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Buy Coal India, target Rs 281: Motilal Oswal Securities

Buy Coal India at a price target of Rs 281.

ETMarkets.com|
Mar 01, 2019, 05.39 PM IST
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The current market price of Coal India is Rs 232.40.
Motilal Oswal Securities has a buy call on Coal India with a target price of Rs 281.

The current market price of Coal India is Rs 232.40.

Time period given by the brokerage is one year when Coal India price can reach the defined target.

Investment rationale by the brokerage:
Valuations at 50 per cent discount to its averages and dividend yield at 9-10 per cent: Coal India (COAL) has witnessed unprecedented de-rating over the past 2-3 years. Its stock is currently trading at 7.4x P/E v/s average of 14x (Exhibit 1:), despite strong RoE at 35-40 per cent (Exhibit 2:) and 3.5x EV/EBITDA v/s average of 7.2x (Exhibit 3:). The company continues to generate strong free cash flows (Exhibit 4:), which allows it to distribute dividends in excess of 100 per cent of earnings (Exhibit 5:). Currently, dividend yield has increased to 9-10 per cent with current valuations at 45-50 per cent discount to long-term averages, which is a typical trait of a commodity stock at the peak of an earnings cycle. But, the same is perplexing in the case of COAL as 81 per cent of its revenue is non-cyclical. Selling price of FSA coal is currently at 50 per cent discount to E-auction prices i.e. market price, which means there is still significant pricing power left with the company. Only 19 per cent of the revenue is subject to the market price of coal and is cyclical in nature. If we were to model historically the lowest E-auction price of Rs 1,536/t (in FY17), the stock would still be trading at 4.3x EV/EBITDA, P/E of 9.2x and dividend yield of nearly 8 per cent, which means valuations would still range between 35-40 per cent discount to historical averages.

Key concern #1: coal demand will be crowded out by renewable energy- Indian power has huge potential for growth because per capita electricity consumption in the country is just 1/3rd of the world average. Currently, average energy load is nearly 140GW (equivalent to 100 per cent PLF), which is expected to grow to more than 3x over time, while total renewable energy (RE) potential is 900GW, meaning an average energy generation of nearly 150GW. RE’s share in the power mix can reach maximum of 35 per cent in India, which means that an average demand of 250-280GW will have to be met by coal. Thus, we believe coal demand will increase 2.5-3x over time even if the entire RE potential is fully tapped. Coal will continue to be the key driver of power generation in India. Though COAL accounts for 83 per cent of the domestic coal production, it meets only 66 per cent of the domestic demand, with a huge opportunity for import substitution. Therefore, we believe, demand for domestic coal will grow at a faster rate than power generation.

Key concern #2: continuous selling by the promoters- The Government of India (GoI) has sold nearly Rs 378b worth of shares in the last five years. GoI can further reduce stake by maximum 20 per cent (worth nearly Rs 220b at current market cap). Future selling will be much less than in the last five years.

Valuations and dividend yields are compelling: COAL has managed to keep cost under control despite inflationary pressure. Operating leverage and high natural attrition are driving operating efficiencies. Price hike about a year ago boosted earnings, offsetting the wage hike impact. Coal quality issues have completely worked through in the revenue. Adj. EBITDA is expected to increase at CAGR of 12 per cent and EPS at 16 per cent over FY18-21E. We have reduced target price to Rs 281 (earlier Rs 338) by reducing EV/EBITDA multiple from 6.5x to 5x to account for our concerns. Maintain Buy.

Unprecedented de-rating of stock: Coal India (COAL) has witnessed unprecedented de-rating over the past 2-3 years. Its stock is currently trading at 7.4x P/E v/s average of 14x (Exhibit 1:), despite strong RoE at 35-40 per cent (Exhibit 2:) and 3.5x EV/EBITDA v/s average of 7.2x (Exhibit 3:). The company continues to generate strong free cash flows (Exhibit 4:), which allows it to distribute dividends in excess of 100 per cent of earnings (Exhibit 5:). Currently, dividend yield has increased to 9-10 per cent with current valuations at 45-50 per cent discount to long-term averages, which is a typical trait of a commodity stock at the peak of an earnings cycle. But, the same is perplexing in the case of COAL as 81 per cent of its revenue is non-cyclical. Selling price of fuel supply agreement (FSA) coal is currently at 50 per cent discount to E-auction prices i.e. market price, which means there is still significant pricing power left with the company. Only 19 per cent of the revenue is subject to the market price of coal and is cyclical in nature. If we were to model historically the lowest E-auction price of Rs 1,536/t (in FY17), the stock would still be trading at 4.3x EV/EBITDA, P/E of 9.2x and dividend yield of nearly 8 per cent, which means valuations would still range between 35-40 per cent discount to historical averages.

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