04 Nov 2015 17:54 IST

Why investors may not find Coal India red hot

Green concerns globally, falling coal prices along with company specific issues may scuttle the coal giant’s divestment this year

Come second half of a financial year, and there is frantic action on the divestment front. And the top choice among public sector companies that are put up for stake sale is Coal India (CIL). The PSU, with a market capitalisation of over ₹200,000 crore, is among the large coal producers globally. But the government’s optimistic estimate of raising ₹21,000 crore through a 10 per cent stake sale in the Maharatna can be marred by concerns over one colour – green.

Pollution concerns globally, falling coal prices along with company specific issues may scuttle the coal giant’s divestment this year.

On the mend

In the past, there was one seemingly insurmountable problem – stagnant output. In spite of robust coal demand from large sectors such as power, steel, aluminium and cement, output could not pick up. India has fifth largest coal reserves in the world but output level was stuck at under 500 million tonnes for many years due to no ground level changes to increase productivity and add new mines.

This led to higher reliance on imports — both coking coal used as a raw material for steel and thermal coal used to generate power — from Australia, Indonesia and South Africa. Imports increased from 73 MT in 2009-10 to an estimated 242 MT in 2014-15. As per data from the Indian Ports Association, thermal coal imports in 12 major ports jumped over 22 per cent year-on-year in April-August 2015. And given the slowdown in China, it is predicted that India may surpass China to become the world’s largest thermal coal importer within the next few years.

CIL, currently a monopoly, can benefit from this demand growth. Government’s push to increase output seems to be yielding results and the company’s output between April-August period increased over 9 per cent, compared to a year-ago.

Transportation — called rake availability — was another bottleneck that limited sales. There is a lot of progress in addressing this problem, through the expedited construction of railway links — the Jharsuguda-Barpali railway link project in Odisha, for instance, is expected to be completed by 2017. Development of three railway links could increase transportation by 200 MT in five years.

Well-placed

CIL is also at an enviable position, compared with global peers who are facing a lot of stress. Global thermal coal prices have been on a free fall, down from a high of about $80 per tonne in 2011 to about $40 currently. But local coal price was only loosely pegged to international prices and was at a discount to global prices in the past. For instance, power producers were charged about $25 per tonne on average.

Not just that, the company could command a huge premium on coal sold in e-auction – which accounts for around 10 per cent of volume, but 25 per cent of operating profits. So while Rio Tinto reported 20 per cent revenue fall in its Australian coal mine, CIL’s revenue increased 5 per cent in 2014-15 (to ₹74,100 crore).

Also, private players bought coal mines at a premium, leading to high debt on their books and debt service issues. For instance, Alpha Natural Resources, the largest coal producer in US, filed for bankruptcy in August 2015. CIL is far from operationally efficient compared to miners globally; but it helps if you get your mines for free. With net profit margins of 40-50 per cent, it has raked up a huge cash balance — ₹53,000 crore, as of March 2015 with its recurring cash profits.

Environment-related issues

That said, concerns over pollution may impact future costs and usage. Coal is not a clean fuel and its detrimental effects on the environment are not anything new. But globally, there is pressure to limit the usage of coal due to climate impact considerations. There is interest in alternate fuel sources such as natural gas which emits half as much carbon-dioxide compared to coal and is also becoming cheaper.

CIL’s commitment to environment is also being questioned, with the company yet to implement the Sustainable Development Policy it committed to back in 2013.

The policy required the PSU to pursue mining, integrating environmental, socio-cultural and economic factors. Foreign bankers have expressed concerns about the delay in implementing the goal and this may impact their interest in buying CIL shares.

Murky future

Their lukewarm interest is against the backdrop of a murky future of coal globally due to growing ‘green’ considerations. Globally, there is pressure from investors and governments to reduce coal usage. Thermal coal power plants are expected to increase 22 per cent between 2013-2023, according to General Electric, but natural gas capacity additions edge it out with 23 per cent growth. Likewise, renewable energy capacity will increase by 32 per cent.

India has set a target of doubling coal output to one billion tonnes by 2019; but it has to choose between a rock and a hard place — increase coal usage and risk environmental issues or limit usage and compromise growth targets. It is likely that output cannot be increased disregarding environmental concerns.

Already, the 2015-16 Budget increased the clean energy cess from ₹50 to ₹100 per tonne. Power producers may also face higher costs due to stricter pollution norms in the future. These, along with the Government’s push to increase usage of renewable energy may dampen demand growth.

Prices may remain subdued globally due to tepid demand growth in developed countries as well as China; also, producers may be able to break even at lower international prices if their currency weakens. So, with break-even in their local currency prices, supply may not drop even at lower coal prices.

Even as global coal prices fell, CIL has not revised its prices; as a result, certain high-calorie coal is costlier than imported equivalents. Inability to maintain prices will impact revenue and profit growth.

So, stock sale plans for CIL may not be smooth sailing and the Government may have to clarify its priority — on growth and environment. Unless that is done, investors are not likely to flock to this offer.

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