibit 14: Ebitda/t upside capped

500 400 300 200 100 FY09 FY10 FY11 FY12 EBITDA/t
Source: Company, Emkay Research

Exhibit 15: EPS growth to remain subdued

35.0 30.0 25.0 20.0 389 15.0 10.0 5.0 FY13E FY14E FY15E 3.2 FY09 FY10 FY11 FY12 EPS
Source: Company, Emkay Research

271

248

318

361

379

385

23.4 15.2 17.2

27.5

27.9

30.0

FY13E

FY14E

FY15E

Exhibit 16: ROE to decline

45% 40% 35% 30% 25% 20% FY10 FY11 FY12 ROE
Source: Company, Emkay Research

Exhibit 17: ROCE also on downtrend

60% 50% 40%

43% 37%

30%
40% 39% 34% 33%

57%

52%

54%

54%

20% 10% 0%

48%

46%

FY13E

FY14E

FY15E

FY10

FY11

FY12 ROCE

FY13E

FY14E

FY15E

Source: Company, Emkay Research

Emkay Research

June 04, 2013

12

Coal India

Initiating Coverage

Return profile to remain muted

Despite the huge amount of cash on books, CILs return ratios have been impressive (ROE of >35%), mainly due to higher operating margins, driven by e-auction and washed coal, which used to offset the cost increase, despite a nil price hike enforced in the power segment since October 16, 2009. Given the change in sales volume mix, softening of global prices (which is likely to put pressure on prices of e-auction and A&B grade coal) and the difficulty to pass on the cost increase in the high inflationary environment with two consecutive price hikes (we have not assumed a price hike for FY15E.) could lead to lower return ratios. We expect ROE to edge lower to 34% and 32.1% in FY14E and FY15E, from 40% and 39.1% in FY12 and FY13, respectively.
Exhibit 18: Emkay assumption FY14E Volume (MT) Production % Growth Dispatches % Growth Price Hike Power FSA Non Power FSA E-auction A&B Washed coal Dispatches Power FSA Non Power FSA E-auction A&B Washed coal & other by product
Source: Company, Emkay research,

FY15E 501 5.3% 513 5.0% 0.0% 5.0% 5% 5% 5% 75.7% 5.2% 5% 9.5% 4.2%

476 5.3% 488 5.0% 8.0% 8.0% -5% -8% 8% 74.7% 5.5% 6% 10.1% 4%

See downside risk to consensus estimates

Our earnings for CIL for FY14E and FY15E are 4% and 7%, respectively, lower than the than consensus . This implies that consensus earnings are expecting a CAGR of 8.5% as against our EPS CAGR of just 4.5%. We believe that consensus estimates factor in a slightly optimistic offtake and pricing scenario for CIL, resulting in FY13-15E EPS growth (CAGR) of 8.5% as against our EPS growth (CAGR) of 4.5%. Given the twin headwinds of increasing the share of allocation to the power sector and the structurally low margin in fuel supply to the sector, we see a significant negative surprise with regard to the consensus earnings estimate. We believe that the major reason for the variation between our and consensus earnings estimates is largely because: a) cons ensus does not factor in a change of mix tilted towards the power segment, b) our nil expectation of a price hike in the power segment during FY15E, c) consensus has factored in incentives in estimates, which in our estimate remain the downside risk to the consensus estimate.
Exhibit 19: Emkay vs. Consensus estimates FY14E Rs bn Sales EBITDA EBITDA margin (%) PAT EPS
Source: Emkay Research, Bloomberg

FY15E Var (%) (3) (4) (4) Emkay Consensus 763 216 28 190 30.0 797 234 29 204 32.35 (7.0) (7.2) Var (%) (4.3) (7.9) 733 210 29 184

Emkay Consensus 714 202 28 176 27.9

29.1

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Potential triggers for stock performance

De-regulate prices for non-power consumer
To improve its growth profile, CIL could look at de-regulating prices of coal for its nonpower customers . This would imply that these customers would have to pay e-auction prices, which, in turn, would mean an 80% increase in prices of coal for them. However, given the fact that these customers account for only 4.5% of total volumes, the upgrade in our FY14E/FY15E EPS would be 7.6%/9%, while the EPS CAGR could jump from 4.6% to 9.0%. However, with non-power consumers already paying 30-35% higher prices compared to power consumers, and also in the backdrop of weak economic conditions, such a big coal price hike would be extremely difficult to implement. On the contrary, a sharp decline in global coal prices would narrow the difference in pricing and could force the non-power sector to look at imports, leading to possible losses for CIL.
Exhibit 20: De-regulate the non-power sector FY14E Volumes Non-power FSA realization/ton (same as our FY14E e-auction realization) FY14E/FY15E EPS (Rs/share) % upgrade in FY14E/FY15E FY13-15E CAGR (%)
Source: Emkay Research

25.3 2417 27.9/29.9 7.6/9 9.0

Higher dispatch growth, with incremental supply to e-auction customers

The second option for CIL to offset the drop in its profitability would be to increase dispatch growth and supply incremental volumes to e -auction customers. Our sensitivity model indicates a 3.5% earnings upgrade for a 1% increase in volumes, assuming that incremental volumes above 5% growth would be diverted towards e-auction. Thus, the maximum potential upgrade from this could be to the tune of 7.1% on 2% beat on our dispatch growth assumption of 5%. Although CIL might positively surprise on volumes, we believe that there remains a limited possibility of diverting those incremental volumes entirely to e-auction, given the shortage in supplying coal under the new power FSA at 65% trigger levels even at 5% volume growth. Further, with CIL being watched closely of late, it would not be able to manage quantities by supplying at lower rates to the power sector (paying penalty) and at higher rates to e-auction (higher realizations). Thus, higher volumes would not lead to proportionately higher profits because of supply to the power sector. Moreover, the companys production growth hinges largely on clearances from MOEF, while dispatches are dependent on the railways. With major railway projects still at the takeoff stage and likely to take 2-3 years to materialize, dispatches are unlikely to grow at a rate materially higher than our assumption of 5% growth.
Exhibit 21: EPS sensitivity to change in volumes and price for FY14E EPS Rs/share -2% -1% 0% 1% 2% -2% 24.61 25.26 25.91 26.55 27.20 -1% 25.59 26.25 26.91 27.57 28.23 0% 26.57 27.25 27.92 28.59 29.26 1% 27.55 28.24 28.92 29.61 30.30 2% 28.53 29.23 29.93 30.63 31.33

Exhibit 22: EPS sensitivity to change in volumes and price for FY15E EPS Rs/share -2% -1% 0% 1% 2%
Source: Emkay Research

-2% 26.15 26.94 27.74 28.54 29.33

-1% 27.23 28.04 28.85 29.66 30.47

0% 28.31 29.13 29.96 30.78 31.60

1% 29.39 30.23 31.06 31.90 32.73

2% 30.47 31.32 32.17 33.02 33.87

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Exhibit 23: CIL production for power FY12 Linkage-based capacity addition Production Availability for power Availability for post-FY09 Cumulative availability for post-FY09 Stock liquidation Cumulative reqt. for post-2009 Cumulative reqt. for projects without PPA Shortage for post-FY09 (mt) Shortage for post-FY09 (%) Shortage Imp for coal terms
Source: Company, Emkay Research

Initiating Coverage

FY13E 12,835.00 452.0 340.00 15.00 66.00 13 91 7.3 -17.7 (21.2) (14.1)

FY14E 10,845.00 474.6 359.01 21.02 85.01 11 116 11.3 -19.7 (18.8) (12.5)

FY15E 11,127.00 498.3 380.08 22.07 106.08 10 134 13.8 -14.1 (11.7) (7.8)

25271* 435.8 312 38 38 0 61 4.9 -18.1 (32.3) (21.5)

Buyback/higher dividend to unlock cash

The higher net cash balance (Rs321bn) even after reducing the actuarial plans unfunded liability of Rs137bn and the capex plan (FY14-17E) of Rs164bn, has the potential to be unlocked by either a buyback or a special dividend. We believe that the buyback would be positive, which would boost EPS by 1.4%, allocating capital to shareholders in the right direction, making a 4.5-5% yield instrument. In FY13, CIL declared a final dividend of Rs4.3/share, adding up a full-year dividend per share of Rs14/share (a payout of 52% and dividend yield of 4.5% on the current stock price). We have not factored in any special dividend. However, we have assumed a similar dividend payout ratio of 52% in FY14E/15E.
Exhibit 24: Buyback improves EPS by 1.4% CMP Buyback @ 10% premium Total No. of shares before buyback Buyback of shares (%) Buyback shares Mn Total o/s shares post buyback Cash outgo for buyback Rsbn Loss of other income FY15E Pr ofit before buyback FY15E Profit after buyback FY15E EPS before buyback FY15E EPS after buyback % Chg in EPS
Source: Company, Emkay Research

325 358 6316 5 315.8 6000.2 113.2 6,884.2 189,211 182,326 30.0 30.4 1.4%

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Valuations
Valuation at 6.9x/6.1x FY14E/15E EVE does not provide any upside
Currently, CIL trades at 6.9x/6.1 x EV EBIDTA (considering EBIDTA ex-OBR) for FY14E/15E and 11.7x/10.9x FY14E/FY15E. Although valuations are not expensive compared to its global peers, that are trading at an average EV/E of 6.6x/5.8x, we believe that the valuation does not provide any re-rating scope given CILs expected 4.5% earnings growth.

Stock de-rating unlikely to reverse

The CIL stock has been underperforming over the past 12 months, which clearly reflects increasing headwinds and the impact on its profitability. The stock has seen de-rating, with its one-year forward EV/EBITDA multiple shrinking from 7.7x to 6.9x. However, we believe, in the absence of meaningful earnings revival triggers (as discussed on page 15), the stock is unlikely to see a reversal of this de-rating.

CIL still trades at a premium to other India energy/resource stock

CIL trades at a premium to Indian energy stocks such as ONGC and Oil India, despite 72% of its volumes being sold to the power sector at subsidised rates. At the CMP, CIL [FY14 P/BV at 3.7 x garners a premium of 131%/164%on a P/BV basis compared to ONGC (FY14E P/BV at 1.6x) and Oil India (FY14E P/BV at 1.4x)], which, we believe, would narrow down going forward, given the structural change the company will see, which will contract the margins.

Initiate with a Reduce target of Rs320

We believe that CIL is caught in a conundrum of addressing fuel supply issues of the problem -ridden power generation sector, and its own deteriorating profitability structure and diminishing return profile. We believe that these strong profitability headwinds would impair the companys current high-margin profitability structure and lead to a muted EPS CAGR of 4.5% over FY13-15E compared with a robust 25% EPS CAGR over FY11-13. We initiate coverage on CIL with a Reduce rating and a target price of Rs320. We have valued the stock on an EV/EBITDA basis, assigning a multiple of 6x (at the CMP 11.7x/10.9x FY14/15E earnings), which is largely in line with valuations of global companies. We believe that the target multiple of 6x EV/EBIDTA for CIL is fair, since CIL should not trade at a premium to its global peers, given its low earnings growth (offsets the monopoly premium) over the next 3 years compared to its global peers such as Indonesia, which is likely to see an average EPS growth of 14.4% and 16.7% in FY14E and FY15E, respectively.
Exhibit 25: CIL fair value at Rs320/share FY15E EBITDA Rsmn OBR (Rsmn) Adjusted EBITDA EV/EBITDA EV Value of coal Business Value of coal biz per share Add cash & investments Cash & investment per share Total value per share CMP Upside/(Downside)
Source: Emkay Research

197534 40792 238326 6 1429955 1429955 226 633181 100 320 325 (1.8%)

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Exhibit 26: Comparative valuation FY14 Comparative Valuation India Coal India International cos. (Avg.) China China Coal Fushan Resources Hidli Industry Intl Develop Shenhua Energy Avg. Australia New Hope Corp Avg. Indonesia Adaro Coal Bukit Asam Bumi Resource Indika (Kideco) Indo Tambangraya Megah Avg.
Source: Emkay Research, Bloomberg

Initiating Coverage

FY15 P/BV 3.7 1.45 0.65 0.82 0.37 1.27 0.78 1.39 1.39 1.38 3.03 1.97 0.75 3.68 2.16 EV/ EBITDA 6.9 6.66 5.85 4.98 8.52 5.15 6.12 9.35 9.35 5.70 6.70 7.32 7.59 6.42 6.75 EPS growth 7.3 22.09 1.48 (3.58) 38.46 2.01 9.59 43.31 43.31 7.69 14.07 25.00 29.41 7.53 16.74 Sales growth 6.8 8.48 7.80 (1.27) 22.27 3.46 8.06 29.34 29.34 6.63 14.66 0.36 6.67 4.23 6.51 ROE 32.1 9.68 8.44 7.27 4.76 15.30 8.94 9.32 9.32 14.42 (1.92) 15.00 10.21 32.38 14.02 P/BV 3.3 0.98 0.60 0.79 0.36 1.15 0.73 1.36 1.36 1.28 0.41 1.18 0.64 3.71 1.45 EV/ EBITDA 6.1 5.86 5.35 4.86 7.40 4.86 5.62 6.26 6.26 6.36 5.59 7.39 4.64 6.36 6.07

EPS growth 1.6 59.70 6.31 (0.65) 129.41 8.46 35.88 19.85 19.85 18.18 16.98 0.00 21.43 15.53 14.42

Sales growth 4.6 12.09 10.97 10.97 27.34 7.69 14.24 6.91 6.91 7.79 16.53 10.15 10.99 7.52 10.60

ROE 34 11.89 9.01 7.54 3.05 16.66 9.06 1.26 1.26 14.42 30.29 14.78 11.08 33.97 20.91

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Key Financials (Consolidated) Income Statement

Y/E Mar (Rsmn) Net Sales Growth (%) Expenditure Raw Materials Employee Cost Other Exp EBITDA Growth (%) EBITDA margin (%) Depreciation EBIT EBIT margin (%) Other Income Interest expenses PBT Tax Effective tax rate (%) Adjusted PAT Growth (%) Net Margin (%) (Profit)/loss from JVs/Ass/MI Adj. PAT After JVs/Ass/MI E/O items Reported PAT PAT after MI Growth (%) FY12A 624,155 18.6 467,641 51,230 252,536 163,876 156,513 16.3 25.1 19,692 136,821 21.9 75,369 375 211,815 64,845 30.6 146,971 34.5 23.5 0 146,971 911 147,882 146,971 34.5 FY13A 683,027 9.4 502,191 65,560 273,208 163,423 180,836 15.5 26.5 18,130 162,707 23.8 87,469 452 249,724 76,229 30.5 173,495 18.0 25.4 0 173,495 -69 173,427 173,495 18.0 FY14E FY15E 714,333 763,008 4.6 529,118 67,200 262,188 199,730 185,216 2.4 25.9 20,189 165,026 23.1 89,176 474 253,728 77,387 30.5 176,341 1.6 24.7 0 176,341 0 176,341 176,341 1.6 6.8 565,474 74,216 271,557 219,700 197,534 6.7 25.9 22,041 175,493 23.0 97,251 498 272,246 83,035 30.5 189,211 7.3 24.8 0 189,211 0 189,211 189,211 7.3

Balance Sheet
Y/E Mar (Rsmn) Equity share capital Reserves & surplus Net worth Minority Interest Secured Loans Unsecured Loans Loan Funds Net deferred tax liability Total Liabilities Gross Block Less: Depreciation Net block Capital work in progress Investment Current Assets Inventories Sundry debtors Cash & bank balance Loans & advances Other current assets Current lia & Prov Current liabilities Provisions Net current assets Misc. exp Total Assets FY12A 63,164 FY13A 63,164 FY14E 63,164 FY15E 63,164

341,367 421,557 484,422 551,876 404,530 484,720 547,586 615,039 536 636 636 636 19,770 15,274 35,044 19,770 10,778 30,548 19,770 10,778 30,548 19,770 10,778 30,548

-11,941 -22,550 -22,550 -22,550 428,170 493,354 556,220 623,673 380,964 405,846 448,651 489,809 246,561 264,691 284,880 306,922 134,403 141,155 163,771 182,888 29,034 19,814 874,268 60,713 28,462 23,950 1,019,3 01 56,178 26,816 21,555 1,082,1 95 62,626 26,816 19,399 1,156,4 67 66,894

56,679 104,802 109,596 117,064 582,028 642,130 685,097 747,634 145,023 173,701 182,386 182,386 29,825 42,489 42,489 42,489 629,356 719,514 738,117 761,897 629,356 719,514 738,117 761,897 0 0 0 0 244,912 299,787 344,078 394,570 7 0 0 0 428,170 493,354 556,219 623,673

Cash Flow
Y/E Mar (Rsmn) PBT (Ex-Other income) Depreciation Interest Provided Other Non-Cash items Chg in working cap Tax paid Operating Cashflow Capital expenditure Free Cash Flow Other income Investments Investing Cashflow Equity Capital Raised Loans Taken / (Repaid) Interest Paid Dividend paid (incl tax) Income from investments Others Financing Cashflow Net chg in cash Opening cash position Closing cash position FY12A 212,727 19,692 -50,491 48,347 35,647 -67,044 198,878 -34,094 164,784 0 33,000 -1,094 0 -2,474 -540 0 3,483 FY13A 177,139 18,130 452 -346 5,227 -76,229 124,373 -24,310 100,063 72,585 -4,136 44,139 0 -4,496 -452 0 0 FY14E 180,962 20,189 474 0 -1,325 -77,387 122,914 -41,159 81,755 72,767 2,395 34,003 0 0 -474 0 0 FY15E 193,086 22,041 498 0 12,045 -83,035 144,636 -41,159 103,477 79,159 2,155 40,156 0 0 -498 0 0

Key Ratios
Y/E Mar Profitability (%) EBITDA Margin Net Margin ROCE ROE RoIC Per Share Data (Rs) EPS CEPS BVPS DPS Valuations (x) PER P/CEPS P/BV EV / Sales EV / EBITDA Dividend Yield (%) Gearing Ratio (x) Net Debt/ Equity Net Debt/EBIDTA Working Cap Cycle (days) 25.1 23.5 54.1 39.8 -81.0 23.3 26.4 64.0 10.0 14.0 12.4 5.1 2.4 7.7 3.1 -1.4 -3.5 -197.1 26.5 25.4 54.3 39.0 -80.6 27.5 30.3 76.7 14.0 11.9 10.8 4.3 2.1 7.3 4.3 -1.3 -3.4 -182.9 25.9 24.7 48.4 34.2 -87.2 27.9 31.1 86.7 15.4 11.7 10.5 3.8 2.0 6.9 4.7 -1.2 -3.5 -174.2 25.9 24.8 46.2 32.5 -101.0 30.0 33.4 97.4 16.5 10.9 9.8 3.3 1.8 6.1 5.1 -1.2 -3.6 -168.9 FY12A FY13A FY14E FY15E

-74,291 -103,462 -113,476 -121,757

-73,821 -108,410 -113,950 -122,255 123,963 60,102 42,967 62,537 458,064 582,027 582,028 642,130 642,130 685,097 685,097 747,634

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