Investors with a long-term perspective can buy the stock of public sector iron ore mining major NMDC. Improving sales price, increasing volumes, expansion plans, solid financial position and reasonable valuation make the stock an attractive buy. The company offers a high dividend yield of over 5 per cent and there is talk of a special dividend payment or a share buyback.

In the last year, the NMDC stock fell 25 per cent due to concerns over weak volume, slowing demand and lower output prices. At the current price of Rs 136, the stock trades at around nine times its trailing 12-month earnings. This is lower than the levels it has traded in the past (12-16 times) and is also at a steep discount to its global peers, such as Vale, and local peer Sesa Sterlite.

Increasing volume

NMDC is the largest iron ore producer in the country. In FY13, its share of the country’s output increased to 18 per cent from 16 per cent the year ago. This was due to ban on other miners in Karnataka and Goa, which reduced total output. The company has iron ore reserves of around 1,300 million tonnes (MT) in Karnataka and Chhattisgarh. Most of its ore is of high quality.

Following flat volumes of around 27 MT in FY13, NMDC’s output has been growing. In the September quarter, production increased 12 per cent compared to the same period last year. The company has set a target of about 28 MT for FY14. Also, its expansion plans to add two mines — in Bailadila (Chhattisgarh) and in the Bellary-Hospet region (Karnataka) — are nearing completion. Each of these mines will add 7 MT a year.

The new mines and expansion of its existing mines will help raise capacity to 48 MT per year. The company however, faces production risks due to extremist activity in the Chhattisgarh mines. Higher output from Karnataka (10 per cent yearly increase in the first half of FY14), and output from the new mines may help offset any volume disruptions in Chhattisgarh.

Price uptick

NMDC is likely to witness higher prices as demand for its iron ore picks up from both local steel producers and in the export market. Over the years, the company’s sales volume has kept pace with production, even though demand was muted. Local demand, which forms 90 per cent of its sales, is likely to pick up with local steel production estimated to grow around 5 per cent in the next year.

Even with 11 per cent higher sales in the September quarter, total income dropped five per cent year-over-year to around Rs 3,000 crore due to lower prices offsetting volume growth. NMDC’s realisations in the September quarter are down by around 30 per cent for its high grade ore and by around 17 per cent for its low grade ore, compared to last year. In October, the company raised prices of all grades of ore, citing good local demand and rising global prices. There may be more room for price hikes, as NMDC’s high grade ore, priced at around $70 per MT, sells at a steep discount to the global price of around $130 per MT.

Stable finances

The company has a large cash reserve of around Rs 22,500 crore as of September, equal to around Rs 55 per share. The healthy cash surplus has helped NMDC to fund expansions through joint ventures in Australia, Brazil and South Africa. Besides, there are proposals to set up two steel plants and a pellet plant. The company pays high dividends regularly, with a yield of over 5 per cent currently. The dividend payout ratio was around 43 per cent in FY13. For FY14, the company plans to maintain a dividend pay out of over 50 per cent.

NMDC’s net margins stand at over 50 per cent, thanks to high quality iron ore reserves, low production cost and zero debt. However, margins have dropped from around 65 per cent last year due to lower prices and provisioning ten per cent of sale proceeds for local area development in Karnataka.

In the September quarter, net profit dropped 21 per cent Y-o-Y to Rs 1,310 crore, due to lower top line growth and around 45 per cent increase in expenses. Higher volume and better realisations will help increase profits, while margins should remain stable at around 50 to 55 per cent.

(This article was published on November 9, 2013)
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