Coal India: Stock may be down, but it's not out, for sure

The New Mining Bill, which got its Cabinet nod on Friday, will have its maximum bearing on the 90 percent government-owned Coal India - It was apparent from the way the stock reacted on Friday, falling more than 5 percent.

Why does the bill differentiate between coal mining and other mining companies?

The bill, in its present form, proposes 26 percent of net profit to be shared with the rural people who are displaced due to the mining. Noble intentions, but what is difficult to comprehend is the bill differentiates between coal mining and other mining companies. Other mining companies will pay higher royalty depending on the quality of ore that could be manipulated by individual companies. Could this be because Coal India is mainly owned by the government and is easier to impose the diktat upon? In that case, it is being doubly unfair on minority shareholders of Coal India who have to accept the Bill without much say in it.

Profit sharing mandate gives little clarity on execution

Other than that, even the 26 percent profit sharing mandate gives little clarity on how it will be executed. It gives no answer on whether profit sharing will be based on number of people in a family, or the amount of land owned by a family.

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[caption id=“attachment_97923” align=“alignleft” width=“380” caption=“Various estimates are now being made of what the bill could mean for its profitability. Reuters”]  [/caption]

Profit sharing is also just one clause in the Bill which is a 100-page long document. The Bill also seeks support from state governments in figuring out how the money could be passed on to the affected people in the best possible way. What all of this means is the government will have a difficult time in passing this bill. It is slated to be presented in the next Parliament session in December which is also awaiting debate on the controversial Land Acquisition Bill.

Going by the pace in which the Parliament is functioning and the political deadlock between the ruling coalition and the opposition, the Mining Bill could see the light of the day much later than expected. Kotak says in its latest report that the bill could at best be implemented in the middle of financial year 2013.

Mining bill may result in further price hikes

Getting to Coal India’s specifics, various estimates are now being made of what the bill could mean for its profitability. Coal India Chairman NC Jha is not ready to project any numbers. He says, going by last year’s net profit, the company could feel a pinch of as much as Rs 2,000 crore. The company is currently also negotiating with its 3,83,000 workers on increasing its wages. Coal India had hiked its prices in February, with whopping 150 percent hike in its best grade coal prices. So it is not clear how many further price hikes it could afford.

On the other hand, the company’s wage cost comprises almost 50 percent of its price, which means the other 50 percent of its cost component is generally ignored while assessing the company’s future prospects. Credit Suisse has brought out a detailed report analysing the other half of its cost component and possible improvement of performance here.

Over last five fiscal years from 2006-11, the company has seen just 3 percent compounded growth in non-staff cost. This is contrary to global rise in mining costs due to rising costs in fuel, rubber and steel. Moreover, Coal India functions through multiple subsidiaries, not all of whom perform with same efficiency. Its four largest subsidiaries, MCL, CCL, SECL and NCL contribute 75 percent of its volumes and 87 percent of its operating profits.

While growth in volumes could see greater rise in profits, further price hikes could be easier to justify at inefficient subsidiaries like ECL and BCCL, writes the research house.

Coal India is also planning to invest around Rs 40,000 crore through the next five-year plan mainly to improve its profitability by building washeries, developing new projects and buying machinery. The company has been sitting on a huge pile of cash for a long time, and its efforts to get long-term contracts from coal mines abroad have borne no fruit as yet. Though it might not get long-term coal linkages at discounted rates, it could perhaps secure supply from abroad and pass on higher costs to others.

Private power companies continue to go abroad to secure long-term coal supply through acquisition of assets. But as our earlier analysis has shown, this could not mean low costs for these private companies. If Indonesia goes ahead with greater export duty or even ban on exports , the companies holding assets here could at best use this coal for hedging.

Coal India’s demand story still intact

Coal India will remain the best bet to get coal from, which keeps its demand story intact. If it could improve the profitability by selling more coal through e-auctions (which gives better prices than long term contracts) or by selling washed coal, the company still has immense opportunities to improve its profits. Credit Suisse also points out that as thermal coal mining costs rise globally, Coal India would be able to bargain hard for price hikes as it will offer much lower prices.

As far as the mining bill is concerned, Coal India used more than 26 percent of its profits for CSR activities last year. There is no clarity as to if it can use this fund now for adhering to the new bill. However, channelising these funds mostly for the bill could be difficult as they are also spent for hospitals, schools etc which it might not be able to do away with. Till further clarity emerges, it is not possible to project the exact effect the bill could have on its earnings per share.

Meanwhile, as the bill is debated and implemented, the stock could receive setbacks or fillips in the short to medium term. But the long-term story of improving pricing power, increasing demand for coal and better profitability remains intact. For a long-term investor, the recent correction could be seen as an opportunity to play in the power story of India.