Morningstar initiated equity-research coverage on Coal India recently with a 3-star current rating on the stock. According to equity analyst Manish Vaswani, Coal India's fair value estimate is around Rs 327, even as the stock trades at a marginally higher price.
We launched our equity-research initiative in November 2011 and will, through this year, rapidly ramp up stock-analysis coverage on widely-owned stocks.
How are we different?
Unlike other research firms that issue research reports with a 'buy', 'sell' or 'hold' rating along with a target price, we take a longer-term approach to investing.
Our analysts evaluate businesses for what they think their fair value should be, which is arrived at by considering various metrics such as return on invested capital, free cash flow, sustainability of competitive advantages among other things. (Read more in this article).
In the "Thesis" section of the Analyst Report, we detail out our case on our view of the company.
Here's an excerpt from the Coal India report: "India's growing energy demand should help sustain Coal India's excess returns in the long term." It further highlights the firm's virtual monopoly in the coal sector in the country, and talks about whether it would be able to meet the challenge of rising demand, especially for better-quality coal, in the face of rising imports in the years ahead.
After that, we sum up what we perceive should be the firm's fair value, after forecasting its estimated revenue growth, profit margins, and capital investment (and all of the numbers that go into them) for each firm we cover.
In the case of Coal India, our analyst estimates its fair value at Rs 327 per share based on production and subsequent sales growth at its subsidiaries as well as growth in sales realization per ton over the next few years.
Then we will detail out various threats that could derail our long-term assumptions for the business in the section called "Risk".
Also, we issue an Economic Moat™ rating for each firm on the scale of None, Narrow and Wide. We believe in Warren Buffet's philosophy that a company's sustainability of its competitive advantages, or "moat", over its competitors is crucial in creating value over the long term. Coal India carries a "Narrow" Economic Moat rating.
Read more about economic moats here and in the Morningstar methodology document.
Each business is different when it comes to the ease or difficulty of ascertaining its fair value--a simple consumer product company may have fairly predictable sales while a commodity producer's revenues may depend on a lot of difficult-to-gauge economic factors. Thus, we assign an "Uncertainty" rating, the scale being: low, medium, high and very high.
Finally, we will assign a "Consider Buy" and "Consider Sell" price, where we think a stock will have become attractive or expensive to be bought or sold.
As in the case of Coal India, a stock trading near our fair value estimate will be a 3-star stock while a deviation in the stock price will see its star rating increase or decrease, with 5 stars being a heavily-discounted stock on our measures while a 1-star stock will be expensive. (Note that a stock's star rating may change either because of a change in its price or because of an update in its fair value estimate.)
The higher a firm's fair value uncertainty, the deeper will the discount to its fair value estimate have to be in order for it to reach "Consider Buy". Read about our approach to fair value uncertainty here.
Here is an FAQ on the Morningstar Rating for Stocks.
Registered Morningstar users (registration is free) can access the Coal India Stock Analyst Report (PDF) here.