A Study of Impact of the Presidential Directive to Coal India
India currently has plans to ramp up coal based power generation on a massive scale. Domestic supply has consistently fallen short of demand and the gap has been widening. Coal India Limited, a public sector company, mines about 80% of the coal in the country and is being directed by the government via a presidential directive to commit to supplying this through Fuel Supply Agreements. This analysis estimates the impact of the recent presidential directive ordering Coal India Ltd. (CIL) to sign fuel-supply agreements (FSA) with power utilities, guaranteeing 80% of the Annual Contracted Quantity (ACQ). We have assessed likely impacts of the implementation of this directive on CIL under different scenarios. The study is divided into three parts.
- In part I, we have estimated the financial cost incurred by CIL in order to follow this directive, considering various scenarios of coal production and power capacity addition in the country. We have estimated the addition of power capacity over FY12-17 and projected the likely shortfall for CIL assuming that its production grows at 1%, 5% and 7% over FY2012 production.
- In part II, we have estimated the likely penalty that CIL will have to bear under various levels of coal demand and production shortfalls.
- In part III, we have estimated the likely loss CIL would have on account of diversion of e-auction coal for meeting the FSA agreement requirements.
- Shortfall: Assuming an optimistic 5% growth rate in CIL’s coal production, Coal India Limited is likely to face an average annual shortfall of ~82 MT over the period 2013-2017. This is if they are set a supply target of 80% Annual Contracted Quantity (ACQ) for all power plants (PPA+non-PPA). Even at a lower target of 65% ACQ, there will be an annual average shortfall of ~44 mtpa. If a target of 100% ACQ were considered, CIL would fall short by a huge annual average of ~132 MT. However, CIL’s production growth rate in the last five years has been much lower and was just 1% between 2010-12. At a 1% production growth rate, the shortfall would be considerably more, ranging from an annual average of ~100 to ~189 MT.
- Import Bill: CIL’s coal import bill will amount to an average of Rs. 254,001 mn annually for the period 2013-2017, again assuming a 5% coal production growth and a supply target of 80% ACQ. This is computed for the average of ~82 mt of coal that CIL would have to import annually in order to honour FSAs, at projected international prices for 2015. If CIL’s production growth remains at the current 1%, the import bill would amount to Rs.429,822 mn annually for the five year period. The import cost will have to be borne either by CIL, power producer, or end-consumer.
- Penalty: Taking the median scenario of 5% production growth rate, CIL will fall short of the 80% ACQ level by 13% (average) in the period 2013-2017, incurring a penalty rate of 1.5%. The penalty would amount to Rs.9510 mn at current prices. If CIL’s production growth remains at the current 1%, CIL would fall short of an 80% ACQ by 23% (average) in the period 2013-2017. This level of shortage would incur multiple penalty slabs, and would cumulatively amount to Rs. 43,738 mn.
- Foregone income due to E-auction coal diversion to FSA: CIL currently sells approximately 11.5% of its coal through e-auction, where it gets a higher price for the coal. If CIL is forced to divert the e-auction coal to meet FSA requirements, the income foregone by CIL will amount to an average annual of Rs 15,890 mn for the period 2013-2017, assuming a 5% production growth rate and e-auction prices remain constant (which is an extremely conservative estimate).
As I write, Facebook has made its much spoken-about debut on Nasdaq and after some swings in value, is making 7% return in the opening few hours for the lucky ones who laid their hands on the stock before it went public. There are stories on every website about how much money which owner is making, who owns how much of Facebook (I recently discovered that there is an entire website dedicated to who the owners of Facebook are…), how big the FB IPO is etc. People who can’t tell a mutual fund from a fixed deposit are posting on their Facebook accounts that Facebook is going “public”. All this hoopla made me think if it makes sense to invest in the company’s stock if one looked at it from the perspective of the long term investor. (and by ‘long term’ I do NOT mean 6 months). I have been thinking about doing this for some time now, but being caught up in one thing or another, I could not do much about it.
So, let me just begin by asking the most basic of questions: why do you buy a stock? The answer, of course, is: to become a part owner of a company and thereby to become a partner in the profits of the company. Indeed, in normal cases, we pay to buy a stock because throughout the existence of the company, this stock will earn profits for us. So the question of whether to invest in a particular company or not depends on how much the company will earn for me and how much do I have to pay for it. There is no point buying a company’s stock for 100 rupees, if it earns only 10 rupees throughout its lifetime.
Now, the market is valuing FB at $110 billion (bn). (about 7% of India’s GDP!) To put that in perspective, the world’s most valuable company, Apple Inc is valued at around $500 bn and India’s most valuable company, TCS (at today’s closing prices, anyhow) is valued at just over $ 4 bn. To put this in another perspective, when India was facing a slowdown in 2008, our Government announced a stimulus package to revive the ENTIRE economy which was estimated at that time to be… hold your breath… $ 6 bn. FB is worth 18 times that!
So, the market is giving a lot of value to the business activities of FB, which means it perceives that FB will be able to earn a lot for its investors. Compared to its sales and profits, FB does not appear cheap on the first look. The company is trading at a Price/Earnings ratio of over 67x. Comparatively, other leading Technology stocks like Google and Apple are trading at Price/Earnings ratios of 19x and 13x, respectively (all based on estimated figures). It is clear that to justify its valuations, FB will have to substantially increase its profits. And soon. For instance, to ensure that an investor putting his money right now gets a return of 15% over the next five years, FB will have to increase its value to over $ 220 bn. Assuming that the market at that point values it at the same level as it is valuing Google today (i.e. a P/E of 19), FB’s earnings will have to be over $ 11 bn. In other words, FB will have to crank up its earnings by nearly 50% every year for the next 5 years, in order that an investor buying its stock today ONLY JUST gets rewarded adequately. It is a tough ask, but companies in their early growth phase have been known to exhibit even higher growths.
Before we answer that question, however, first let’s see how FB generates its income? 85% of its revenues last year came from advertising. Although FB is looking at a lot of options to increase its revenue streams, advertising seems the most likely to form the ‘bedrock’ of the revenues for at least a few years. How do these guys increase revenues? It could be by increasing advertisement rates, which is already being tried and has a limitation because of the supply and demand for ad space. FB could increase the volume of advertisements, but that would be tricky to achieve without adversely affecting the ad rates, thus negating the ad volumes increase to some extent. The impact of increase in advertisements, however, could be trickier than only that. Remember the movie, The Social Network? There is one scene in the movie where the character of Mark Zuckerberg says that he has a “cool” asset and he will not do anything to destroy the coolness of it. That is such great business sense, which has worked wonderfully well for FB so far. Can you imagine a FB where ads pop up every time you comment on your friend’s photograph? The challenge before FB would be to increase its ad revenues while keeping its “coolness quotient” intact.
There is another point that I have not understood, being “technologically challenged” myself. And it is this – how effective are ads on FB? While this could be a subject of intense debate, General Motors does not seem to think too highly of them. They recently withdrew their paid ads worth $ 10 million from FB. Even recent studies have found that advertisement click-through rates on FB are half as effective as the rest of the internet. The reasoning given behind this phenomenon is that a typical user goes to FB in search of entertainment and socializing and is therefore is less likely to buy stuff or check out advertisements. Whatever be the reason, this highlights the challenges facing FB in increasing its ad revenues.
It is interesting to see what has been happening to the revenue increases recently. These are the percentage increases in the revenues of FB, compared to the same period last year, for the past 3 quarters: 104%, 55% and 45%. The revenue growth has fallen from 104% to 45%, well below the 50% that we said we needed. More damning is the trend – it has fallen drastically. In fact, compared to the previous quarter, revenues in March 2012 have actually fallen. Although this may well be a blip in the overall growth, this could just as easily be the sign of things to come. In yearly terms, FB is expected to increase its revenue by 64% in 2012, which one assumes would only fall in the time to come. Coupled with the paragraph above, these figures put doubts in one’s mind over the ability of the advertisement revenue stream to pull through the company’s growth rate sufficiently (i.e. a minimum of 50%).
And what if the company does manage to do its stuff quite well and manages to show a 50% growth in income over the next 5 years? The investor only just makes money. Of course, there is the possibility that the growth rate turns out to be much higher than 50%, or the market values FB’s earnings well above 20x, in which case the investors make a lot of money. But the chances of such a scenario are slim. The question, then, is this – is the risk worth taking? Are the odds in favour of or against the investor? While this is a question that each investor must answer for himself/herself, I am not rushing over to invest any time soon!!
Equitorials quoted in Economic Times >
Please find attached Equitorials article that featured in latest issue of Images Business of Beauty (#1 magazine of Beauty Business)
Positioning into mass premium segment – Hitachi Home and Life Solutions (HHLS) that primarily caters to the premium segment, is now entering tier-II and tier-III cities with low-priced products. The company has launched new range of window and split AC “KAZE” as low price product. This will help the company gain market share in the Room Air conditioners segment in the near future. The company has set a target to capture 10% market share in terms of sales volume, compared to the current market share of 7%.
Rural markets offer a big opportunity – Rural consumer durables market is growing by 30% currently, while it is expected to grow by 45% in FY12. Rural markets are expected to post much faster growth than urban markets in medium term led by increased rural Income, increased distribution reach of companies, and customized products for rural consumers. The industry is expected to grow at a compounded annual growth rate (CAGR) of 18% till 2014-15.
Outlook & Valuation - The AC industry is expected to grow at 15-20% over 3-5 years, while we expect HHLS to register a CAGR of 14% over FY2011-13E. The decline in EBITDA in FY11 over FY10 was mainly because of the rise in raw material prices (mainly copper). We expect EBITDA margins to improve to 6.1% in FY13E. The forecasted PAT shows decrease of 32% in FY12E mainly due to decline in sales because of climatic change, short summer season and longer winter season. The PAT is expected to rise by 50% in FY13. At current valuations the stock is trading at 9.8x FY2013E EPS. We have arrived at Target Price of Rs142. Hence, we recommend BUY on the stock.
WoS – 3 Sanjeev Patkar 24-Feb-2012
In the third part of our series of interviews with stock market leaders, we talk with Mr. Sanjeev Patkar, Head of Research at one of India’s largest Asset Management Company SBI Mutual Fund (Asset Under Management (AUM) of more than Rs40,000cr at the end of Dec-11). Mr Patkar is probably the only person that we have encountered in stock market who doesn’t have a finance educational background. An Engineering topper and Marketing major from JBIMS, Mr Sanjeev’s uniqueness doesn’t end there. He has very diversified work experience ranging from sell side to buy side to credit rating to framing maritime policy of the State of Maharashtra and Executive Assistant to MD’s office. Read on to find out more about his journey and success mantra.
Q When was your first encounter with stock markets?
A Post my MBA, I got selected by CRISIL in their credit rating department, even though I didn’t specialise in finance. Given my engineering background I had a strong analytical ability and that’s what CRISIL liked in me for their newly formed credit rating department. That was my first encounter with real finance. I researched & rated 60-70 companies across different industries and sectors. After that I got an opportunity to work with india’s largest FII (AUM -Rs3,500cr) Jardine Fleming. Post that I moved on to work with GE Capital, globally known as one of the finest organisations. Then I got an opportunity to work with some of the best names on Dalal Street like ENAM and Kotak PMS. After that I took a break and did something totally different from stock markets – I worked with i-maritime a maritime industry consulting company, where I helped Maharashtra state government to form their port & other shipping related policies. From there I move on to Welspun, where I worked as an Executive Assistant to MD, where I got an opportunity to interact with Dr. Eliyahu M. Goldratt author of the famous novel, The Goal. I got to learn immensely on how a company’s business – customer – market cap, all is linked very simply. With strong business experience, I moved back to stock market. I joined Dolat Capital as their Head of Research, then to Almondz Capital and currently am with SBI Mutual Fund.
Q What has been your learning from stock market over the years? What’s your philosophy or strategies for stock market? What technique do you use? How has your technique changed over a period of time?
A You’ve got to focus on the Business Model of the company, understand where business is adding value to its customer. To quote Dr. Eliyahu M. Goldratt “Market Cap(italisation) is monetised representation of perceived value added by the company in its product/service in the eye of the customer”. That’s the simplest explanation of what the company should be doing that will help it create wealth for its shareholders. Companies have to figure out where they are adding value to the customer and focus on that. There is a Black Box that every business has that delivers value to its customer. Your job as an Analyst or Fund Manager or Head of Research or Stock Investor is to figure out where business adds value to its customer and who does it best and that’s how you come up with best winning stock ideas. Like Infosys has its own PSPD model (Predictability, Sustainability, Profitability and
De-risked model). One has to understand the right business model to deliver value to the customer and where the focus of the management is. The company should have strong business model that not only delivers value to customer but will continue to do so on a long term (sustainable) basis and that too in a profitable manner. Once I had met the management of Hero MotoCorp (erstwhile Hero Honda). We were with Mr Ravi Sood (CFO) and asked him “Sir, how do you guys make profit?” and he replied in a very simple line “expenses that one makes during boom and saving one does during the recession”. The philosophy of the management was very clear – not to indulge in any unnecessary expenses and give exactly what customers need.
Q How do you typically evaluate a stock? What kind of things do you look at, in any order? Can you highlight 3-4 key things that every analyst should look at?
A I look at a stock in very simple manner as I indicated earlier. I look at the Business Model of the company, figure out what customers need and find a company that does exactly the same. The best way to find a good company is to have an approach of a businessman while analyzing any company. You should be like a Marwari – they are the best businessmen. They monitor three things – first, fixed expenses (“kharcha-paani”, second, variable cost (maal-samaan”) and third, working capital (“ugraani”). This is what business is all about. Evaluate a company/business, then see financials and finally come to valuation and figure out a good price to buy. One should have approach that of businessman. When you have Rs500 or Rs1000, you can always hire people like Mr Mukesh Ambani or Mr Sunil Mittal by buying their stock, who work 18 hours a day to ensure they create wealth not only for themselves, but for you too.
Q How many market cycles have you seen? How was your experience during that time? Can you share anecdotal stories of your success or failure?
A When we worked at Crisil, we were blessed by the changing environment of falling tariffs and duties, which were challenging established businesses/ mega corporations. Who would have imagined NOCIL to get vanished only to be gobbled up by Reliance at the end of the cycle? In almost each of the cycle one was unsure of whether things were changing – and in a sure denial when they were changing the other way. When Tata announced its Indica – it was its last peak, and history almost repeated when Mr. Tata announced NANO. Frankly, when we moved in we were hardly aware of what to analyse, how to analyse, and why and where to invest. It is through your mistakes that you learn.
On the positive side, Dolat was one of the enterprising stints, where to get noticed we did some breakthrough work. Before all these 2G & 3G scams broke out, during my early days, we did research on “Spectrum”. Once you analyse telecom sector you know that it is the most crucial raw material and it is something you can’t see, touch or feel and we made reports making sense of this and trying to value it. We were also among the first few to understand the value migration in energy basket from conventional fossil liquids to Gas sector.
Q What makes a successful analyst different from others?
A Successful analyst is like a child. He questions everything and gets to know everything. You know how small children are – they keep on questioning you this & that and rack your brains. At the same time you have to be very humble, flexible, enthusiastic, inquisitive and enjoy the whole process.
Q What are the major misconceptions that people have about stock market in general and about analyst/ fund managers in particular?
A We are just like film stars. We both sell dreams and if it doesn’t work people punish us badly. They forget we are humans just like anybody else. We are no gods or demi-gods or super-humans with super powers.
Q What do you expect from newcomers to the stock markets? What are the qualities that new participants, especially students should possess for being successful in the stock markets? How should one go about acquiring those qualities?
A Investing as a profession is a brilliant combination of almost all the basic disciplines: Science, Arts, Psychology… you name it…
In terms of soft skills – attitude, willingness to work hard, humility and in terms of hard skills that can be taught – industry analysis, understanding business models, financial statement analysis like Marwari businessmen, willingness to do on-ground research, strong knowledge of Excel (Excel in Excel), knowledge of basic valuation tools & techniques.
Few must-read books for students – The Goal, Warren Buffett Way, Little book That Beats The Market and Little Book That Creates Wealth, Cashflow Quadrant, The Professional, Winning Habits, Romancing the Balancesheet, The Secret, You Can Be Stock Market Genius and How To Make Money In Stocks.
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IPO Note on Multi Commodity Exchange of India Ltd – subscribe – 17-Feb-2012
We attended IPO analyst meet of MCX, overall company has good business model and stock is very attractively valued even at upper price band.
Couple of key reason why we like MCX- Strong competitive position – market share of 80%, ability to come up with innovative product and huge market opportunity.
Currently only Futures are allowed in Commodities, while Options are still being considered by regulator. Any headway in allowing option, MCX would be biggest beneficiary of the same due to already strong market share.
Globally Futures & Options volumes are anywhere in range of 40-50x of each commodity compared to its actual spot market. While in case of India it stands in region of 15-20x, offering strong market growth visibility.
In terms of valuation, at upper price band company would have market cap of Rs5,263cr, which would trade at 5x its 9mFY12Book Value and 18x FY12 Profit (month annualised earning). Given there are no comparable peers in India we have looked at international comparison. Globally in developed as well developing country many of commodity exchanges are listed. In case of developed markets, average PE is in range of 18-19x one year forward earning and growing at 8-9%, while in case of developing/emerging market it’s trading at 25-30x one year forward earnings, while growth being very high in region of 15-25%. Hence we believe, MCX valuation even on upper band of IPO is valued very attractively and recommend investor to Subscribe to the IPO.
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