Coal India's strong second-quarter results indicate a better-than-estimated operating margin outlook for fiscal 2016. The accelerated opening of new mines is leading to stronger sales volume growth which, coupled with lower fuel and power prices, has largely offset the lack of upward revision in salable coal prices this year.
Despite the fall in the absolute level of treasury income to Rs 14 billion (36% of profit before tax) from Rs 20 billion (57% of profit before tax), adjusted earnings per share increased 16% to Rs 4 versus the prior year. Sales volume, production, and selling prices grew 10%, 6%, and 1%, respectively, to 122 million tonnes, 108 million tonnes, and Rs 1,430 per tonne.
The results led us to raise our fiscal 2016 operating margin estimate to 23.3% versus 22.5% earlier. However, we adjusted our revenue lower on our view that weak international coal prices will weigh on Coal India, and this led to a slight 2% decline in our full-year earnings estimate of Rs 24.8 per share.
Coal India is benefiting from positive operating leverage in a seasonally weak second quarter owing to higher productivity in existing mines with operating margins rising to 19% versus 14% in last year. We think the full-year coal offtake will be 525 million tonnes (up 9% versus last year), lower than the government's 550 million-tonne target, which we believe is ambitious.
With minimal change to our earnings outlook, we keep our fair value of Rs 380 per share, long-term forecasts, and narrow moat rating. The increase in mining productivity via mechanization and opening new mines should help Coal India offset the subdued pricing outlook. We maintain our long-term 23% operating margin forecast, in line with the three year average.
Coal India enjoys a narrow moat due to cost advantage afforded by vast and relatively shallow open-cut coal mines. High fair value uncertainty reflects dependence of growth on government policies and the requirement for reform to ease logistical bottlenecks.
