Trading of shares started in the first week of Novemeber 2010, which initially showed very good signs, suffered a little later within few days. It is obvious that its value will be determined by market forces, but the real challenges for the Coal India lie somewhere else in the fact that the proceeds of the IPO went to the Centre and the Company did not raise any equity from the public offering. The debt-equity ratio of CIL (consolidated) as on March 31, 2009 was 0.31:1 and is on the rise. India aims to raise Rs 400 billion ($9 billion) by March next year from state sector sales with the proceeds to be used for social programmes and reducing the budget deficit.

Coal India's IPO allowed both foreign and retail investors to buy into the resource behemoth, which produces 82 per cent of India's coal. The offer closed on October 21, 2010. Demand was strongest form financial institutions. Coal India's employees shunned the issue amid fears that the sale could lead to full privatisation of the company and job losses.

Coal India has the world's largest extractable coal reserves with over 22 billion tonnes - ahead of rivals China Shenhua Energy and the world's largest private-sector miner Peabody Energy of the United States. It is worth mentioning here that the world's largest coal miner, CIL is producing over 80 percent of India's coal through 471 mines across eight states. It produced 431.26 million tonnes of raw coal in 2009-10.

How was it possible for CIL, the only unlisted navaratna public sector company, to sell its shares in such a big way even when everybody knows that all that is black in the stocks is not coal and the government owned company is suffering from many ills? The answer to this question is simple. The attractive valuations, a near monopoly status and a widening demand supply gap in the domestic coal market made it possible. Coal India’s claim that it is the largest coal mining company in the world in terms of reserve-base and annual production was well received by FIs and retail investors.

Coal India is a holding company for 11 subsidiaries. All of them are engaged in the development and operation of coal mines as well as exploration and design, making it an integrated coal mining company.
Coal India has a near monopoly with 82 per cent share of India's total coal production. The gap between demand and supply of coal is widening. One of the interpretation of this fact suggests that the company is unable to supply the quantity required to fulfill the level of demand. It also suggests a weakness of the company. But, for investors, it was a good thing, because it gives a chance to the company to increase its profits by calibrating the price of coal at higher level. Rising profits of the company was perceived by them as the company's improving operating metrics. High return on equity (38 per cent for 2009-10), despite significant cash balances, too bolstered its prospects.

Coal India may deserve to trade at a marginal discount to peers in light of the higher realisations of the overseas players, such as China Shenhua Energy, China Coal Energy, Yanzhou Coal Mining (China) and Peabody Energy (US), due to better quality reserves and market-linked prices.
The operating margins of these peer companies for the calendar year 2009 ranged from 18.7 per cent to 39 per cent as against the 22 per cent (for 2009-10) of CIL.

The company has huge cash coffers of Rs 39,000 crore (around Rs 62/share) to fund future capex and overseas mine acquisitions.

Business overview

According to SRK Consulting, a UK-based mine auditor, the current resource base of Coal India is 64 billion tonnes with 21 billion tonnes of extractable reserves. The extractable reserves are sufficient to sustain current levels of production for 50 years.

Coal India operates 471 mines, of which 163 are open cast mines, 273 under-ground and 35 mixed mines. More than 90 per cent of the present production comes from open cast mines, which have a low stripping ratio ( between thickness of coal seam and above lying strata).

This reduces the time required for development and allows high mechanisation that improves productivity. This improvement in development and operational parameters has been the key factor underpinning Coal India's financial performance. Despite having two sick subsidiaries (negative net worth) under its belt, it continues to be among the most profitable companies.

The sales grew at 14 per cent, compounded annually over the period FY2007-10, while the net profit clocked a 32 per cent growth. The company's operating margins stood at 22 per cent for the year ended March 2010, which is expected to improve on the back of rising realisations and falling costs.
Of the 142 mines to be tapped over the next decade, 77 are being developed and have already received environment approvals. Almost 90 per cent of the land for the projects coming up in Eleventh Plan is also owned by the company, reducing execution risks.
According to Ministry of Coal, the domestic demand-supply gap of coal for 2009-10, at 67 million tonnes or 11.5 per cent of demand, was bridged through coal imports.

The gap is expected to widen to over 120 million tonnes by 2012 despite domestic production ramping up.

Coal India may see its production increase from 435 mtpa (million tonnes per annum) to 643 mtpa (a 6 per cent CAGR) over the next seven years.

Demand on the other hand is expected to grow in double digits, translating into better realisations. According to the offer document, non-coking coal and coking coal demand are expected to grow at a compounded rate of 11.3 per cent and 9.7 per cent up to FY-2014.

The company is looking at overseas acquisitions to augment supplies. It entered Mozambique through its subsidiary to develop coal in that country and is exploring opportunities in Indonesia, Australia and the US. While the majority of power projects are attempting to tap captive coal mines, these projects are still in the drawing board stages. In the near term, they have to turn to imports or buy in e-auction at market determined rates (from which CIL is a beneficiary).

To improve the production and reduce costs, Coal India is reviewing legacy mines and negotiating with buyers for higher coal prices that can ensure at least a 12 per cent return.

The proportion of expensive under-ground mines has fallen from 13.3 per cent in 2005-06 to 10 per cent as of March 2010.

The impact of this on the cost structure is quite high as the current cost of mining per tonne from open-cast mines is at Rs 520 per tonne compared to Rs 2,145 per tonne in under-ground mines.

Mechanised open cast mining trims employee costs for the company; the employee base is already down 3.7 per cent over the last three years and a net reduction of 11,000 employees is expected this year; from the current base of 4 lakh.

CIL also plans to add 111 million tonnes of coal washeries which would improve the beneficiated coal output, which has higher calorific value.
The average price realised for beneficiated coal (Rs 2134/tonne in FY-2010) is almost double the average price for the entire output, with only marginal addition to costs for washing. Currently the high grade coal is sold at import parity price unlike cost plus in case of low-grade coal.

The proportion of coal sold through e-auctions is also expected to go up to 20 per cent from the current 13 per cent, owing to the demand-supply gap.
While the existing fuel supply agreements (FSAs) with power projects stipulate that Coal India meet 90 per cent of its commitment or else pay a penalty to the clients, the commitment is lower at 60 per cent for non power sectors.

New power FSAs too have a 50 per cent commitment. This allows room for Coal India to sell larger quantities through e-auction.

The impending risks

Coal mining business in the present day situation is highly risky. Climate Change is the new area that has been in focus for quite some time.

Execution delays may crop up owing to regulatory, legal and environmental hurdles, land acquisition delays, political risks and social disturbances.
Geographical concentration of resources may impose logistical problems. ECL and BCCL, wholly owned subsidiaries, despite turning profitable recently have negative net worth of Rs 6015 crore and Rs 5400 crore respectively. These companies contributed 36.4 per cent to the overall employee costs but only 13.4 per cent to the revenues of the parent.

The new MMDR Bill may require Coal India to set aside 26 per cent of the profits for resettlement and rehabilitation activities of project affected persons. However, given the company's monopoly status and pricing power, the additional costs can be passed on to consumers.

The accounting treatment for over-burden removal may change once IFRS accounting principles are adopted.
This would mean charging the expense in the same accounting year, instead of spreading it over the life of the project. There may be a dip in profits once IFRS is adopted from April 2011 and profits may also be lumpy.

Authenticity of CIL’s pithead stocks is doubtful on account of shells or black stones mixed in the coal dumps, the value of which bolsters the company’s annual income in its balance sheet. The valuation of such pithead stocks helped CIL and its subsidiaries window-dress the annual accounts for years. It is a well known fact that whenever CIL had change of guards at the top, the veracity of pithead stock reports was questioned by the new chairman.

For years, Coal India functioned as a losing concern, mainly because of the poor performance of some of its heavily-manned subsidiaries such as Bharat Coking Coal (BCCL) and Eastern Coal-fields (ECL).

Making headlines

CIL’s annual report hardly made big front page news. However, it has made in the matter of PIO issues and will be making now on because the world will be watching the stock exchange-listed new Coal India.
CIL’s performance will now come under the public lens, including those of investors’ forum and the stock market regulator, the Securities & Exchange Board of India (SEBI). While the government has mopped up Rs. 15,200 crore by unloading in the market only 10 per cent of its stake in CIL, the responsibility for fulfilling the performance projections in the offer document (prospectus) for the government share sale rests entirely on the management of the company.
For the first time since the nationalization of the coal industry by the government some four decades ago, CIL management will be answerable outside the confines of New Delhi’s Shastri Bhawan, the seat of ministers and bureaucrats in the department of coal. The management will have to meet the expectations of private investors, including foreign institutional investors, who pumped in large funds to acquire high-premium (Rs. 245 per share) CIL shares.
The IPO has brought little tangible financial benefit to CIL, except pushing up its notional market valuation to $35 billion.
The CIL management has already come under the public scanner for “errors” in the company’s profit and loss statement, following which the SEBI had immediately asked the company to allow ‘withdrawal of bids’ by any interested investor or investors. The company was asked to publish a corrigendum to the financial statement for the benefit of the public, which CIL had readily agreed.
One wonders if the ‘errors’ in the company’s financial statement were deliberate. Rather mysteriously, these ‘errors’ even escaped the trained eyes of SEBI bosses and the managers of the IPO, which included such leading names in the financial management world as Citigroup, Morgan Stanley, Bank of America-Merrill Lynch, Deutsche Bank, Kotak Mahindra Capital and Enam Securities?
Fortunately for CIL and SEBI, the euphoria about the IPO and its massive over 15 times oversubscription helped bury the news of ‘errors in CIL’s financial statement’. The mistake was underplayed by all concerned, including the media.

CIL has already eaten its own words on the company’s production target for the year, downsizing it from an earlier projected level of 520 million tonnes to 486 million tonnes.

The history of mafia operations in the coal belt carrying political patronage, illegal mining, coal theft, financial corruption, inflated project costs, the difficulty in acquisition of tribal land for mining, environmental challenge, etc. have long hampered CIL’s ability to operate up to its true potential. The average production growth has been just around four to five per cent annually. The coal production and colliery expansion programmes are now facing a bigger challenge from a formidable combine of militant Maoist revolutionary groups and the traditional coal mafia in the mining belt covering Jharkhand, parts of West Bengal, Orissa and Chhattisgarh.

Another challenge for the CIL is its being over-manned and a very slow mechanization. The production cost is therefore very high.

Another way of looking at facts

Although CIL claims itself to be the world’s largest coal mining company, Indian ranks fourth in terms of world’s proven coal reserves, which are estimated at 847 billion tonnes after the USA, Russia and China. India’s coal reserves are estimated at around 200 billion tonnes. China is the world’s largest coal producer and consumer.

CIL’s performance cannot be considered good, keeping in view that India is increasingly suffering shortage of coal, forcing its steel plants, thermal power plants. We are forced to import coal to meet the supply gap. CIL’s production of metallurgical coal or coking coal and steam coal has been stagnating for several years.

It has resulted in making India one of the world’s largest importers of coal. Its import requirement is expected to reach 185 million tonnes by 2015. India has been importing coal since Janata Party rule (1977-80), when Morarji Desai was the Prime Minister. In early 1980s India’s total coal import was just around one million tonnes. The Tuticorin power plant in Tamil Nadu was the first to obtain permission to import coal.

The quality has always been a matter of concern not the quantity that contains high ash content, shell or black stone. The ash content in Indian coal ranges from 35 to 45 percent which makes operations for thermal power plant difficult. Almost 70 per cent of such coals are consumed by thermal plants. The poor quality of coal affects the function of boilers. Washing improves the quality, but it is expensive and leads to loss of coal in recovery. Of course, CIL can’t be blamed for the poor coal quality, but if its operational practices are improved, it may certainly help in reduction of shell content in coal.

The move of the government to unload its share does allow small private holding, but it will remain overwhelmingly a government controlled company. It indicates about the intention of the government in favour of privatization, but it cannot be said that this small private holding in CIL will bring any appreciable change in its operational style leading towards better management practices, greater operational transparency, higher efficiency, larger investment in technology and bigger level of production.