Stock Fundamentals

Should you subscribe to NMDC’s offer for sale?

Satya Sontanam BL RESEARCH BUREAU | Updated on July 07, 2021

With the correction in stock price, the arbitrage opportunity is diminished

NMDC recently announced an offer for sale (OFS) where the government is set to offload 7.49 per cent stake in the company. The floor price has been fixed at ₹165 per share, a discount of 5.87 per cent to the closing price as on the date of announcement, July 5. The OFS, which was open for non-retail investors on Tuesday, is open for retail investors today, i.e. July 7, 2021.

The government currently owns 68.29 per cent stake in the company. Its stake will come down to 60.8 per cent if investors subscribe to the entire issue.

However, since the time of the announcement, the stock has been trending lower. At the time of writing this, the stock was trading at close to the offer price. Hence, there is not much of a case now for retail investors to subscribe.

Valuation

At the floor price, the company is valued at 7.8 times its FY21 earnings as against the three-year average of 8.79 times. Even on the basis of forward estimates of earnings (Bloomberg consensus) for the current fiscal, the company trades at 5.8 times over a three-year average of 7.6 times.

Although the current valuations look cheaper compared to its historical average and the decent outlook in the current industry environment, investors with low-risk appetite should be cautious entering the stock at these levels, given risks in case of any downturn in the commodities cycle.

Outlook

The prospects of iron ore industry is directly linked to the prospects of the steel sector.

The long-term prospects of the domestic steel sector seem sound. The Centre’s focus on infrastructure development projects, including metro rail, smart cities, affordable housing, dedicated freight and high-speed rail corridors, is expected to create significant demand for steel in the long run.

In this scenario, NMDC is well placed to cater to the growing requirement of iron ore. The company aims to increase ore output levels from 34 million tonnes per annum (mtpa) in FY21 to 67 mtpa by 2025 and 100 mtpa by 2030, which requires adding more mines by the company. NMDC’s current net debt-free status also positions it well to make investments for expansion.

Having said that, the domestic iron ore market is also likely to become more competitive on account of new players bagging the mining lease rights in the recent auctions (though high premium offered by bidders does put the viability of new merchant players under question). Also, a few domestic steel-makers are acquiring mines through auctions in a bid to integrate backwards. If this fructifies in big way, the pricing power of the company may come down and that may add some pressure on the margins.

Further pressure on margins is likely as company is now required to pay an additional premium of 22.5 per cent on the average sale price of ore from some mines now and all mines from next year. This is in addition to the current statutory levies (including royalty) being already paid at about 19 per cent of the sale price.

As the premium amount is not a pass-through, to offset the rise in cost besides other factors, the company hiked the prices of lumps and fines by ₹2,300 per tonne and ₹2,250 per tonne, respectively, in FY21.

We need to wait and watch whether prices at these levels are sustainable for a long period, since any correction in steel prices would act as a headwind to the iron ore prices as well.

Given the uncertainty on the margins going ahead, which will impact the earnings, entering the stock now may not be a good idea, given the rally witnessed in the stock since the beginning of the year 2021. The offer price is about 62 per cent higher than the price in the beginning of February 2020, just before the market crash.

Published on July 07, 2021

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