GMDC - Buy

Low-cost lignite operations, a steady expansion track record and healthy growing captive market in the form of Gujarat make Gujarat Mineral Development Corporation a good bet in the mining space.

The company's enterprise value/EBIDTA value of seven times is lower than that of Coal India and Neyvelli Lignite Corporation. This seems incongruous, given that GMDC has delivered volume and profit growth, which outpaces its larger peers.

The number is on a par with global peers. But with advantages such as exclusive mining rights, low-operating cost and captive market, the company is more likely to deliver on its premium. Despite gaining 29 per cent over the last one year, GMDC's shares at Rs 168 makes for a compelling buy for investors with a long-term horizon.

BUSINESS

GMDC operate in two segments: Mining and power. Lignite and bauxite dominate the mining portfolio in volume terms. Lignite, a form of coal used in power plants, accounted for over 77 per cent of overall sales in 2010-11.

The company sells lignite to Gujarat State Electricity Corporation, Adani Wilmar, Indian Rayon, and so on. GMDC mined and sold over ten million tonnes of lignite in 2010-11. Power generation came in a distant second, accounting for over 17 per cent of revenues. The rest is accounted for by a mix of bauxite, fluorspar and manganese.

The company's trump card is a result of Gujarat state policy to vest exclusive rights in the State for developing lignite, bauxite and manganese with GMDC. This circumvents the rather arduous process of obtaining permits faced by miners in other states. In addition to ramping up output at existing mines, GMDC has also managed to open several lignite mines. That saves considerable time for GMDC which only has to acquire an environmental and mining clearance.

While investors could be sceptical that the company's 785 million tonnes of proven lignite reserves could go the national way of being mired in bureaucracy, there are some encouraging signs for GMDC.

First, 74 per cent of the company is held by the Gujarat State government. So, in this particular case, the State government, which is aggressively pushing for investments, is well incentivised to get lignite mines up and running. Same goes for its sizable reserves of bauxite and limestone, both of which GMDC has.

In addition to its current operations, the company plans to exploit mining reserves through government-mandated minority stakes in value-addition projects.

Projects on the anvil for GMDC include alumina refineries, aluminium smelters and limestone supply for cement outfits.

Second, the company has grown its output at a compounded rate of 6.4 per cent per annum steadily between FY07 and FY11. These along with regular 10-15 per cent price hikes have more than doubled the company's revenues from lignite sales.

STRONG FINANCIALS

Since FY07, GMDC has seen sales and net profits grow at a compounded pace of 24.5 per cent and 41 per cent respectively to Rs 1,415 crore and Rs 375 crore respectively in FY2011.

The company has had a little help from segments such as power generation and bauxite. Increased production and realisations have seen revenues rise by almost four-fold and 12-fold to Rs 234 crore and Rs 63 crore respectively.

More recently, despite rains leading to mine-outages between July and August 2011, the six months ended September 2011 saw the company's net sales and profits rise by 20 and 34 per cent respectively to Rs 711 crore and Rs 216 crore respectively. The company benefitted from price hikes undertaken early in 2011.

The company's operating margins have hovered in the 46-54 per cent range since FY07. The fiscal ended 2011 witnessed operating margins of 46 per cent as the less-profitable power business chipped in with a bigger proportion of sales.

But the support to margins comes in the form of more mining with power generation remaining more or less constant.

Lignite mining is among the most profitable divisions for the company. By end-2014, the company is expected to mine 30 per cent more lignite. This is expected to aid volume growth.

Aiding GMDC's cause in sustaining robust profit and sales growth is the increasing proportion of sales to merchant customers.

They usually pay more for the company's lignite than the regulated yields from Gujarat State Electricity Corporation.

These clients and their growing demand is expected to help GMDC sustain sales and profit growth. The company's debt levels are negligible.

LIGNITE SCORES

The cost of generating power from lignite is lower than the cost of generating power from expensive coal.

This could make lignite the preferred fuel for Gujarat-based industrial producers setting up captive power capacity.

With the current supply-side restrictions on coal supply due to regulatory concerns and infrastructure bottlenecks, coal is neither cheap nor readily available, while lignite for power producers fits the bill.

The risk for GMDC is the enforcement of price controls in the event of higher power prices.

The high exposure to Gujarat poses a concentration risk. While at this point, the State does rank highly on GDP growth parameters, lignite prices will be among the target group in a downturn.

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