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India Metals & Mining New Draft Mining Act: In the Right Direction, Practicability Remains a Question Mark
Our stance remains positive on the Indian metals and
mining sector since these proposals, if implemented
properly, could boost the pace of projects in India even
though they may shrink the profits of mining divisions of
various companies.
What's new: As we come closer to the likely
presentation of the draft MMDR (Mines and Minerals
Development and Regulation, 2010) bill in the coming
winter session of the parliament, we attempt to analyze
some of the more pertinent proposals of the bill.
The profit sharing proposal is a noble and forward
looking move but looks difficult to implement in its
current form: The new law may mandate companies to
share 26% of their PAT from mining operations with the
local communities. Of our coverage universe, Sesa Goa
NMDC and Sterlite could feel the biggest negative
impact; we believe Hindalco and Tata would feel the
least impact in the short term.
Our expectation on some of the grey areas: While
there is still some lack of clarity in industry circles
regarding the nuances and mode of implementation we
expect (1) Only mining operations will need to share
their profits and not the downstream operations, (2) Due
to practical considerations, later on, the pay out may be
linked only to royalty payment instead of the current
proposal to link it to either royalty or PAT, (3) Even long
running mines where R&R issues have been settled
properly, and long ago, may have to bear the burden,
(4) Companies like NMDC should be able to pass on the
impact in part, while companies like Hindalco, Tata,
SAIL etc with high value addition may have only nominal
impact in the medium term,(5) Some mining projects
may be fast tracked post implementation of these
proposals and so NPV impact should be minimal for the
sector. Currently the new proposals are not in our base
case scenario.proposal
• If the idea is to share mining profits with local
communities (and more specifically the displaced
people) then the profit sharing needs to be more
focused in our view. In its current form the pay out has
to be made to the district mining foundation. In this
case the displaced people for a particular mine will, in
effect, be forced to share their compensation with the
entire district’s population. Further, the spending of
this money will be at the discretion of the district
collector, which means that the actual displaced
people may not get the entire benefit.
• Linking this payout to PAT is good as a concept as it
seeks to make the displaced people partners in the
profit of the mines. This also in a way is taking into
account the ability of the mining company to share the
gains as it is linked to net profit. However, since this is
also taking into account the operational costs various
companies in the same area may have to shell out
different pay out , for reasons of scale etc which may
not sound logical. Also, industry demand for making
this pay out tax deductible looks plausible to us.
Hence, we feel that, later on, this will be linked only to
royalty payment.
• For vertically-integrated companies having captive
mines, the determination of mining profits may be a
debatable and subjective exercise. We feel this is one
of the most contentious issues in the implementation
of the proposed bill. Already some are of the view that
to improve practicability of the newly proposed law,
captive mines of downstream companies may be
required to be put under separate companies though
we feel this is an unlikely scenario.
• For mines that have been in operation for more than
10-15 years and for which the displaced people have
been properly compensated, there may be a debate
as to who should be the beneficiaries in case the profit
sharing is to be implemented for these mines too.
• Companies that already undertake meaningful
expenditure on CSR activity may demand that this
proposed pay out be adjusted against that
expenditure.
• We do not think that profit sharing will hinder the
growth and development of mining industry though we
do feel this will discourage smaller and non serious
players from moving into the space.
Impact of the new proposals
• Effectively a mining company’s tax rate will
become 50% post implementation of these
proposals in the current form. Given the high
return ratios and margins from mining companies
on one hand and the growing land acquisition
issues on the other we feel that companies
seeking to start new mines will increasingly need
to share the benefits from the mineral wealth with
the displaced people.
• This will prompt companies to think of mining as a
part of metal chain and so the trend of captive
mining will pick up further.
• Interestingly if this move leads to a reduction of
1.75 years in project gestation (from 4 years to
2.25 years in our rough industry model) the
negative impact on equity valuation for a typical
iron ore project becomes zero per our DCF based
model.
Possible impact by company:
Sesa Goa - Sesa's coke and pig iron business (about 3% of
PAT) should be exempt from this tax.
NMDC - Since NMDC's pricing is based on a net basis (all tax,
levies etc have to be borne by customers) and given that its
prices are lower than comparable import parity prices it may be
able to pass on some portion of the PAT impact. Assuming a
pass through of 40% to 60%, we estimate NMDC's PAT impact
would be 10% to 15%.
Sterlite - We are only taking the impact from the profit sharing
by zinc mining operations where a substantial portion of the
profit comes from mining. Sterlite's mining operations are
relatively small for aluminum business.
Hindalco - Bauxite forms a very small part of the aluminum
value chain and Hindalco's coal self sufficiency for its power
generation is small. Also Indian operations form only about
40% of Hindalco's profits.
Nalco - Even though bauxite does not form a large part of
aluminum value chain for Nalco's PAT, the impact is relatively
on the higher side since (a) about 30% of Nalco's PAT comes
from alumina sales where bauxite forms a substantial chunk of
the profits, and (b) Nalco's bauxite costs are very low
SAIL - Iron ore forms a relatively small part in the steel value
chain in India
Tata Steel - (a) Iron ore forms a relatively small part in the steel
value chain in India. (a) Indian operations are 65% of
consolidated profits
JSPL - Though JSPL's iron ore mining costs are on the higher
side it also sells about 1.5 mt ore in the market where
profitability is quite high. Its 1,000 MW power plant and the
captive power plant have full coal self sufficiency. Assuming
JSPL is able to pass on 15% to 25% of the iron ore impact and
40-50% of coal impact (JSPL sells a large portion of its power
in the merchant market) the PAT impact should be 4.5% to
5.5%.
JSW - JSW has just about 15% self sufficiency from Indian
mines. However if one assumes that NMDC passes on some of
its PAT impact then JSW's impact should be about 4%
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