Weak outlook emerges for NMDC as strong steel cycle appears to have peaked

Most analysts have a hold rating on the stock of India's largest iron ore mining company

Like other metals companies, India’s largest iron ore miner NMDC delivered good results in Q2FY22. However, profitability dipped sequentially, and expenses, such as royalty payments, soared. There is a question mark going forward about the sustainability of profit margins, since the strong steel cycle appears to have peaked, and corrected substantially in Q3FY22.

NMDC generated consolidated revenues from operations of Rs 6,793 crore in Q2FY22, which was 204 per cent rise YoY over Rs 2,229 crore in Q2FY21 and 4 per cent higher QoQ over Rs 6,512 crore in Q1FY22. It had an EBITDA of Rs 3,188 crore, which was 190 per cent higher YoY over Rs 1,098 crore and down 26 per cent QoQ versus Rs 4,313 crore. Net debt is negligible with a debt: equity ratio of 0.03 and the balance sheet saw further deleveraging of about Rs 1,000 crore in H1FY22.

One key rise in QoQ expense was royalty payments having climbed to Rs 2,761 crore, versus Rs 2,015 crore in Q1FY22. NMDC derives roughly 98-99 per cent of revenues from iron ore sales. In physical terms, ore production in Q2 reached 8.8 million tonnes (MT) versus 8.9 MT in Q1; and sales in Q2 were at 8.9 MT versus sales at 9.57 MT in Q1.

Iron ore prices have fallen drastically only in the past three months. The lower profitability of Q2 versus Q1 is explained by the rising royalty payments, and by rising other expenses rather than falling realisations per tonne. However, the domestic price of lump ore has dropped by 15 per cent between September 2021 and November 30, 2021. The price of fines has dropped by 12 per cent in the same period.

Internationally, iron ore prices have declined 30 per cent in the calendar year and they have declined 55 per cent from peak values in May – June 2021. The cooling off in China coupled to the fear of defaults from large real estate developers has led to a drop in demand for construction materials like steel. The rising trend of Covid cases in Europe (and Africa) has also led to the downgrade of global growth prospects. As a result, India may face competition from cheap imports from China and Korea, which have already reached import parity adjusted for customs tariffs.

NMDC is setting up a 3 MT per annum steel plant in Nagarnar, Chhattisgarh and it is planned to demerge this when it’s commissioned, setting it up as a separate company. That would be quick monetisation but there are labour agitations around the issue that could potentially hold up a demerger. The estimated cost of the plant is Rs 23,140 crore and the government's stake in NMDC is around 60.8 per cent, post the sale of a small stake in July 2021. Enhanced steel capacity could enable NMDC to move up the value chain, improving realisations.

If the iron-steel cycle is normalising, or correcting after a big bull run, margins may stagnate or fall for the company. However, domestic demand could improve, given an acceleration in construction activity. Royalty revisions under the MMDR also imply 22-23 per cent increase in ad-valorem payments in future.

The stock has traded in a band between Rs 135-Rs 155 for the past three months. It’s up 37 per cent in the last 12 months. Most analysts have Hold recommendations but for example, the ICICI Securities' target price of Rs 150 implies no appreciation from current levels.