Multiple tailwinds in NMDC point to major upside, mine-lease premium weighs

Favourable demand-supply situation pushing up ore prices, value unlocking through demerger, high dividends and cheap valuations are key positives

The public-sector unit, NMDC is a potential beneficiary of the supply chain disruption in global commodity markets. Ukraine and Russia are both major players in iron and steel and iron ore exports, and the war has led to that supply – about 10 per cent of iron and steel exports – being cut off. As one of India’s largest players in iron ore, NMDC has been able to hike prices for the third time since January 2022. Although ore prices may taper in 2022-23, the uncertainties of the conflict and sanctions makes timelines difficult to predict. As of now through the medium-term prices remain firm and NMDC’s prices are still substantially lower – around 40 per cent less than international prices.

NMDC is also looking at value addition, since its steel plant should be commissioned soon. The demerger of its subsidiary the Nagarnar Iron and Steel Company could also lead to a jump in valuations but that will have to wait on news-flow. This demerger would split the company into the mining entity and the steel producer. The demerger would require an issuance of shares to NMDC shareholders in the new steel plant.

Analysts estimate that NMDC will produce around 41 million tonnes (MT) of ore in 2021-22, which would be a record – the highest in the last decade was 35 MT in 2017-18.  Blended realisations this year would be around Rs 6,680 per tonne, compared to Rs 4,663 per tonne in 2020-21. Operating expenses are estimated to be around Rs 3,230 per tonne with EBITDA per tonne of around Rs 3,450 versus Rs 2,670 for the prior fiscal. Volumes are likely to grow at around 5 per cent in 2022-23. The EBITDA margin is around 39 per cent with a ROCE (return on capital employed) of 20 per cent. NMDC has practically zero debt.

The company is a consistent, heavy dividend payer, with a likely double-digit yield this fiscal. It has paid Rs 14.75 as interim dividend. It is conservatively valued, with a PE of around 5 whereas its global peers (Rio Tinto, BHP Billiton) are generally valued at the range of PE 11-15. It also has an EV/EBITDA ratio of below 5, which is lower than its average valuation of around 7.

The management guidance is that the steel plant demerger will take place by March-April 2022 and subsequent listing on stock exchanges will take another 2-3 months post demerger. The demerger would see transfer of the steel plant’s debt to the new entity, NSL and thus improve return ratios. The CWIP (capital works in progress) of the 3 MT per annum plant is around Rs 19,000 crore (total capex of around Rs 21,500 crore expected) so there’s significant value-unlocking in this split.

The downside risks could include a sharp correction in iron ore price, or higher royalty premium of 22.5 per cent for mine-lease renewals could adversely impact earnings. Note that the margins were impacted through the first three quarters of 2021-22 due to the royalty hike. If the demerger and listing is delayed, it would also disappoint investors who are expecting the valuation-unlock.

Various analysts have target prices of Rs 200-215, which implies a potential gain of roughly 35-40 per cent from the current market price. The stock has traded flat for the last month and gained 17 per cent in the last year.