Coal India – Institutional Fetish for the Stock

Coal India Limited (CIL), the largest global coal producer (output 431mtpa) looks well positioned to gain from acceleration of domestic coal demand. Despite its 82% market share in India, most of Coal India’s sales are at prices that represent a c60% discount to imported coal. While this seems to suggest that Coal India lacks true pricing power, this is far from the truth, as Coal India’s capital cost for new mine development is amongst the lowest in the world, and selling arrangements make customers liable for it.

Proposed changes in indirect taxes and royalties are borne by customers, and customers largely pay advances for purchases.

CIL (reserves 18.8bn tons, 82% of India’s output) should gain from 1.8x rise in power capacity over FY10-15E as it sells 80% of its volume to power utilities. Its lower reserves are low kcal (67% are E & F grades). However this is offset by its lower strip ratio (1.7x) and 90% of output from open-cast mines. Its cost of production (US$16/t) is one of the lowest among peers.

We expect CIL to be rerated over next 3-4 quarters as the market becomes increasingly aware of the relatively low risk in CIL’s earnings performance in view of the close correlation with economic growth.

Coal India is expected to report an EPS of Rs 17.4 for FY 11 and Rs 19.89 for FY 12 with a 12 month price target of Rs 360.