Coal India has recently (25th September 2010) filed its draft Red Herring Prospectus with SEBI. This may be a good time to understand various factors that would probably help investors make their decision on the issue. Please note that I am making a recommendation as to one should invest in the issue or not, instead all the positive and negative factors are highlighted in this note so that it would hopefully enable investors to make an enlightened decision. We cover the global as well as the national macro-economic as well as company specific factors in our note.
It is pertinent that investors note that the price of the issue has not been announced but there are a number of stories in the newspapers that expect the issue to be priced in the region of about 225-250 and the issue is expected to open for subscription on 18th October 2010. Investors should keep in mind that price is what they pay and value is what they get and hence the IPO pricing may a critical factor that should go into the decision to subscribe to the issue in the short-term. I personally believe that if the rumoured pricing (i.e. Rs.225-250) is correct then it may be considered to be steep for short-term investors. But those with a 5-10 year perspective should accumulate fundamentally sound coal companies (stocks or assets) over the next few years, in light of the business potential. The fundamentals of the coal business are likely to be dramatically affected only if the World GDP shrinks by more than 2% annually for the next four years – an unlikely event. However, over the next two years, expect extreme volatility in the global stock markets and hence taking a call on coal prices (technically) could be challenging. The technical risks have increased for the simple reason that the US Markets are discounting a nominal GDP growth of about 7% (last seen in 1989) or record high profit margins, both of which are theoretically possible, but practically unlikely.
Coal: The Global Scenario:
The fundamentals of the coal business have probably never been so good – macro economic basis as well as commodity specific. Almost all the emerging economies are growing at a very fast clip. Capital seems to be more than willing to risk higher return in the East where there are still growth opportunities due to the high levels of poverty and more importantly because investment opportunities have declined in the west. Interest rates are expected to be benign over the next few years, if not for the next decade.
The interesting aspect of the coal business is that over the past few years, instead of a decline on reliance on coal in the electricity generation business, there has been an increase. It has been pointed out that in 2010, 94 gigawatts of coal fired power plants are expected to go on stream leading to an additional 375 million tonnes of annual coal demand. Add to this the global demographics and the existing state of the socio-economic conditions indicate that nearly 3.6 billion people worldwide (2.263 billion in Asia, 921 million in Africa and 466 million in Latin America) have only partial access to electricity. The CEO of Peabody Energy has pointed out that if 2010 demand for coal were to continue, it would lead to an additional (new) demand of approximately 1 billion tonnes of coal every three years , with 90% of the new demand coming from Asia (especially India and China).
It is pertinent that investors note that the price of the issue has not been announced but there are a number of stories in the newspapers that expect the issue to be priced in the region of about 225-250 and the issue is expected to open for subscription on 18th October 2010. Investors should keep in mind that price is what they pay and value is what they get and hence the IPO pricing may a critical factor that should go into the decision to subscribe to the issue in the short-term. I personally believe that if the rumoured pricing (i.e. Rs.225-250) is correct then it may be considered to be steep for short-term investors. But those with a 5-10 year perspective should accumulate fundamentally sound coal companies (stocks or assets) over the next few years, in light of the business potential. The fundamentals of the coal business are likely to be dramatically affected only if the World GDP shrinks by more than 2% annually for the next four years – an unlikely event. However, over the next two years, expect extreme volatility in the global stock markets and hence taking a call on coal prices (technically) could be challenging. The technical risks have increased for the simple reason that the US Markets are discounting a nominal GDP growth of about 7% (last seen in 1989) or record high profit margins, both of which are theoretically possible, but practically unlikely.
Coal: The Global Scenario:
The fundamentals of the coal business have probably never been so good – macro economic basis as well as commodity specific. Almost all the emerging economies are growing at a very fast clip. Capital seems to be more than willing to risk higher return in the East where there are still growth opportunities due to the high levels of poverty and more importantly because investment opportunities have declined in the west. Interest rates are expected to be benign over the next few years, if not for the next decade.
The interesting aspect of the coal business is that over the past few years, instead of a decline on reliance on coal in the electricity generation business, there has been an increase. It has been pointed out that in 2010, 94 gigawatts of coal fired power plants are expected to go on stream leading to an additional 375 million tonnes of annual coal demand. Add to this the global demographics and the existing state of the socio-economic conditions indicate that nearly 3.6 billion people worldwide (2.263 billion in Asia, 921 million in Africa and 466 million in Latin America) have only partial access to electricity. The CEO of Peabody Energy has pointed out that if 2010 demand for coal were to continue, it would lead to an additional (new) demand of approximately 1 billion tonnes of coal every three years , with 90% of the new demand coming from Asia (especially India and China).
The chart below illustrates the New Coal based thermal plants under construction in different parts of the world (in Gigawatts):
The coal story is not one without its drawbacks. There will be increased outcry about the environmental problems related to coal mining and coal based power. However, coal fired power continues to be the cheapest source and would continue to remain the cheapest for at least the next three (if not more decades). Coal is not easily replaceable in the near future. It has been pointed out that it would require about 1800 times present generation capacity, 2.5 billion wind turbines, 1150 nuclear plants, three times present Russia’s natural gas production (70 tcf), and approximately 2250 big dams to replace present coal capacities – most of which are even theoretically impossible. Over the ten year period (1999-2009) coal based thermal plants have produced nearly 46% of the world’s total energy requirements. Instead of a decreased dependence on coal due to global warming considerations it is expected that by 2035 coal fuelled plants will increase by 90%. Asia is the biggest market for coal and in 2009 it accounted for nearly 65% of the total global consumption of coal, with China and India accounting for the lion’s share. Nearly 13% of the total coal produced is used by steel Industry.
Coal India: The Company:
India accounts for nearly 6.7% of the world’s recoverable reserves. India accounted for about 8% (or about 557 million tones) of the total global production in 2009 and is the third largest producer and consumer of coal.
The company was established in 1973 as a product of the nationalisation of the coal industry and is now the largest producer of coal in the world. As of March 31, 2010, the company operates nearly 471 mines in 21 major coalfields across eight states in India, including 163 open cast mines, 273 underground mines and 35 mixed mines (which include both open cast and underground mines). It also operates coal mines in Mozambique. It is considered to be the largest coal reserve holder of coal in the world. It is in the process of expanding its production capacity. As of March 2010, the company has received the necessary approvals for expanding capacity in 22 existing mines and to start 23 new mine projects. Most of its production was through open cast mining.
Coal India produced approximately 82% of the coal produced in India and it produced nearly 431 tonnes of raw coal. In 2009, the largest consumer of coal in India is the power generation sector which accounted for nearly 77% and it meets 52.4% of the total energy demand in India. By 2032, coal is expected to meet more than 50% of India’s energy requirements. Interestingly, the primary energy consumption in India has grown by approximately 700% over the last four decades. Demand growth is expected for at least the next five years, if not more. The Company estimates that it would not be able to meet the demand and claims that there will be a shortfall in our ability to supply coal from its production to the tune of approximately 110 million tonnes for fiscal 2011 and 235 million tonnes for fiscal 2012 and increase further over the subsequent years .
As of April 2009, Indian coal reserves were placed at 276.81 billion tones. Coal India’s reserves accounted for nearly 64.78 billion tones of which 34.43 billion tones had been considered for mining. The total extractable resources had been estimated at 21.75 billion tones. In contrast US based Peabody Energy holds 9 billion tonnnes and China Shenhua Energy Co Ltd 7 billion tonnes of coal reserves.
Coal India: The Company:
India accounts for nearly 6.7% of the world’s recoverable reserves. India accounted for about 8% (or about 557 million tones) of the total global production in 2009 and is the third largest producer and consumer of coal.
The company was established in 1973 as a product of the nationalisation of the coal industry and is now the largest producer of coal in the world. As of March 31, 2010, the company operates nearly 471 mines in 21 major coalfields across eight states in India, including 163 open cast mines, 273 underground mines and 35 mixed mines (which include both open cast and underground mines). It also operates coal mines in Mozambique. It is considered to be the largest coal reserve holder of coal in the world. It is in the process of expanding its production capacity. As of March 2010, the company has received the necessary approvals for expanding capacity in 22 existing mines and to start 23 new mine projects. Most of its production was through open cast mining.
Coal India produced approximately 82% of the coal produced in India and it produced nearly 431 tonnes of raw coal. In 2009, the largest consumer of coal in India is the power generation sector which accounted for nearly 77% and it meets 52.4% of the total energy demand in India. By 2032, coal is expected to meet more than 50% of India’s energy requirements. Interestingly, the primary energy consumption in India has grown by approximately 700% over the last four decades. Demand growth is expected for at least the next five years, if not more. The Company estimates that it would not be able to meet the demand and claims that there will be a shortfall in our ability to supply coal from its production to the tune of approximately 110 million tonnes for fiscal 2011 and 235 million tonnes for fiscal 2012 and increase further over the subsequent years .
As of April 2009, Indian coal reserves were placed at 276.81 billion tones. Coal India’s reserves accounted for nearly 64.78 billion tones of which 34.43 billion tones had been considered for mining. The total extractable resources had been estimated at 21.75 billion tones. In contrast US based Peabody Energy holds 9 billion tonnnes and China Shenhua Energy Co Ltd 7 billion tonnes of coal reserves.
The total income of the was about Rs.52,592 crores in 2010, while its profit after tax was about Rs.9824 crores. As of March 2010 its cash and bank balances were nearly Rs.4,000 crores.
Positives:
- Low debt (only about 2100 crores), though it total contingent liabilities are about Rs.10,500 crores.
- The Company had a networth of nearly Rs.15,000 crores
- Sales of more than Rs.44,000
- Equity capital is around Rs.6300 crores while it has reserves worth 9200 crores.
- 2010 profit was about 8200 crores.
- Most of the coal it produces is thermal coal.
- Demand for non-coking coal in India is projected to grow at a CAGR of 11.3% from 508 million tonnes to approximately 868 million tonnes by 2014. The demand for coking coal is expected to increase at a CAGR of 9.7% over the same period.
- The Return on Networth as of 31 March 2010 was 38.3% (as per restated consolidated financial statements).
- The NAV/ book value per Equity Share as at March 31, 2010 was Rs. 24.67 as per the company’s restated stand alone financial statements and Rs.40.92 as per its restated consolidated financial statements
- The unfortunate aspect of Coal India is that it is a near monopoly that cannot wield its monopoly power due to governmental regulations that touch nearly aspect of its functioning. The government is prone to micromanaging the functioning of the company
- Even after the IPO, the Government of India will continue to hold about 90% of the equity thereby meaning that there could be subsequent increase in the floating stock of the company. Considering the fact that the Government of India is pressed for funds any rise in price of the company would make it specially attractive for the government to dilute its holdings further since the government has made known its intention that it would gradually divest its holding in public sector undertakings to about 51% over the next few years.
- Proceeds of the offer will not go to the company thereby making little difference its financial performance over the short-term.
- Government environmental regulations are likely to impact its profitability over the long-term(The recent proposal of the GoI to demarcate certain coal-bearing forest areas in India into various categories, which is proposed to include a category in which mining activities are prohibited, may adversely affect our business prospects, results of operations and financial condition.)
- Coal price sold by the company is fixed by the government, though Coal imports are allowed under the Open General License by consumers directly. In 2010 India is expected to import about 67.74 million tones of coal.
- Problematically the distribution of coal produced by the company has to be in accordance with the prices and in consonance with the policies and goals of the Government of India. The government policy is the biggest black swan as far as the company is concerned. The company was forced to renounce it rights to certain mines in the Parvatpur and Brahmani blocks in the Jharia and Rajmahal coalfields some years back.
- We may add the major problems related to a prolonged global downturn to the list of negatives.
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