The government’s proposal to disinvest 5% stake via the ‘buyback’ mechanism and only 5% via an OFS is a positive surprise, according to Nomura Equity Research

Global news agency Bloomberg, quoting a draft proposal by the Indian ministry of finance, states that the Government of India plans to raise Rs20,000 crore ($3.7 billion) by disinvesting 10% stake in Coal India (CIL) through a 5% sale to the public (i.e. secondary offering) and a 5% sale to the company (i.e., buyback), given CIL’s $12 billion cash chest.

The ministry of coal has been asked to take CIL’s workers’ unions into confidence and gather support for the share sale. The unions were assured at the time of CIL’s IPO in 2010 that there would be no further disinvestment. Coal secretary SK Srivastava is quoted as saying “We anticipate some labour issues and we will do our best to take them into confidence.”

Nomura Equity Research, in its Quick Note, on the government’s proposal believes that the prospects of a potential 10% disinvestment in CIL through a secondary offering (OFS) has been an overhang on the stock since the Government of India pegged its FY2014 disinvestment target at Rs40,000 crore in the Union Budget (presented on 28^th February).

It adds that the overhang has been exaggerated in the backdrop of NTPC’s stock price correction between the government announcing its intent to divest stake in the company (November 2012) up to the actual stake sale (February 2013).

Accordingly, relative to expectations, the government’s proposal to disinvest 5% stake via the ‘buyback’ mechanism and only 5% via an OFS is a positive surprise, according to the brokerage.

Nomura states that CIL’s workers’ unions would need to be on board for any move by the government to lower its stake in the company, particularly via an OFS, to materialize. It further states that if the draft proposal is implemented, a buyback would potentially precede the OFS.

“We believe that when there is an OFS around the corner, it would likely be preceded by a ‘hike in price of notified coal’ in order to boost CIL’s operating margin (which is under pressure) and in turn, securing a better offering price, the report by Nomura Equity Research said.

According to the brokerage, a 5% share buyback by CIL at its CMP (Rs310.65 per share) would entail a cash outgo of Rs10,000 crore ($1.8 billion); with other things remaining constant, FY14F/15F normalized EPS (base case) may rise by 3.6%/2.8%.

On normalized earnings (pre-overburden removal EBITDA and PAT, excluding a potential incidence of 26% mining tax), the stock trades at FY14F 9.6x P/E, 5.2x EV/EBITDA. It maintains a ‘BUY’ on the stock.