This Sun Will Take Longer To Set

This blog is about Indian coal sector and evaluation of Coal India Ltd. (CIL) as an investment opportunity. It covers the entire understanding of coal sector, starting with some global data, then Indian sector and then CIL as a company.

Disclaimer: This blog is not a recommendation to buy / hold / sell any stock. This blog is mainly for information and educational purpose only. The intention to share write ups on this blog is to create a repository of ideas so that investors / visitors on the website / blog can have a look at various frameworks & approaches. Please read the detailed disclaimer at the bottom of the post.

About Coal:

Coal is a fossil fuel and is in far more abundance than oil & gas. Coal reserves worldwide in 2018 accounted for 145 years of production.

Coal is the most burned fossil fuel in the world.

• Coal is a black combustible sedimentary rock formed as rock strata called coal seams.
• Coal is mostly made-up of carbon with other elements like hydrogen, sulphur, oxygen and nitrogen.
• Coal is most environmentally unfriendly.
• Coal supplies around 1/4th of the world’s primary energy and 2/5th of its electricity.
• As there is no particular composition of coal, it varies based on its compositions.

Types of Coal:

Coal is classified into four main types or ranks: anthracite, bituminous, sub bituminous and lignite. These rankings or the classifications depend upon the carbon content, ash content and on the amount of energy the coal can produce.

Ash content of coal is the non-combustible residue left after coal is burnt. Ash content also gives an indication about the quality of the coal.

Bituminous Coal can be further divided into 2 categories – Thermal coal and Coking coal.

-    Thermal coal is used for Power generation, Cement industries and other industrial uses.

-    Coking coal is used in Iron & Steel industry

GLOBAL

Coal & Lignite Production & Consumption:

In 2018, a total of 7684 MT of coal was produced, of which top 10 countries account for 91% of total coal production. Top 10 largest coal producers are as under:

• China is largest producer of coal, producing almost 45% of the world production. Being the market leader in most of the metal production, the high percentage is validated.
• China is also the largest consumer of coal (~50%)
• India ranks 2nd in production and consumption followed by USA and Australia.

Coal & Lignite Exports:

• Australia exports 32% of the world coal. Australia has high reserves of both thermal coal and coking coal.
• Australian coking coal is shipped to India while Australian thermal coal is shipped to China.
• Indonesia ranks second in the world in terms of exports mainly thermal coal, followed by Russia and USA.

Coal & Lignite Imports:

• China being the largest producer, largest consumer is also the largest importer of coal globally.
• India ranks second in coal imports. 1/4th of India’s imports accounts for metallurgical coal, as the country does not have reserves for them. India imports a lot of thermal coal from Indonesia.
• Balance imports comprise of thermal coal mainly power generation.

INDIA

Facts:

• India has a total coal reserves of around 319 billion tonnes of which ~148 billion tonnes is available for use and balance are indicated reserves.
• India accounts for 1/10th of the world coal reserves.
• Indian coal has a high ash content (not suitable for steel industry) and therefore 80% of the coal is generally used for power generation.
• Inspite being the second largest coal producer in the world, India meets 25% of its coal demand through imports
• Coal India Limited (henceforth referred as “CIL”) is the world’s largest coal producing company in the world, accounting for 80% of the Indian market share followed by Singareni Collieries Company Limited (SCCL) with 10% market share, rest accounted by other smaller merchant and captive miners.

As seen from the above graph India is not rich in coking coal, hence the same needs to be imported (as blast furnace feed for making steel).

State-wise coal Reserves:

Now, if we look at the above graph most of the coal reserves are located in the Eastern parts of India, which in turn will make the transportation cost very high for the coal to reach the entire country (buyers located in West and South).

Grades of Coal in India:

Below mentioned are grades of coking coal available in India

As can be seen above, this is the broad list of coking coal grades available in India. Coking coal is mainly used for in steel plants. Washery grade I – VI is used in both power and non-power sectors, depending upon their ash content.

Grades of non-coking coal available in India:

India produces higher share of non-coking coal ranging between G9 – G13.

Issue With Indian Coal Sector:

• Low grade coal
• No freedom on coal price revision
• More oriented to cater power sector
• Cheapest coal prices in the world even when global spot prices are at low
• High Employee Cost
• High premium on captive mines
• Delay in commercialization of mines

India Coal Imports:

India is an importing country. It imports grades which are not available and also the grades where domestic prices are more expensive. In the later part, we will show you the production levels by CIL, meantime lets look at the Indian imports:

• India’s imports have been rising at 13.5% CAGR to meet the growing energy demand in last 10 years.
• A lot of coastal based buyers opt to import coal since expensive domestic freight makes imports more feasible.
• Production on the other hand has only increased at 3.04% CAGR.
• India’s coking coal requirements can only be met by imports, in absence of good coking coal reserves.

India Energy Mix:

India’s energy mix is as follows:

India power capacity has rapidly increased in the last decade, from ~155GW to ~370GW led by coal and renewables (mainly solar). 60% of the capacity is thermal based, while 25% is renewables. Power generation has increased from ~600BU in 2005 to ~1400BU in 2020 @5.80% CAGR.

Total power generation capacity is expected to touch ~960GW (CAGR 4.88%) with 50% share of renewables. Share of renewables will increase from 10% to 25%.

Thermal:

• Thermal energy makes 76% of India’s total energy mix; while capacity wise it is only 60%.
• Coal based generation grew at 6% CAGR from 2005-2020, taking its share to 92% (from 83%) of thermal energy. Balance share in thermal is oil & gas.
• Coal based generation is expected to grow at 4% till 2040. The share of thermal in energy is split is expected to slide to 65%, of which coal comprising of 60%.
• Natural gas accounts for 6% of the total electricity generation in India at 25GW capacity (operating at 23% PLF), whereas that of coal is ~55%.
• Gas based generation has dipped post 2011 (poor domestic reserves led to tightness in supply)
• Unavailability and high price of imported natural gas kept gas plants PLF low.
• The recent plunge in the natural gas spot prices has raised an opportunity for India to switch to gas based power plants.
• The Indian power plants are however not retrofitted to use alternate fuels for power generation.
• As long as the new era of gas and clean energy steps in, coal will continue to remain dominant.

Renewable Energy – RE:

India has the following renewable sources:

• Solar energy
• Wind energy
• Hydro-energy
• Bio-mass

Present renewable energy setup:

• Solar & wind energy account for highest share in the renewable energy.
• Solar energy has picked up rapidly in last 4 years.
• Biomass has remained constant (absolute terms) in last 4 years
• Current capacity of renewable energy is 88 GW.
• Optimistic vision of India is to have a total capacity of 175 GW by 2022 and 275 GW by 2027 which is far away.
• Renewable energy capacity addition has not been more than 20 GW in any year. Hence coal is here to stay.

Renewables Generation:

• Renewables capacity addition has been on a rise since 2004, however energy generation from renewable has been low @ ~140BU.
• Most of the incremental renewables generation has come post 2014.
• Renewables account for 25% of the total power plant capacity, but only 10% in generation.
• Hydro (~165BU) and nuclear (~45BU) based generation has more or less been flat over the last decade.
• By 2040, share of RE in total capacity is projected at 50%, with only 25% in generation.
• Even if the share of RE increases it is expected that they will first substitute the imported coal space, keeping the demand for Indian coal intact.
• So, we can conclude by saying that Indian coal demand will continue to grow with consumption.

Issues with Renewables:

• Renewables are lower form of energy as compared to thermal energy (Coal and Oil & Gas).
• Renewables is not available 24 hours
• Renewables PLF’s does not only vary on a typical day but across various seasons. For example, solar energy cannot be generated before sunrise and after sunset, unexpected cloud cover can lower the generation. Furthermore, solar energy cannot be easily stored, as it comes with high cost. So, summers season may generate a lot of energy but not all of it can be consumed. Solar heat availability is the highest between 11am to 3pm. Monsoon seasons also lowers the solar generation capacity.

Wind energy also suffers from variability, the deviations is not as extreme as solar power plants. Capacity utilization of a wind based power plant would be maximum during monsoon season, the generation capacity may vary across other season.

Share of Hydro-energy in total capacity generation is expected to decline with other forms of RE expected to take over.

Hydro energy as much as is eco-friendly, but is not affordable.

Hydro based power plants require uninterrupted water supply, which can be met only by dams, reservoir, rivers etc.

Constructions of dams, reservoirs, land acquisitions, political interference are required to setup Hydro based power plants. Hydro plants therefore are very capital intensive.

In India, there is a peak demand for power after 8 pm, as renewables are not available 24*7, the dependency then falls on these thermal power plants.

Indian Power Sector:

In India power is an essential commodity, government needs to keep the cost intact. Power plants cannot afford expensive sources of energy as the end user is not willing to pay a higher price. Thus, coal continues to remain the backbone of power sector in India.

Below chart gives a brief about the power sector value chain:

• Complete power sector is stressed
• In-efficiency in power generating capacity
• Power plants are designed to operate on coal of a specific quality—small deviations may lower efficiency while larger differences may not allow operations. 
• DisCom’s have also lost an average of 23 percent of their power to technical and “commercial” losses (theft and non-payment) In-efficiency leads to imports in Thermal coal as more coal is consumed than usual to generate power.

With these reasons, power sector procurement of coal is regulated and prices offered are at deep discount to market prices. We will cover the pricing part later in the blog. The distress in the power sector (forward value chain for coal) is one of the key reasons for coal sector to NOT boom.

Coal Block Allocation:

• From 1993 to 2011 a total of 218 coal blocks were allocated.
• In 2013-14, 87 coal blocks were deallocated & 7 coal mines were re-allocated & 28 lignite blocks were allocated.
• In 2014-15 the Supreme Court of India cancelled 204 coal blocks.
• Till 31.03.2018 a total of 107 coal mines were operational in India.

New Mining Policy - 2020:

New mining policy announced by the Govt. will allow more commercial miners into this business which is presently being led by CIL. The policy will ensure competitive pricing, better coal linkages and increase supply in the market.

• GOI has launched auction process for 41 coal blocks for private sector
• No end use restriction on the coal mined
• Coal type wise – 37 non-coking, 2 coking, 2 combo-mines
• Coal Reserves – Each mines having avg upto 500-700 MT of reserves
• No near threat to CIL business since would take upto 3-5 years for the production 
• Ongoing issues like land acquisiton, forrest clearance, PCB clearance, State Govt clearance likely to sustain.

India Captive Miners:

Captive mining means coal mined for self-use and which cannot be sold in the market. Captive mining puts restriction on the end use of coal. Captive miners have around 10% market share in India.

The manner under which a company would prefer acquiring coal is as below:

• FSA
• E-auctions
• Imported Coal 
• Captive Mines

Volumes under captives mines have been from 30 MT (in 2010) to 55-60MT (in 2020). Because captive mines usually have higher premiums attached to it (while bidding aggressively), making it the last choice for using that coal. Captive mines are generally kept as a backup to avoid any disruptions in supply. Captive miners do not have any minimum output criteria and are usually under utilized.

Indian Merchant Miners:

Commercial / merchant mining allows the company to mine coal commercially without putting any end-use restrictions. The 2 main players are SCCL and CIL discussed below:

Singareni Collieries Company Limited (SCCL):

• SCCL is a JV between government of Telangana and Government of India with an Equity participation of 51:49 respectively.
• SCCL produced around 65 million tonnes of coal which is around 10% of the total all India coal production.
• SCCL currently operates through 45 Mines:

        -    18 Opencast Mines

        -    27 Underground Mines

Coal India Limited (CIL):

Facts:

• Coal India Limited (CIL) is a state-owned Indian mining company promoted by Indian Government. CIL has achieved the status of a Maharatna in April 2011.
• CIL operates through its 7 fully owned coal producing subsidiaries and 1 mine planning and consultancy company in India.

        -    Eastern Coalfields Limited – ECL

        -    Bharat Coking coal Limited – BCCL

        -    Central Coalfields Limited – CCL

        -    Western Coalfields Limited – WCL

        -    Southern Eastern Coalfields Limited – SECL

        -    Northern Coalfields Limited – NCL

        -    Mahanadi Coalfields Limited – MCL

        -    Central Mine Planning and Design Institute Limited – CMPDIL

• CIL is the largest coal producing company in the world, accounting for around ~80% market share in India and one of the largest corporate employers.

CIL Shareholding Pattern:

Government has been reducing stake in CIL on account of ETF selling to meet disinvestments target. CIL is one of the favorite cash cows for disinvestments. The Govt stake has reduced from 78% to 66% in last 5 years.

Basket selling of shares via ETF and other modes creates a selling pressure on the stock, and is one of the key reasons for the pressure on the stock. This selling pressure may continue in future too, whenever the Govt is in needs of funds.

CIL – Production vs Off-take:

CIL produces around 80% of the total coal production in India. Production grew @3.5% CAGR over the last decade.

CIL – Subsidiary wise utilization:

The reduction in capacity utilization is on account delays in Land acquisitions, forest clearance and other reasons, this also being the reason for a slow growth in production.

Demand Drivers:

The following are the demand driver for coal in India:

• Power (Power utilities including Independent Power Plants)
• Power (Captive)
• Defense 
• Railways 
• Fertilizers
• Iron and Steel (7%)
• Cement (1%)
• Aluminium
• Paper Industry
• Glass/Ceramics/Pottery
• Chemical 
• State nominated agencies
• Traders etc

Power sector is the main driver for coal with 80% share.

Import Parity / Cost Built up:

The below table gives a fair view about the cost build up and how domestic prices are being compared to landed imports.

Per tonne	USD	INR	Remarks
FOB Indonesia 4,200Kcal	27	2,025
Freight	8	600
India CIF price	35	2,625
BCD + CVD	1	108
Clean Energy Cess	5	400
Port Handling	7	488
Landed price at the port	48	3,620
CIL E-auction price (4300KCal/Kg) FY20	28	2,100
Additional duties / Cess	11	840	of this Rs 400/t is clean energy cess
CIL E-auction price	39	2,940
CIL E-auction price (@4200KCal/Kg)	38	2,872	Gap of ~Rs750/$10/t vs. imports

The above prices are as on Aug-20 and is a comparison between imported coal cost and the e-auctioned coal cost of CIL.

Realizations:

CIL generally makes its sale in the following manner:

-    Fuel Supply Agreements (FSA)

-    E-auctions

-    Washed Coal.

Fuel Supply Agreements (FSA):

• FSA is a legally enforceable buyer-seller coal supply agreement. It is the commitment towards uninterrupted supply of coal. FSA accounts for ~80-85% of the total coal supplied by volume, by CIL.
• FSA can be entered by consumers in every sector if the annual requirements exceed 4200 tonnes.
• CIL’s FSAs can be broadly categorized into:

        -    FSA with power producers (utilities, private and captive)

        -    FSA with non-power producers

        -    FSA with state nominated agency

• As per the new FSA norms, if CIL supplies up-to 80% of the Annual Contracted Quantity (ACQ), there will be no penalty imposed on the shortfall quantity.
• As the end product prices in power are administered by the Government, CIL has no freedom on FSA price revision.
• In last 2 decades, only 9 times the prices under FSA has been revised, more so in order to match inflation and rising manpower cost.
• FSA prices are at deep discount to global prices
• FSAs are usually signed for a period of 15-20 years and reviewed every 5 years; these are take or pay contracts.

E-Auctions:

• Production quantity, which is left after supplying coal through FSA is sold through e-auctions. E-auctions fetches greater realization for the company and quantities are usually at the directive of the Ministry of Coal.
• In off-power periods like monsoon, a lot of coal is sold via this route.
• E-auctions constitutes around ~10% of the total coal supplied by volume, however it accounts of almost ~35% of their EBITDA. E-auctions provide higher margins for the company.
• E-auctions prices enjoy huge premiums over FSA. Premiums range from 40% to 120% (average ~70%).
• E-auctions generally compete with global prices.
• Coal under e-auctions are supplied on the basis of import parity.
• Generally, companies situated in the coastal areas, prefer to meet their coal requirements over and above FSA volumes via imports than e-auction (coastal buyers are better off importing than to bear domestic long distance freight) - Also refer above, the preference shown by buyers.
• E-Auction premiums for Q1FY20 were almost zero. However, they have improved to 9% over FSA in Aug-20.
• CIL plans to sell 20% of the production through E-auction in FY21, which may increase margins. (key upside risk)

Washed Coal:

• Coal which have undergone the process (beneficiation) of coal washing, resulting into value addition by way of reduction in ash content.
• Out of the total coal produced by CIL ~3% is washed coal. Washed coal are the costliest compared to FSA and e-auctions.
• Coal is washed by the through coal washeries.
• CIL has planned to setup coal washeries for about 111 million tonnes.

Average Sales Realizations:

CIL usually follows cost plus pricing. FSA prices are not linked to global prices. FSA Coal is at a significant discount to global prices, because of the government mandate to keep power prices in check. E-auction are volatile in nature since they track import / regional prices.

CIL sells it total quantity produced as follows:

• FSA: 82%-85%
• E-auctions: 10%
• Washed Coal: 3%-5%

As most of the sales are done via FSA, average sales prices (ASP) track FSA prices and are less volatile in nature (gentle upward sloping curve). Going ahead we believe FSA prices are going to be slightly upward sloping and not volatile at all (if not extremely high too).

Grade Slippages:

• Another factor which affects blended realizations is grade. Since 2013, CIL’s grade of coal produced has fallen by 5% (CAGR of 1% fall every year). Because realizations for different grades are different, it affects the blended ASP.
• CIL’s output comes from 400+ mines and hence, the output the quality is difficult to predict going forward.
• It also depends on which mines the incremental output is coming from and on grades of new projects. However, that CIL’s ASP growth has not fallen despite a fall in grades due to improvement in pricing.
• Major slippage is a downside risk, but cannot be estimated at this point in time.

Global Coal Prices:

The above charts depicts the trends of global coal prices. CIL’s business is however not highly affected by the trend in global coal prices (except e-auction). The ASP of CIL has been rising at a very slow rate, which makes CIL business largely unaffected due to trends in global coal prices.

CIL’s Cost Break-up:

• Employee cost accounts for more than 50% of total cost for CIL followed by mining expenditure.
• Higher manpower cost (fixed in nature) leads to higher operating leverage.
• As mentioned earlier, CIL is one of the largest corporate employers in India, and it has a huge employee count due to legacy reasons (like most PSU’s) which will only be falling on the back of natural attrition.
• Employee count has been falling at a CAGR of 4% over the past 5 years.
• FY18 saw a substantial rise in employee cost as it included a one time gratuity charge. The next hike is due in FY22. With higher production and natural attrition, employee cost per tonne of coal produced should remain capped.
• Currently, it aims at suspending operations at 23 mines producing less than 50,000 tonnes. It hopes to save Rs.6 bn from these closures.

Employee Cost:

Underground mines have a higher cost of production than opencast / surface mining due to high use of machineries and high manpower. ECL, BCCL and WCL have a high employee cost per tonne as majority of the coal produced by these subsidiaries are from underground mines and they have old legacy issues (higher employees).

CIL’s Capex:

Capex in mostly incurred by CIL towards:

• New mining project
• Setting up Railways infrastructure
• New technology
• Improved machinery etc

FY21 capex is guided for 10,000 crores.

Transportation:

Coal mining and the production activity are concentrated in the eastern part of India. Also Coastal buyers are sensitive to freight rates. Coal in India is transported through:

-    Railways 

-    Roadways

-    Sea Freight (Imports)

Approx. transportation costs for few power plants are mentioned below:

Railways and Roadways:

Around 70% of the coal is transported through railways. CIL based on their estimated production level enters into the agreement with Indian railways for availability of rakes. Availability of rakes per day has increased to ~240 (from ~160 in FY11) growing at 4-5% p.a. Rakes availability also at times leads to lower off take due:

-    Railways falling short to provide rakes to CIL

-    CIL demands more rakes than actual contracted

-    Road transports are generally for shorter distances.

Sea Freight:

The decision to either import coal over and above volumes contracted under FSA depends on the following:

• Global Coal Prices
• Sea Freight
• Foreign Exchange Fluctuations
• Quality of Coal imported
• E-auctions price
• Domestic transportation cost

 

The above charts represent the sea freight from Australia and Brazil to China as a representative.

Project Delays:

Project delays posed a great problem for CIL to increase their production which could in turn reduce imports. Project delays have been account of following reasons:

• Forest Clearance
• Land Acquisitions
• State Clearance
• Tender executions, etc.

Inventory Buildup:

During monsoon season, mining activity slows down which in turn leads to lower than usual production. CIL stacks up inventory during the month of January, February and March in order to have an uninterrupted supply during monsoon seasons. However the on going pandemic has resulted into higher inventory at power plants and lower demand from the power sector, can pose an overall reduce in offtake.

Going ahead volumes will shift to non-power sectors in the near term and CIL will curtail production to match with the offtake. CIL has also been taking various steps to encourage non-power offtake, with special auctions for non-power and for those who import coal.

EBITDA:

Slow drain in EBIDTA is mainly because of non-frequent hikes in FSAs. In 2019, there was a hike in the prices of the FSA prices, which led to an increase in the EBITDA/tonne. The next hike shall be in FY2022. Moreover since the demand from the power sector has reduced due to on-going pandemic, it will positively impact the EBITDA/tonne as more coal would be available for sale in e-auction.

History of Dividend:

CIL’s average dividend yield has been above 10%. CIL has paid dividend every year.

In future, dividends are expected to go up as cash flows improve.

Financials:

Valuations:

• CIL is currently trading at 130.
• Present valuations are just 5-6 years of cashflow.
• FSA pricing is flat / slight upward sloping;
• E- Auction prices are at bottom (9% premium to FSA); only going to improve
• EV/EBITDA of 3.5x (FY2022)
• It has corrected drastically on account of the following reasons:

            -    Weak global thermal coal prices

            -    Negative coal production growth in FY20 (slow offtake is a downside risk)

            -    Continuous supply of shares during CPSE ETF sales

            -    ESG concerns

            -    The recent impact of the COVID-19 pandemic

            -    Weak domestic coal demand (mainly power)

• We expect coal to play a vital role in the power sector.

CIL = Cyclical Global Price Play?

CIL’s price chart has seen a downward trend since the highs of 2015. CIL stock doesn’t seem to track coal prices which are highly volatile. The pressure on the stock is on account of various reasons mentioned already.

CIL – Positives:

• Low cost producer (top quartile)
• Strong balance sheet
• Dividend yield play
• Lowest valuations
• Power plants capacity is here to stay
• Replacement of imports is a big opportunity
• More share of e-auction (changing sales mix)
• Employee headcounts to reduce by 40% over a decade; contract labor to be more popular
• FSA hike to match salary hikes (maintain margins)
• Huge coal reserves of ~19bn tonnes sufficient for the next 27 years
• Low stripping ratio (~2x as against global 4-10x)
• Energy demand to track GDP
• Ambitious growth plans (1bn tonnes) and continuous capex spends

CIL – Negatives:

• Off-take risks (production is no more a problem; demand can be) mainly by power sector
• Commercial mining
• No freedom in price revision.
• Sunset sector
• ESG concerns
• Rapid RE growth
• Cash on balance sheet
• Grade slippage
• Unavailability of rakes from Indian railways
• Reduction in international coal prices (though seems to have bottomed out)
• Delays due to land acquisition/forest & state clearance
• Govt interference; pressure from coal ministry

Summary:

• Coal is a non-environmental friendly product and hence its users are going to find a way to replace coal, but that may take a longer time.
• Renewables will grow but may not be able to replace the function of coal instantly. Longer it takes for renewables to replace, longer coal lives. It is not going out of our lives anytime soon
• The key upside trigger is higher volumes (high operating leverage) with favorable sales mix (e-auctions), which can also be achieved through import substitution.
• It is generating good cash flows and the dividend yield can be expected to be good.
• Investors are shying away from this counter on ESG concerns in a big way.
• There may not a big downside risk but it may not have a big upside too (can give a 50-70% upside)

Thank You

Authored By Ashutosh Chaubey

Moderated By Jeet Gala & Manali Gala

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Source of the data:

Some of the data used in this blog is created by Centra, while some data may have been fetched through various websites, content, files, brokerage house notes, etc. available freely on the social media.

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