Investors in Coal India (CIL) can consider selling the stock, having received the dividend of Rs 29 per share. The stock lost 23 per cent last year on worries about Government stake dilution, lower production and risks to future earnings.

The decision to return cash to the Government through dividend may remove divestment-related uncertainty for the stock for now. But CIL’s financial performance is likely to remain muted and there are no growth triggers to boost the stock price over a two/three-year timeframe.

CIL’s large cash pile of around Rs 64,000 crore as on September 2013 has been a source of comfort to investors in the past. The company has been a good dividend payer. Recently, it paid an interim of Rs 29. But given that there are no asset purchases or investments planned, the cash is likely to be used primarily for dividend payments. Without significant investment plans that can materially boost output, the market is unlikely to assign additional value to the cash pile.

In its core business, there are concerns about CIL’s earnings taking a hit from its inability to meet the fuel supply agreements (FSA) signed recently with power companies. The new agreements require much high delivery commitments, estimated to be over one-and-a-half times FY14 planned output. While the easing of the environmental norms would enable expansion of existing mines by close to 10 per cent, other issues remain. The company has not been able to ramp up output due to issues such as weather and non-availability of railway rakes. For the nine months ended December 2013, its output and sales fell short of targets by about 4 per cent. Additional rail links are expected to come up by 2016, and progress in this regard needs to be watched.

The inability to ramp up output will affect Coal India’s prospects in two ways. First, CIL may have to pay penalties if it does not meet its FSA commitments. Second, even assuming delivery targets are met, the company may not have much coal for e-auction sales, which fetch much higher revenue per tonne. The company’s revenue growth may hinge on its ability to increase sale prices. It did raise prices by around 8 per cent last year. However, with global coal prices on a decline and coal costs dictating electricity pricing, CIL may face policy pressure to keep its prices under check. Recent disputes with clients and a ruling by the Competition Commission of India on quality issues too may affect realisations.

Margins may also suffer as CIL’s expenses have been on an uptrend due to higher diesel cost and wage bill. Currently, 90 per cent of the coal output comes from low-cost opencast mines. But a shift to underground mining due to environmental concerns has the potential to reduce profitability, as the cost of extraction will increase four-fold. Currently, net profit margins are around 25 per cent and these may likely shrink by 2-3 percentage points. Fears of a stake sale pressuring share prices may have receded for now, but with the Government holding 90 per cent stake, divestment in the future cannot be ruled out. In the meantime, the high government holding stands in the way of the company’s ability to adopt pricing and volume strategies that maximise commercial benefits. At the current price of Rs 272, CIL trades at under nine times its estimated FY15 earnings.

(This article was published on January 18, 2014)
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