Coal India Limited (CIL) IPO – In Depth Analysis of India's Largest IPO shows it to be a Safe Investment at Cheap Valuation

Coal India Limited (CIL) is coming out with an Initial Public Offering on October 18,2010 in which the Indian Government will divest a 10% stake in the company for around $3.3 Billion giving the company a market valuation of $33 Billion.63 million shares will be offered in this public issue with a 5% discount for retail investors.This will be the largest Indian IPO till date and give investors access to monopoly Coal Producer of the country.With massive reserves,huge captive domestic demand and steady growth,the company offers a safe investment venue for investors.Risks with this company are little given India’s fast growing economy’s dependence on coal powered energy.Despite Coal being the dirtiest form of Energy,its cheapness and abundance has made it the Fuel Source of Choice for India’s numerous new  power producers.Despite Global Warming Concerns,King Coal is not going to end its reign anytime soon.Here is an indepth analysis of Coal India’s Stock drilled from its DHRP prospectus.

OVERVIEW

1) CIL is responsible for ~82% of India’s Coal Production from its 471 Mines in 8 states.The Company has been growing production at 8-9% in the last 2 years though most of it is lower grade non-coking coal.Note India is the 3rd largest producer and consumer of Coal in the World with 77% of India’s power generation dependent on Coal.

2) Coal India is the Largest Coal Producer in the World with 400,000 employees.It is a Holding Company with 7 subsidiaries one of which mines coal in Mozambique.The company is increasing benefaction of Coal which will lead to more value add and higher prices.The company is expanding capacity to meet the 11.3% CAGR for coal demand in India for the next 5 years.

ADVANTAGES

1)  The Largest and One of Lowest Cost Producers of Coal in the World.The company sells its coal under Long Term Agreements (FSAs) at lower than international prices.It has a social mandate as well therefore,the company does not follow a strict pricing regime.This is both a Weakness and a Strength as well.The company has sold around 431 million tons of Coal for ~$11 Billion implying an ASP of around $26/ton which is almost a  65% discount to non-coking coal price of $72/ton.

2) India’s Fast Growing Economy is Dependent on Coal Energy – This guarantees a stable growing Demand for its Products which is unlikely to change in the Future.Due to its low costs,CIL is capable of exporting its products if in the case that Domestic Demand Declines.

3) Coal Based Power Generation to increase by 60% in the next 4 years with Demand Outpacing Supply driven by Private Sector Capacity Additions from 86 GW of Coal based Energy Generation at Present.Besides the other coal consumption sectors like Steel and Cement are also growing at an equally fast pace.India is already importing around 66 million tons of coal which is going to increase rapidly.

4) Largest Reserves in the World implying 138 years at Current Production Rate – The company has identified around 64 Billion Tons of Coal Reserves which would imply 138 Years of Reserves at a Production Rate of 500 million tons a Year.Note India is supposed to have 6.7% of the World’s Coal Reserves with geological resource of 277 Billion Tons.There is huge scope of growth since China at 3 Billion Tons produces almost 6 times as much coal as India does.However the Reserves would run out much faster that is in less than 50 years at growth rates of around 8-10% per annum.

5) Huge Difference in International Price and CIL’s Coal Cost – The International Price of the cheapest grade of Coal was $72/ton declining about 40-50% from 2008 highs.The cost of production for CIL average just about $16/ton.This means that if CIL sold Coal in the International Market it would earn a Gross Margin of almost 80%.

6) Increasing Value Add through Coal Washeries and International Expansion – The Company aims to expand its Coal Washeries Capacity from 39 million tons by another 111 million tons to increase the value add for its customers.Coal Washeries will also be made mandatory for new mines with greater than 2.5 million tons capacity.The company is also  expanding internationally in coal rich countries like Indonesia and Australia.

FINANCIALS

1) Balance Sheet is Very Strong – Company has a Net Cash Position of almost $8.5 Billion compared to the proposed market cap of $35 Billion giving it a very high 25% ratio of Cash to Stock Price .The Company’s Consolidated Net Worth of ~Rs 25,000 crore would imply a P/B of 6.

2) Income Statement also satisfying on all parameters –  The company has consistently managed 20-25% Operating Margin.The Net Margin of 15-20% and Dividend payout at ~20% is also good.The Company has also steadily grown its top line in the last 2-3 years.

RISKS

1) Coal is increasingly coming under stricter environmental and safegy regulations – The adverse affect of Coal Mining on Water,Air,Human and Animal Health is well known.However the lack of alternatives currently preclude the possibility of any material change in Coal Demand.However costs  due to increasing project delays and improving safety/environment will continue to increase

2) Raniganj and Jharia Coalfields face problem of Subsidence due to non-scientific mining – These areas face a huge threat of Land Subsidence due to unregulated mining before nationalization.However Government of India has come out with a comprehensive plan to rehabilitate the population in these areas through seperate Funds.These are funded by a cess on coal produced in India which is ultimately passed onto consumers reducing CIL’s liability.

3) Corruption and Pilferage– Being a Government of India undertaking,the company suffers from corruption which is endemic in government departments and companies.The company also suffers from pilferage of its coal and illegal mining from its designated mining areas.The problem is particulary severe in West Bengal where coal is openly stolen with the administration looking on.Illegal Mining is also a lucrative activity in the Coal Mining areas of the State

SUMMARY

Coal India Limited (CIL) would be a safe stock to invest in if it priced in the indicated manner that is a $33 Billion Market Capitalization.This stock won’t be a multi bagger but would offer decent price appreciation with almost no downside risks.At trailing P/E of 15x and 3 year average trailing P/E of 20x,the company is not expensive given its competitive strengths.Its dividend yield would be around 1.5% with growth of around ~10-12%.However if you exclude  $8.5 Billion in Cash,then the stock seems cheap at around trailing P/E of  11x.It has a P/B of 6x and P/S of around 3x.With its ASP being at a 65% Discount to the International Price,the Company has a Huge Moat around its Business Model and I would recommend it as a Buy.