IL&FS - Gujarat NRE Coke

Industry update

Limited issue of export licenses by China to drive coke prices upward Coke prices were at its peak in May 2004 due to an export curb by China. During this time, China issued export licenses, which fell short of global demand, leading to an increase in export license cost to as high as US$200 per tonne (a little less than half the prevailing coke prices of about US$450-480 per tonne).

The Chinese government has once again restricted issue of export licenses to 10mn tonne. On the other hand, export potential from China is about 15-16mn tonne. Such a move would in turn lead to deficit of coke in the global market. While there are conflicting views regarding the manner in which the Chinese government may react, speculations are rife about the possibility of the Chinese government issuing licenses to the tune of 14mn tonne in total. This will still lead to a shortfall in export licenses during the end of CY07, resulting in sharp increase in coke prices.

Business Overview

Coking coal mines in Australia to feed company’s coke oven batteries: GNCL has its own captive coking coal mines in Australia and its entire requirement for the same is expected to be met through import from these mines. While Gujarat NRE Australia Ltd. (GNAL) has already started shipping coking coal, GNRN too is expected to commence supply of coking coal soon. Coking coal mined from captive mines will be cheaper by around US$25-30 per tonne leading to tremendous savings in cost for the company. Moreover, GNCL’s reliance on coking coal suppliers for timely delivery of raw material will also reduce, thereby partially reducing the overall risk to the company’s business.

Value unlocking of investments in Australia & New Zealand likely: GNCL has made substantial investments in Australia and New Zealand. Of these, GNAL has mining lease of 300mn tonne and started commercial production in July 2005. So far the company has mined 0.4mn tonne and plans to increase its capacity from 1mn tonne in 2007 to 4mn tonne by 2010. GNCL plans to dilute not more than 5% stake in GNAL in 2007 and list it on the Australian Stock Exchange (ASE). Taking a long-term view of coking coal prices of about US$75- 77 per tonne, GNCL has valued GNAL at A$300mn. GNRN is listed on the ASE and has reserves of 96mn tonne and market capitalisation of A$28mn. The company expects to reach coking coal production of 1.5mn tonne by 2010.

Valuation

We expect GNCL to report net profit of Rs2.04bn during FY08E (EPS of Rs8.4). At the current price, GNCL is trading at a P/E and EV/EBIDTA of 5.9x and 6.2x FY08E respectively. GNCL has cash of Rs700mn in its books as on March 2007. The company’s investment in Gujarat NRE Resources NL (GNRN), the listed entity, at the prevailing market price is worth Rs3.5 per GNCL share. Met coke business is highly volatile in nature. Hence, the risk profile of the company’s business is high. However, the current industry dynamics indicate further firming up of coke prices going forward. With the stock price likely to follow international coke price movements we believe that GNCL provides a good trading opportunity and hence recommend a ‘Buy’.