THE BUZZ
The Wall Street Journal reported that Coal India Ltd’s (CIL)
board of directors has finally given the green light for the company to sign
Fuel Supply Agreements (FSAs) with power producers in India. This comes after a
presidential directive issued by India’s government to the state-owned company
to sign the accords after CIL missed the initial deadline of 31 March. We
understand that the FSAs will be signed within the next 3 days before 20 April.
OUR TAKE
What happened back then? 90% owned by the state government,
CIL is the largest coal producer in the world in terms of capacity. It
contributes to some 90% of coal production in India. In
FY03/11, CIL produced 436m tonnes of
coal, missing the government’s previous target of 447m tonnes as heavy rainfall hit operations. Consequently,
several power stations had to stop or cut production late last year due to fuel
shortages, leading to blackouts in some parts of the country. To ensure
sufficient coal supply going forward, India’s Prime Minister Office
administration has set an initial deadline of 31 March for CIL to enter into
FSAs with power producers. Nonetheless, the deadline was not met, prompting
Prime Minister Manmohan Singh's administration to issue a presidential
directive on 5 April to ensure that CIL sign the accords within the next 15 days.
Deceivingly positive.
At first glance, the announcement seems positive with the FSAs between CIL and
power producers finally being sorted out to ensure sufficient coal supply to
meet fuel requirements. The long-awaited agreement is expected
to benefit power plants with an
estimated capacity of 50kMW with the nation now sitting on total 193kMW
of installed capacity. Nonetheless,
after counterchecking with other media sources from India, we found out
that CIL has set itself a lower penalty (to be paid to power producers) if it fails
to meet the minimum supply obligations, which we deem a negative surprise.
Lower penalty puts
conviction in doubt. Under the FSAs as approved by CIL’s board, should the
company fail to supply at least 80% of the contracted coal to the new power stations,
it would only have to pay 0.01% of the value of the shortfall as the penalty as
opposed to the 10% stipulated previously. And again to the disadvantage of the power producers in India, the penalty
clause will only be triggered after
three years from the date of signing the FSAs. In our view, the FSAs have
nearly wiped off all the liabilities that CIL will have to bear arising from
a potential default in case of a coal
supply shortfall. This puts its commitment towards ensuring sufficient
fuel requirements in doubt and leads us to believe that there is increasing
risk of shortages in fuel supply, which could jeopardize the entire power
industry in India.
Nothing is certain in
India. Although Mudajaya’s management confirmed that its 26%-owned associate
RKM Powergen has secured a backup coal supply in India amounting to 99m tonnes which will meet the fuel requirements for its 4x360MW power plant in Chhattisgarh
for over 15 years, we are increasingly
concerned over the flip-flopping of policies
by India’s existing administration. A few recent examples include the ban on
cotton exports, introduction of a provision that allows India to tax foreign
takeover of Indian assets retroactively
to 1962, cancellation of telecom licences issued previously
to some foreign telco operators, revocation of its approval to allow
foreign supermarkets to enter India as well as suspension of South Korean
steelmaker Posco’s plans to build a USD12bn steel mill in India. This latest
piece of announcement aggravates our concerns further as we deem the lowered
penalty a lower commitment from CIL to honour the FSAs and we also do not
discount the possibility of the Indian government taking back its words on the allocated
backup coal supply. There is mounting pressure from opposition parties which question
the huge 50%-60% discount attached to the contracted coal supply pricing, which
reportedly translates into a loss of national income of over INR10tn.
Imported coal not a
viable option for now. Should the local coal supply fall short, RKM Powergen
would likely have to source its fuel requirements in the international coal
market as the last resort. Currently, imported coal is trading at
USD90-110/tonne vis-à-vis RKM Powergen’s coal linkages with the Indian Government at
an effective price of USD40-50/tonne. Nonetheless, we understand that the existing
fuel cost pass-through formula does
not explicitly incorporate a potential hike in operating expenses should RKM Powergen source its coal requirements from
outside of India. Given the political ruckus that is created every time a state
electricity board contemplates a tariff hike, we think a revision in its
existing fuel cost pass-through formula is rather unlikely at this juncture and
hence, imported coal does not look like a viable option in the near term.
Risks of Chattisgarh
being left idle increase. RKM
Powergen’s power plant in Chhattisgarh is scheduled to commence operations by
4Q12 with the first unit likely to do so by the end of this year, while the 3
remaining will go on stream on a staggered basis, i.e. every 3 months
thereafter. With this latest development, we see increasing risks of its plant
being left idle upon completion, as witnessed in the current scenario for some
of the Independent Power Producers in India, as CIL have removed most of its
liabilities in the event of coal production shortfall. On the other hand, the
possibility of utilizing imported coal,
which is a lot pricier, seems unlikely for now until the state electricity
board gives its nod on the revision of electricity tariffs.
Downgrade to NEUTRAL. We are downgrading our call on Mudajaya from
Buy to NEUTRAL in view of the potential risks arising from a potential
shortfall in coal supply to meet its fuel requirements. By the same token, our FV is now revised down
to RM2.66, after attaching a steeper
discount of 50% (from 30% previously).
While some may argue that our FV now implies a rather appealing 6x FY12
PER being pegged to Mudajaya’s construction earnings sans any
contribution from its Chhattisgarh power venture, our cautious stance is warranted by potential
write-offs in its books (in the form of writing down its investment in RKM
Powergen which stood at RM431m as well as its outstanding receivables of
RM683m) should the Chhattisgarh venture turn sour. Do note that as of Dec 2011,
its remaining works on Chhattisgarh amounted to RM1.8bn, making up close to 50%
of its outstanding orderbook.
Source: OSK188
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