NMDC: Pricey ore

Shares of metal and mining companies are on a strong wicket since early this year, buoyed by rising commodity prices globally.

Iron ore prices, for instance, increased from a low of $47 a tonne to $58 a tonne currently. This has helped the share price of State-owned iron ore major NMDC — it is up from about ₹80 to ₹118 since January.

The stock price gain was also helped by a buyback of 80 crore shares of NMDC at ₹94 a share to bring Government holding in the company to under 75 per cent.

The company also reported robust iron ore production and sale numbers in the first half of 2016-17. Ore prices were also increased — lump by 23 per cent to ₹2,100 a tonne and fines by 20 per cent to ₹1,760 a tonne in October. Investors also enjoyed a dividend of ₹11 a share in 2015-16 — a high dividend yield of 9.3 per cent at current share price levels. However, after the run-up, NMDC’s share trades at a multiple of 17 times its trailing 12-month earnings.

This is much higher than the average multiple of 10 times it had traded over the past three years. The stock price seems to have factored in the higher ore prices and production levels.

Also, tepid price outlook, higher supply expectations and uncertain demand may limit revenue and profit growth. Also, there is likely to be an offer-for-sale early next year, which may also limit the share price increase in the near term. Given these concerns, investors can sell the stock at current levels.

Iron ore prices, which traded at $150 a tonne levels in early 2013, have been on a downtrend, touching a low of under $50 in early 2016. Prices have recovered since early this year, but this may be short-lived.

The price jump was due to a short-term jump in demand from China, which may have been due to speculative commodity trading. The Australian Government expects that ore prices will moderate over the rest of 2016 and trade at $44 a tonne in 2017, down from its $55 a tonne prediction last year.

Lower price expectations are due to a few factors. One, supply is expected to be strong as miners such as BHP Billiton, Rio Tinto and Vale continue to maintain or increase production.

Two, Chinese demand is expected to decline for the second consecutive year. Imports are likely to fall to 920 million tonnes (mt) in 2016, from 953 mt in 2015, according to China Iron & Steel Association. China may also boost local iron ore production, adding pressure on price.

NMDC’s realisations may also be impacted by local issues.

In April 2016, the company cut the price of its high-grade ore by 10 per cent and lower grade ore by 12 per cent. Prices of higher grade ore were further reduced by 5.5 per cent in June 2016. While prices were increased in October, how well the company can sustain sales at these levels remains to be seen.

Analysis by ICRA shows that inventory levels are high and production is increasing, denting local iron ore prices. Ore production increased 23 per cent in 2015-16, as more mines resumed production after bans were lifted. In 2016-17, ore output is expected to increase to 170 mt, up from 155 mt last year.

NMDC’s iron output which stood at 28 mt in 2015-16 is also set to increase; it targets 35 mt in 2016-17. Total production is set to increase to 50 mt by 2018-19.

World Steel Association predicts demand in India will grow by 5.4 per cent annually in both 2016 and 2017. While this is robust, it may not be adequate to absorb supplies of iron ore.

The company’s cash surplus of around ₹14,800 crore as of March 2016 may also reduce substantially. The company is buying back shares for an estimated outflow of ₹7,520 crore.

NMDC is also setting up a 3 mt capacity steel plant in Chhattisgarh at an investment of ₹15,000 crore. The project has been facing delays due to issues in signing up a strategic partner. Lower cash holding may affect dividend payout in the future.

In the June quarter of 2016-17, NMDC’s revenue fell 5 per cent to ₹2,066 crore while profit sank 30 per cent to ₹711 crore.

In 2015-16, revenue slipped 47 per cent year-on-year to ₹6,454 crore; profit fell 53 per cent to ₹2,932 crore.

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