High quality iron ore reserves, low cost of production and zero debt give it an edge over peers.

Investors with a long-term perspective can buy the stock of public sector iron ore mining major NMDC. Attractive valuation, the company’s shift to a new pricing mechanism which improves its pricing power, big-ticket expansion plans in iron ore and steel, and a solid financial position support the recommendation.

Regulatory uncertainties, concerns over weak volumes, low price for its output and a difficult economic environment took a toll on the stock over the past year.

More pricing muscle

Despite some recent gains, the NMDC stock is down almost 30 per cent since last October and its current price of Rs 181 trades at around 10 times its trailing 12-month earnings.

This is lower than the levels it has traded at in the past (13-16 times), and is also at a discount to some of its global peers.

NMDC’s high quality iron ore reserves, low cost of production and zero debt give it an edge and help it post superior margins (around 65 per cent at the net level) compared to domestic peers such as Sesa Goa and global peers such as Vale and BHP Billiton.

This, despite realisations for the company’s output being at a significant discount to global prices. Earlier this fiscal, NMDC, which derives the bulk of its revenues from the domestic market, shifted to a new pricing mechanism.

From the earlier ‘netback’ system based on export parity prices, the company has linked the price for its output to domestic demand-supply dynamics.

This has enabled it to maintain and even increase prices in recent months even while global iron ore prices fell sharply due to concerns about slowing growth in China and other major economies.

Mining restrictions benefit

NMDC, which has its major iron ore mines in Chhattisgarh and Karnataka, has also been a beneficiary of the mining restrictions imposed in Karnataka last year.

The company, which is not subject to these restrictions, significantly improved its output from the Southern state to cater to increased demand from steel players. In the March quarter though, extremist-inflicted damage to its slurry pipeline in Chhattisgarh, and a reduction in prices dented the company’s sales and profit.

With repairs undertaken and prices also firming up, the company’s performance should receive a boost. Over the past four years, NMDC has grown sales at an annual average of 18.5 per cent to Rs 11,261 crore in FY-12.

In the same period, the company’s profits grew at 22.3 per cent annually to Rs 7,265 crore. In FY-12, the company’s iron ore production grew by 7 per cent to 27.26 million tonnes.

Expansion plans

In the long term, NMDC seems likely to retain its position as the country’s premier iron ore producer. The company plans to expand its production from around 27 mtpa to 50 mtpa over the next four to five years. It should not have trouble finding a market for its wares, considering the massive expansion being planned by steel majors in the country.

NMDC itself is setting up on a 3 mtpa steel plant in Chhattisgarh and has plans to build another 3 mtpa steel plant in Karnataka in partnership with Severstal of Russia. It also plans to set up a 1.2 mtpa pellet plant in Karnataka.

The company is also increasing its overseas presence having acquired 50 per cent stake in Legacy Iron Ore last year.

Reports indicate that it may soon pick 26 per cent stake in Brazilian iron ore company Amplus. Funding the expansion plans should not be a constraint, given NMDC’s cash reserves of more than Rs 20,000 crore and zero debt status.

Risks and concerns

In the near-term, the NMDC stock may be under pressure given the government’s reported plans to sell stake in the company as part of its disinvestment programme. But this concern is mitigated to some extent by the offer-for-sale auction route likely to be adopted by the government to dilute its holding. This route of stake sale should contain declines in the stock price.

The ongoing economic uncertainty, if it intensifies, could mean reduced demand and realisation for the company’s products. But over the long-run, NMDC seems poised to benefit from improvement in market conditions and expansion in market size.

A likely relaxation by the Supreme Court on mining restrictions may improve iron-ore supply conditions and dilute some of the advantage enjoyed by NMDC over the last year.

The proposed mining bill, when passed, will increase NMDC’s cost bill by an amount equal to its royalty cost. But, given the company’s competitive pricing compared to the cost of imported iron ore, NMDC may have enough room to raise prices to offset the cost increase.

Extremist related disruption in production in Chattisgarh remains a risk.

(This article was published on August 11, 2012)
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