After being in the news for more than two years, NMDC’s demerger of its steel business (NMDC Steel) is now in its last stage, with October 28 as the record date for the demerger. NMDC shareholders will receive one share of NMDC Steel for every share ofNMDC held as on the record date.
NMDC set up NMDC Steel as a subsidiary in January 2015 to integrate and diversify from volatile iron ore prices. The steel plant located in Nagarnar, Chhattisgarh, with a planned capacity of 3 million tonnes (MT), is yet to be commissioned after seven years, and its management is hopeful of producing Hot Rolled Coil steel by March 2023. Post demerger, the promoter (GoI) plans to operate and invite investors for the steel plant.
Sum of the parts
The demerger has allowed for the initial estimates of value unlocking to be discovered in NMDC’s share price today, as the stock is trading, excluding the value of the steel business. Only shareholders who bought NMDC until October 26 will receive NMDC steel shares, as their names will reflect in the list of shareholders as of the record date (October 28). NMDC stock has opened today at ₹93.7, a 28 per cent discount to Tuesday’s closing price of ₹130.75. When taking this to print, the stock price has moved to around ₹100, and the discount improved to 23 per cent. Theoretically, the discount could have been as high as 40 per cent going by the book value of NMDC steel of around ₹20,000 crore and the comparable valuation assigned to it. But this discount has been offset by prospects of unencumbered NMDC that will now operate without the losses associated with commercialising the steel plant or servicing the associated debt. Thus, the demerger is a case where the sum of parts is bigger than the whole, and this value can be realised by separating the two businesses
NMDC has invested ₹20,420 crore till May 2022 against an expected ₹22,000 crore for the steel plant compared to the market cap of ₹38,320 crore of NMDC (based on Tuesday’s closing). The last leg of commercialisation expenses and milestone-related payments would account for the difference of ₹2,000 crore, to be funded by internal accruals, credit line and debt. NMDC Steel may have a book value of around ₹20,000 crore and a debt of ₹1,700 crore at the time of listing.
In the middle of the steel cycle and with peers largely de-leveraged and still in expansion mode to increase steel capacity, the valuation of NMDC Steel will be weighed against its greenfield status and a PSU label (60.8 per cent stake will be held by GoI). SAIL, another PSU in steel production with 20 MT steel capacity, is trading at 0.6 times its book value compared to its lowest of 0.2 times traded in FY20. This range is a 50 per cent discount to the other three producers (Tata Steel, JSW Steel and Jindal Steel and Power). This implies that on a theoretical basis, demerging NMDC Steel should strip anywhere between ₹13 per share (0.2 times NMDC Steel’s book value) to ₹51 per share (0.75 times). In recent transactions, Tata Steel made a brownfield acquisition of Neelanchal Ispat with 1 MT capacity for ₹12,000 crore, and other transactions have averaged around ₹8,000 crore per MT. But these were functioning steel plants compared to NMDC, which is on the verge of commercialisation.
NMDC stock was trading at 7.4 times FY23 earnings on Tuesday’s closing price of ₹130.75, which is in line with its last five-year average. The valuation is much cheaper after today’s decline at around 5.75 times. NMDC can gain an improved outlook post the event, which currently supports the stock price. NMDC is pursuing volume- driven growth. This will be supported by capital budgeting and management bandwidth that is unburdened with the commercialisation of the steel plant. The dividend yield is another support to the stock of NMDC. Despite currently lower iron ore prices following export duties on steel products and ore, NMDC sustained a high dividend yield in FY22 (around 14 per cent based on the current price). Expectations of a similar dividend amount (which can improve after the demerger) are likely to provide valuation support for the stock price as well.