Stock Call. Why you should hold on to NMDC stock

The Covid-19 outbreak has severely impacted operations at NMDC, one of the largest iron ore mining companies in India.

In Q1FY21, the consolidated revenue and profit of NMDC fell by 40.6 per cent and 54.9 per cent y-o-y to ₹1,937 crore and ₹532 crore, respectively. But the operations rebounded quickly, as evident in the production and sales numbers in August 2020, which stood at 1.62 million tonnes (1.41 mt in August 2019) and 1.79 mt (1.49 mt in August 2019), respectively.

That said, NMDC could see some pain in the near term owing to other events, uncertainty in recovery of demand aside.

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 latter had demanded higher premium (80 per cent of sale value of ore) on renewal of mine lease in 2018.

Now, a committee, under the chairmanship of the Mines Secretary, has been formed to look into how much premium a State or Central PSU should pay on renewal of mines.

A decision is expected in the next three months; NMDC, meanwhile, can restart mine operations at Donimalai by paying a 22.5 per cent premium.

Any decision by the committee that requires the company to pay a premium (as against nil earlier) will be effective retrospectively (likely from the date of renewal) and will adversely impact the company.

Further, the domestic iron ore market is 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.

Needless to say, headwinds to the economic revival and worsening of the pandemic are also key risks which investors should watch out for.

Hence, while a notable fall in stock price this year limits the downside hereon, investors with a three- to five-year horizon can hold on to the stock and wait and watch to see how these events unfold.

At the current price, the stock trades at about eight times its forward one-year estimated earnings, on par with its three-year historical average. Recovery in demand, debt-free status of the company, healthy margins and good dividend yields should hold the company in good stead over the long run.

Good prospects

NMDC, a navratna Central Public Sector Enterprise (CPSE), has been producing about 32 mt over the past five years. In FY20, the company contributed around 18 per cent to the total domestic iron ore production (excluding iron ore produced for captive use) in the country.

The demand for iron ore is directly linked to the performance of the steel sector. Around 1.5 tonnes of iron ore is required to produce one tonne of steel.

As per the estimates of the World Steel Association (WSA), steel demand in India is expected to fall by 18 per cent y-o-y in 2020, but recovery is expected to be robust at 15 per cent in 2021 (though on a low base).

While the outlook for steel in the near-term looks subdued, the long-run prospects seem sound.

The Centre’s focus on infrastructure development projects, including smart cities, affordable housing, dedicated freight and high-speed rail corridors, is expected to create significant demand for steel in the long run. Further, thrust on using domestically manufactured iron and steel products in government procurements will be a positive for the steel sector.

With per-capita steel consumption in India at much lower levels and the National Steel Policy’s objective of producing 300 mt by 2030, the metal’s demand is set to rise in the long term.

Also, an increase in demand for high-grade ore worldwide, considering environmental concerns, is expected to benefit NMDC as the company produces one of the best grades of ore.

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.

The plan includes expansion of existing mines and developing greenfield mines in partnership with the Chhattisgarh Mineral Development Corporation.

NMDC, with its net-debt free status, will be well-placed to fund the greenfield projects, through debt if need be.

On the realisations front, NMDC generally revises the price for its output periodically, based on global prices and demand-supply in India. It has been able to pass on costs to customers, aiding operating profit margin, which has been 50-60 per cent in the last few years.

In a recent favourable development, NMDC announced demerger of its upcoming steel plant in Nagarnar, Chhattisgarh (which is close to commission phase) with a capacity of 3 mt per annum, and form a separate entity. The expenditure incurred on the construction of the steel plant has been ₹16,994 crore (till March 2020), while the total approved project cost was ₹23,140 crore. Any further capex for the plant will likely be incurred by the new demerged entity. The demerger move is expected to unlock the value at NMDC as the cash flows of the company will be focussed purely on its mining business.

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