CIL looks much better positioned for growth with low volatility vs. coal peers. We are now more convinced about its volume growth and pricing power. Receding government controls may help lift CIL’s margins and returns.
(I) 31% Ebitda CAGR in FY15-18e, leading to a 2,150 bp improvement in RoE: This is despite our relatively modest 3% CAGR (compound annual growth rate) in coal prices for the power sector. Much of the thrust comes from a changing business environment toward sustainability. In line with our growth estimates, we see 36% total return potential over one year; 30% upside to our new price target and 6% yield.
(ii) Expansion plans inspires confidence: Our analysis of constraints, opportunities and execution initiatives suggests that volume CAGR in FY15-18 will be well ahead of consensus (9.9% vs. 7-7.5%). Indeed, our assessment of low dependence on rail lines and greenfield projects, and a high percentage of large-scale mines through FY18 lend plausibility to our bull-case scenario (10.5%–in line with CIL’s target).
(iii) Why global energy investors will look at CIL: Low earnings volatility, high levels of insulation from global price fluctuations, high return ratios and solid growth are some of the reasons why global energy investors will increasingly look at Coal India. CIL is among the best coal stocks in the region, based on comparative analysis vs. regional peers of factors like growth in production and price trends (CAGR of 6% and 9%, respectively, for FY15-17 vs. -2% to +6% for peers), RoE (50% vs. 4% average for peers in FY17e) and dividend yield (6.0% vs. 2.6% for Asian peers in FY17e). Its earnings volatility has been low; the revival of growth that is likely from here is bolstering the prospects now.
Transforming into a new company—Profitability, Growth and Returns: The government’s changing attitude and favourably changing business environment are set to bolster CIL’s key drivers—average realisations and volume growth. Even though the government will continue to control coal prices for the power sector, it is increasingly letting CIL pursue profit maximisation by other routes. CIL has never enjoyed such a supportive business environment, and, in our view, most of the changes are structural in nature. We raise our price target 18%, suggesting upside of 30% from current levels. We also have high conviction in our projections of 5.6% and 6.0% dividend yields in FY16 and FY17, respectively.
Investment arguments
(i) Solid earnings growth (rare in the past) ahead, with substantial improvement in earnings quality. We project that this will enhance RoE (return on equity) to 54.4% (FY18e) and free cash flow yields from 7.7% in FY15 to 9.8% in FY16 and 11.5% in FY17. This is despite our relatively modest 3% CAGR in coal prices for the power sector, which indicates the changes taking place in the company’s long-term business model.
(ii) Changes within the company and in the operating environment: We point to railways, central government, state governments, and the company’s plans to manage the relationships with local communities better. Our recent mine-by-mine analysis of the projects in context of their capacity, equipment planning, rail logistics and clearance status has given us a high level of confidence in our above-consensus expectations.
(iii) Enhanced interest from global energy investors: Our detailed work on comparative analysis with the regional peer group suggests that CIL is better placed on key metrics, with high levels of earnings and returns, stability and growth.
Interest highly aligned with the government: In our view, coal sector reforms, including improved performance of CIL, are among the showcase successes for the new government. We also believe the government will continue its pursuit of removing hurdles for the industry. In a way, this can be seen as a test case for the government’s ability to resolve economic issues in general by taking logical and market-oriented steps. This should drive a further and sustained improvement in CIL’s stock performance.
