Stock Fundamentals

Why you should accumulate the stock of NMDC

Satya Sontanam BL Research Bureau BL Research Bureau | Updated on December 19, 2020

Higher realisations, sanguine prospects and cost-control measures work in favour

In a major relief to NMDC, the Government of India (GoI) earlier this month reached an agreement with Government of Karn nataka and the Ministry of Steel to extend Donimalai iron ore mine lease.

Operations at the Donimalai mines of the company (which contribute about 20 per cent to the company’s iron ore output) were suspended from November 2018, amid a tiff between NMDC and the Karnataka government. The conflict arose as latter had demanded a higher premium (80 per cent of sale value of ore) on renewal of mine lease in 2018. Amid the face-off, the State government cancelled renewal of NMDC’s mine lease in August 2019.

With the Centre’s intervention now, the mining lease has been extended.

However, the question still remains on what would be the premium payable on renewal of mining lease for PSUs (public sector units). NMDC has been currently permitted to commence mining at Donimalai subject to the company paying 22.5 per cent of sale price to the state government. This is in addition to the royalty and other statutory levies that come to about 15 per cent.

However, an actual premium a State or Central PSU should pay on renewal of mines (post 2015) is yet to be announced by the committee formed for this purpose under the chairmanship of the Mines Secretary.

Any decision by the committee that requires the company to pay a premium (as against nil earlier), effective retrospectively (from the date of renewal), will impact earnings of most of the mines of NMDC both in Chhattisgarh and Karnataka. That would likely be a key overhang on the operating profit of the company.

Having said that, strong fundamentals for the iron ore market on the back of better than expected recovery in the steel sector – the user industry, demand visibility, cost control measures are expected to overshadow the negative impact of premium payment to an extent.

In line with the broader market, the stock price of NMDC also went up by about 83 per cent from its low in March 2020. At the current market price, the stock trades at higher 11.5 times its trailing twelve month earnings, as against the three-year average of 8.6 times. Investors with high-risk appetite and with three- to five-year horizon may consider adding the stock on dips. Recovery in demand, healthy margins and good dividend yields should hold the company in good stead. In the last couple of years, the dividend yield of the company stood at 4-6 per cent.

On recovery path

After being severely impacted by the outbreak of Covid-19, the operations of the company saw a rebound in the second quarter of the fiscal. The sales volumes in Q2 FY21stood at 6.6 million tonnes (mt), up 14 per cent y-o-y, supported by robust demand for steel domestically. The production and sales figures announced by NMDC for the month of November 2020 also suggests healthy demand for ore in the market. Despite lower production volumes at NMDC in the first quarter of the fiscal, the management has maintained the volumes target at 32 mt for FY21 (flat y-o-y).

On the realisations front too, NMDC has taken a cumulative hike of ₹2,250 per tonne on lumps (65.5 per cent Fe) since its low in May 2020. Realisations now stand at ₹4,500 per tonne. In addition to the higher demand, supply deficit of ore in the domestic market too has helped realisations to an extent. Global iron ore prices too moved up sharply in this period, from about $80 per tonne in May 2020 to more than $140 per tonne now.

Good prospects

NMDC Ltd, a navratna Central Public Sector Enterprise, has been recording an average annual production of over 32 mt over the last five years. The company contributed to around 18 per cent to domestic production (excluding captive iron ore production). NMDC sells one of the best grade Iron ores globally.

The prospects of iron ore industry is directly linked to the prospects of the steel sector. Around 1.5 tonnes of iron ore is required to produce one tonne of steel.

The long-term prospects of the 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.

To meet the growing requirements of iron ore of the Indian steel sector, NMDC plans to increase the production capacity from existing 43 mt per annum to 67 mt by FY23. While this looks stretched (given the huge capital requirement and the track record of a few PSUs in meeting the deadline), immediate rise in volumes from Donimalai mines, expansion of output in Kumaraswamy mines (in Karnataka) from 7 mt to 10 mt per annum will give a leg-up to the company in the near future.

NMDC recently announced the demerger of its upcoming steel plant in Nagarnar, Chhattisgarh (which is close to commissioning phase) with a capacity of 3 mt per annum.With this, any further capex on the plant, will likely be incurred by the demerged entity and NMDC will remain focused purely on its mining business. Also, NMDC will continue to remain as a supplier to the demerged steel plant on an arm’s-length basis, which will be a positive for the former in terms of demand.

Further, as a part of cost control efforts, the slurry pipeline for the logistics of the ore, which will likely be commissioned in the next two-three years, is expected to bring benefit of ₹300-400 per tonne of ore transport and improve profitability for the company.

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Published on December 19, 2020
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