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Coal India - A Value Buy or a Value Trap?

Coal India, a public sector enterprise, has fallen about 21% from its all time high price in the recent market correction.

Coal India (Daily) chart

This has led many to conjecture that it may now be a value buy. The reasons have substance.

Coal India is currently trading at an EV to EBITDA of 2.1, which is quite below its 5-year median value of 3.1, and has a large cash balance of about 20% of its current market value sitting on balance sheet.

Coal India also plans to increase its coal production at 1 billion tonnes per annum from the current 700 million tonnes per annum. This, at a time when India's power demand stays high. An added benefit is Coal India's high dividend yield of more than 9%.

So what could go wrong?

Well, for one, remember that a majority (more than 70%) of the coal that Coal India's produces is sold at fixed prices for long-term under what we call Fuel Supply Arrangements (FSA).

These fixed rates are very rarely revised upwards as that may immediately lead to an increase in electricity prices. Note that coal prices under FSA have only been revised 9 times in last 23 years.

What's the probability that prices will be revised upwards when elections are near?

Sure, the company also does e-auctions where the coal is sold at 200% premium over FSA prices because prices in e-auctions are linked to imported coal. But e-auctions only comprise about 8-15% of Coal India's total coal supply. Not much. And with recession looming globally, global coal prices may be in for further correction.

Another point is NTPC is a major customer of Coal India and has a debt of Rs 2.1 lakh crore. With interest rates rising, NTPC may be faced with higher interest burden thus putting its business under pressure.

Note also that a huge cash balance on Coal India's books may look nice except when you realize that the company has huge provisions of nearly Rs 70000 crores.

Source: Coal India Annual Report (Notes to Financial Statements)

This amount is more than 1.5 times its total cash balance of approx. Rs 36450 crores (I'm counting investments, cash and equivalents, and bank balance under this).

Coal India Balance Sheet

So, is Coal India a value buy? Or value trap? What are your views?