Recommendations » India

NMDC company update

Contributed by Angel Broking

3QFY2013 results disappointed; price cuts implemented to improve volumes: NMDC’s 3QFY2013 sales volumes were below our and street expectations. Lower volumes during 3QFY2013 are attributable to lower demand for NMDC’s customers’ products. While sponge iron and domestic steel prices declined during 3QFY2013, NMDC did not take price cuts, as global iron ore prices had increased ~50% during August-December 2012. Hence, higher ore prices resulted in lower demand, especially for lumps, from secondary steel producers. NMDC, as a result, announced two price cuts – ie a 6% cut followed by a 2.2% cut during 4QFY2013, while it retained prices of fines – a move that would restore its volume growth in our view.

Monetization of steel plant could re-rate the stock: NMDC is planning to build an integrated 3mn tonne steel plant in Jagdalpur, Chhattisgarh with a capex of Rs.15,525cr (funded with internal accruals). However, we expect the project to be value dilutive as as steel smelting margins are expected to remain low going forward. Also, funding the steel project with higher debt and lower equity would have made for an optimal capital structure to fund the project, in our opinion.

Nevertheless, recent media reports suggest that NMDC now aims to monetize the steel plant via a 50% stake sale to draw Rs.8,000cr - Rs.10,000cr. Given NMDC’s inexperience in setting up a steel plant, it is aiming to partner a company that has technology capabilities in producing high-end steel products such as CRGO, CRNO and auto-grade steels, which are mostly imported in India. We believe that the stock could get re-rated in case the sale goes through, as it will partially take away the overhang of inefficient use of cash.

Outlook and valuation: Over the past five years, NMDC has traded at an average EV/EBITDA of 11.0x (mainly due to low liquidity), compared to its upper band price valuation of 3.5x FY2015E EV/EBITDA. A strong balance sheet, presence in sellers market (iron ore), low cost of production, high-grade mines and long mine life make NMDC an attractive bet in our view. Valuing the stock at 5.0x FY2015E EV/EBITDA, we derive a target price of Rs.178 and recommend Buy on the stock.