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l Equity Researchl

Important disclosures can be found in the Disclosures AppendixAll rights reserved. Standard Chartered Bank 2013 http://research.standardchartered.com

India IBasic Resources 27 September 2013

India coal

Coal block auctions: A game changer

Share prices as of 25 September 2013Source: Companies, FactSet, Standard Chartered Research estimates

The Union Cabinet of India has approved the auction of coal blocks to private companies. We believe this can

significantly improve coal availability in India in the next four to five years.

The development is positive for power equipment manufacturers, as increased availability of coal will spur demand

for power equipment.

Our scenario analysis using broad contours of guidelines indicates that power producers could realise a healthy

RoE of c.23%, even if they bid at twice the base price.

We maintain our Outperform rating on Coal India and BHEL (BHEL IN, OP, PT INR 182).

Government move to auction coal blocks is a positive stepThe Union Cabinet of India has approved the auction of coal blocks to private

companies. If implemented properly, this can significantly alleviate coal supply issues

four to five years from now. The current domestic coal demand/supply environment

indicates that until FY17, India will continue to import significant quantities of thermal

coal, at c.170mn tonnes from 120mn tonnes in FY14. However, after FY17, thesupply-side bottlenecks should ease considerably, given Coal Indias initiative and

the auction of coal blocks.

According to the guidelines, the Ministry of Environment and Forest (MoEF) will be

involved in the auction process. Hence, regulatory issues should not lead to

significant delays in the projects, in our view. In addition, there are other safeguard

measures that ensure that mine developers commit to minimum project development

requirements and adhere to the defined timeline.

We believe this development will initiate a new investment/capex cycle in the power

sector. Although there is significant demand for power, coal supply issues werepreventing new players from entering the market. This policy initiative should

encourage potential new entrants.

Our scenario analysis, using broad guidelines, indicates that power producers could

realise a healthy RoE of c.23%, even if they bid at twice the base price. Such

profitability is sufficient to spur investments, in our view. Other industries such as

cement/aluminium also gain, as they get an assured supply of coal at lower rates.

Mkt cap Price PT Up/(Dn)

Ticker (USD mn) (lc) Rec (lc) side (%) FY1E FY2E FY1E FY2E FY1E FY2E

Coal India COAL IN 29,902.9 297.00 OP 341.00 14.8 10.8 11.5 6.2 6.2 4.7 4.7

PER (x) EV/EBITDA (x) Div yield (%)

Satish [email protected]

+91 22 4205 5906

Saurabh [email protected]

+91 22 4205 5907

Jay [email protected]

+91 22 4205 5932

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Equity Research lIndia coal

27 September 2013 2

Coal block auctions: A game changerOur analysis shows that coal block auctions can be a significant game changer for coal

availability in the country. If properly implemented, these can significantly alleviate the

coal supply concerns in the country in the next four to five years. We believe that relatively

clean blocks will be put up for auction, which should reduce the time taken for regulatory

approvals significantly. Hence, under normal circumstances, coal blocks can become

operational within five years from the date of auction. According to media reports (The

Hindu Business Line, 23 September 2013), four coal blocks with estimated reserves of

2bn tonnes will be up for auction in the next two to three months.

Coal block auctions: The methologyThe Government of India has approved the methodology for the auction of coal

blocks. On a broader level:

1. The base price will depend on international prices. However, power developerswill get a 90% discount on the base price.

2. There are adequate safeguard mechanisms to ensure developerscommitment.

3. MOEF clearenece does not apear to be a big hurdle in the auction regime.

The base prices will depend on international prices

The base auction price of the coal blocks will depend on international coal prices.

However, there are sufficient concessions for power developers provided they follow

the defined norms of the auction.

The methodology provides for production-linked payment on an INR/tonne basis

and a basic upfront payment of 10% of the intrinsic value of the coal block.

The intrinsic value of the coal blocks will be calculated on the basis of net present value

(NPV) of the block, calculated through the discounted cash flow (DCF) method.

To benchmark the selling price of coal, the international FOB price from public

indices such as Argus/Platts will be used by adjusting it by 15% to provide for

inland transport cost. This would help arrive at the mine-mouth price.

In order to avoid short-term volatility, the average sale price will be calculated

using prices during the past f ive years.

Regulated power developers will get a 90% discount on the intrinsic value for tariff-

based bidding. This methodology will help rationalise the power tariff.

There are safeguard mechanisms to ensure developers commitment

Past experiences with coal block developers have not been encouraging due to their

failure to develop the projects. Hence, the government has incorporated the following

safeguards in the auction guidelines:

There will be an agreement between the Ministry and the bidder to perform

minimum-work programmes at all stages. There will also be development stage

obligations in terms of milestones to be achieved such as obtaining the mining

lease, environment/forest clearances etc.

The bidder will have to provide a performance guarantee during the developmental

stage. The successful bidder will get two years for exploration (for regionally

upgraded blocks) and five years for the development of coal blocks.

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27 September 2013 4

Figure 1: Indian steam coal import requirement may not rise as fast as expected

(mn tonnes) FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E

Coking coal 37.7 41.1 43.9 46.1 48.6 51.5 55.7 60.1 64.9

Non coking coal demand

- Power (utilities) 363.3 379.0 389.6 436.0 479.6 527.6 576.0 626.7 677.4

- Power (captive) 34.1 39.2 40.8 36.9 38.4 40.0 40.0 40.0 40.0

- Cement 20.1 21.4 25.2 13.5 28.5 29.9 32.3 34.9 37.7

- Sponge iron 19.8 23.1 23.1 21.3 18.2 19.3 20.8 22.5 24.3

- Others 76.7 86.2 93.6 81.1 85.2 89.4 93.9 98.6 103.5

Total non coking coal 514.0 548.9 572.2 588.8 649.8 706.2 763.0 822.7 882.9

Total coal Demand 551.6 590.0 616.1 634.9 698.5 757.7 818.7 882.8 947.8

Coal supply

Coal India Limited (CIL) 403.7 431.3 431.3 435.8 465.0 491.0 504.0 545.0 599.0

Singareni Collieries Company Limited (SCCL) 44.5 50.4 51.3 52.2 53.1 54.0 54.0 55.0 55.0

Captive and others 44.5 50.4 50.0 51.9 57.8 57.8 62.4 67.4 74.2

Total coal production 492.8 532.0 532.7 539.9 575.9 602.8 620.4 667.4 728.2

Coal import requirementCoking coal 21.1 24.7 19.5 31.8 32.2 35.5 39.6 44.1 48.9

Non coking coal 37.9 48.6 49.4 71.0 97.2 119.4 158.7 171.3 170.8

Coke and others 1.9 2.4 1.5 2.4 6.0 - - - -

Total imports 60.9 75.6 70.4 105.2 135.4 154.9 198.3 215.4 219.7

Source: Ministry of Coal, Standard Chartered Research

Auctioned coal block will add to the supply pool

According to Coal India management, it is working on the projects that can yield

around 486mn tonnes of coal. Compared with Coal Indiasguidance of 135mtpa of

incremental coal, our demand-supply model assumes c.120mtpa of incremental

coal from ongoing/new projects by FY17.

The auctioned coal blocks will add to this pool of new supply. India plans to auction

around 2bn tonnes of coal reserves by December 2013, and incremental

production could reach 50mtpa after the coal blocks are fully developed.

Given that the government will mitigate procedural/statutory bottlenecks for the

auction (MoEFsin-principle clearance, undisputed land, among others), it is likely

that these coal blocks will be able to produce coal in the next four to five years. In

fact, Jindal Steel and Power (JSPL IN, NR) said on CNBC TV-18 that it can

develop open-cast mines in 6-12 months.

Incremental coal production of 50-60mn tonnes beyond FY17 is possible

We believe India can incrementally produce 50-60mtpa beyond FY17, given Coal

Indias project pipeline and the coal block auctions.

Economic sense for power producers to bid even at twicethe base priceOur analysis indicates that buying coal blocks in auctions makes perfect economic

sense for power developers.

Captive coal blocks should take care of various aspects like vagaries of Coal India

supply, volatility in international coal prices, unavailability of port infrastructure to

import and the lack of a transportation network from ports to power plants.

Our calculation indicates that even if we assume no structural bottlenecks such as

demand, logistics and coal availability, it still makes sense for power developers to

bid for coal blocks.

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27 September 2013 5

Power project developers will have significant operational benefits from coalblocks

Coal Indiassupply under FSAs has not been very regular. While Coal India has

met the FSA obligations, timely supply has remained a key question.

Power developers face challenges even in importing coal. Power production costs

using imported coal are at least 1.5x that of the coal supplied by Coal India. Hence

in merit order dispatches, there is hardly any buyer for such costly power.

Transporting imported coal to the power plant site itself is difficult due to logistics

challenges. Rail networks are not sufficient at many places and track congestion is

becoming an issue as well. Please refer to out SCout, India coal: facing a supply

crisis,dated 4 March 2012.

The RoE of the power plant can reach 23% using auctioned coal

Our calculation indicates that at the base price of the coal block, the RoE of the plant

can easily exceed 20%.

Our base price for the 150mn tonne coal block is INR 81bn: Our base case

calculations use the following assumptions:

Gross coal value (GCV) of the coal block of c.4,000 Kcal/Kg.

Coal prices of c.USD 60/tonne and an exchange rate of USD-INR 60. As given in

the methodology published on the Press Information bureau website, we have

used a 15% discount to the Free on Board (FoB) prices to arrive at the mine-mouth

price.

Production from the coal block of 5mn tonne p.a. A discount rate of c.11% used by

the government, in line with that used in the UMPP (ultra mega power projects)

levelised tariff calculation.

Royalty will be calculated on comparable Coal India prices for the same grade.

Captive coal blocks will have to pay excise duty, but since they do not export, they

will not have to pay CST (central sales tax) or VAT (value added tax).

Assuming an equipment cost of 55mn/MW, the RoE at the average selling price of

NTPC will be c.23%

The government has stipulated that power developers who will win the coal blocks

in the auction will have to bid for the power supply agreements. In this scenario,

the average cost for NTPC (NTPC IN, OP, PT 200) would be a good estimate for

revenue/unit.

We have assumed that the winning bid is twice the base price and the land cost

has been assumed at INR 45bn for the mines.

To reach the stipulated winning bid, revenue sharing from the mine will be at 15%.

5mn tonnes of coal can run a 1000MW power plant.

The upfront payment for the power companies will be 10% of the winning bid

prices.
https://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdfhttps://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdfhttps://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdfhttps://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdfhttps://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdfhttps://research.standardchartered.com/configuration/ROW%20Documents/SCout_-_India_coal__Facing_a_supply_crisis_04_03_12_15_04.pdf

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Figure 2: The down payment for power utilities will be a paltry c.INR 1.8bn for coal blocks with 150 mn tonnes of

reserves

CY18 CY19 CY20 CY21 CY22 CY45 CY46 CY47 CY48

Production (mtpa) 5 5 5 5 5 5 5 5 5Prices (INR/tonne) 3,060 3,060 3,060 3,060 3,060 3,060 3,060 3,060 3,060

Value of coal (INR mn) 15,300 15,300 15,300 15,300 15,300 15,300 15,300 15,300 15,300

Intrinsic value 15,300 13,784 12,418 11,187 10,079 914 823 742 668

Intrinsic value as on CY18 148,315

Intrinsic value as on CY13 88,018

Winning bid for power 176,035

Down payment for steel/cement( INR mn) 17,604

Down payment for power utilities 1,760

Source: Standard Chartered Research estimates

Figure 3: Even if the power developer bids at twice the base price and sells at INR 2.7/unit, the RoE will be c.23%

Cost of producing power in INR/KwHr

PLF 90% Revenue sharing 15%

Auxiliary consumption 8% Production cost 700.0 INR/tonne

Effective PLF 82% Revenue given to govt 459.0 INR/tonne

Unit sales 7.1 mn units Royalty 171.0 INR/tonne

Debt/equity 3.0 Total coal cost 1,330.0 INR/tonne

Debt 41.3 INR mn Freight 200.0 INR/tonne

Equity 13.8 INR mn Coal cost at plant 1,530.0 INR/tonne

Interest rate 10% Calorific value 4,000.0 kcal/kg

Interest cost 4.1 INR mn Heat rate 2,300.0 kcal/kwh

Per unit cost 0.58 INR/unit Coal required 0.6 kg/kwh

Plant life 30.0 Years Coal cost 0.9 INR/kwhDepreciation per unit 0.3 INR/unit Power cost 1.3 INR/kwh

Total cost 2.2 INR/unit Power plant cost 55.0 INR mn

Realisation 2.7 INR/unit

PBT 0.5 INR/unit

Tax 0.1 INR/unit

Pat 0.4 INR/unit

PAT 3.1 INR mn

RoE 23%

Source: Standard Chartered Research estimates

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27 September 2013 7

Disclosures appendixThe information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered B ank Singapore Branch, StandardChartered Securities (India) Limited, Standard Chartered Securities Korea Limited and/or one or more of its affiliates (together with its group of companies, SCB)and the research analyst(s) named in this report. THIS RESEARCH HAS NOT BEEN PRODUCED IN THE UNITED STATES.

Analyst Certification Disclosure:The research analyst or analysts responsible for the content of this research report certify that: (1) the views expressed andattributed to the research analyst or analysts in the research report accurately reflect their personal opinion(s) about the subject securities and issuers and/or othersubject matter as appropriate; and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or viewscontained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisals of analysts.

Where disclosure date appears below, this means the day prior to the report date. All share prices quoted are the closing p rice for the business day prior to thedate of the report, unless otherwise stated.

250.30

283.13

315.96

348.79

381.62

414.45

Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13

INR Recommendation and price target history for Coal India

1

2

3

4

5

Date Recommendation Price target Date Recommendation Price target Date Recommendation Price target

1 8 Dec 10 IN-LINE 338.00 3 24 Nov 11 IN-LINE 334.00 5 28 Aug 13 OUTPERFORM 341.00

2 29 Apr 11 IN-LINE 370.00 4 19 Jul 12 OUTPERFORM 395.00 Source: FactSet prices, SCB recommendations and price targets

124.45

143.46

162.47

181.48

200.49

219.50

Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

INR Recommendation and price target history for NTPC

1 2


1 18 Sep 12 OUTPERFORM 200.40 2 21 Feb 13 OUTPERFORM 200.00 Source: FactSet prices, SCB recommendations and price targets

101.35

187.79

274.22

360.66

447.09

533.53

Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

INR Recommendation and price target history for Bharat Heavy Electricals

12

3 4 5

6

7


1 18 Nov 11 UNDERPERFORM 280.00 4 27 Jul 12 UNDERPERFORM 186.00 6 1 Jul 13 OUTPERFORM 230.00

2 28 Jan 12 UNDERPERFORM 253.20 5 4 Feb 13 UNDERPERFORM 188.00 7 6 Aug 13 OUTPERFORM 182.00

3 24 May 12 UNDERPERFORM 179.00 Source: FactSet prices, SCB recommendations and price targets

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