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MOIL Ltd
Initiation ;Overweight ;MOIL.BO, MOIL IN
Steely driver
• Low cost + large reserves = continued strong margins: initiate with
OW, Mar-12 PT of Rs490 based on 6x FY12E EV/EBITDA. MOIL is
among the few pure play Mn ore producers globally with a large high-grade
reserve base of 22MT (16% of India’s reserves) and average mine life of
~20years. Its cost of production of $65/MT in FY10 was at the lower end of
the global cost curve and should remain stable as MOIL is shielded from
increases in transport costs and royalties/duties as these are borne by the
end-customers. Despite the current subdued pricing environment (MOIL cut
prices by ~10% during 3Q and 4QFY11), we expect stable costs to help the
company maintain EBITDA margins above historical levels (65+%).
• Chinese steel demand is a key driver of prices: MOIL produces purely
for the Indian domestic market, but Chinese demand for Mn ore is a key
driver of Indian Mn prices. While China is the largest producer of Mn ore, it
is mostly low-grade and therefore China remains a net importer of the
commodity. Prices for Mn ore, a key driver of MOIL’s profitability, have
seen a step change over the last few years, driven by the spike in Chinese
steel production. J.P. Morgan’s China steel analyst expects China steel
production to grow at ~5% over FY12-13E versus the 1% y/y growth in
2H10. We believe that Mn ore prices have stabilized and expect an ASP for
MOIL of between Rs10-11K/MT over the medium term.
• High cash levels and strong FCF: MOIL has a strong balance sheet with
no debt (Dec-10 net cash stands at Rs18bn) and generates robust cash flow.
This should support the company’s capex plan of Rs7.7bn over the next 3-4
years to increase production to at least 1.5MT by FY15. MOIL is also
augmenting its ferro-alloy capacity by investing Rs1.5bn in its JVs. We
expect FCF generation to remain strong at $130-140MM per year over
FY11-13E.
• Valuations, price target, key risks: Our target EV/EBITDA multiple
represents a 20% premium to current global mining peer valuations (those
with Mn ore exposure), a target supported in our view by its low cost of
production, robust balance sheet and domestic market focus. Key risks to our
rating are slowdown in China steel demand and subsequent impact on Mn
ore prices and potential changes in the mining law in India.
Investment summary
MOIL is not only the largest producer of Mn ore in the country (5th largest globally)
accounting for 50% of total production volume, it is also among the lowest cost
producers of Mn ore in the world according to the company ($65/MT in FY10).
MOIL has reserves of 22MT (accounting for 16% of India's manganese reserves)
with the average mine life of reserves at ~20 years (based on current production).
The company plans to augments its reserves base by ~3-4MT in FY12E. The
reserves of the company have an average Mn grade of 37% with some mines having
Mn content of ~40-42%.
Mn ore prices are also dependent on demand from ferro-alloy and therefore, steel
production. Similar to other bulk commodities, Chinese demand is critical for
Mn ore prices as the country is a producer of low-grade ore and remains short
on Mn ore. As per our China steel analyst, Chinese steel production growth is
expected to slow to ~5% over 2011-2012 (vs. 10.6% in 2010) leading to continued
demand for imported Mn ore. The muted steel production in China in 2H10 (1% y/y
growth) led to global Mn ore prices correcting by 19% over the last 2 quarters
(MOIL cut prices by ~10% in 3Q and 4Q). However, the Mn ore prices have
stabilized since Nov-10 and we expect MOIL’s Mn ore realization to remain in the
current range of Rs10-11K/MT. We believe that the low cost of production for the
company will allow it to maintain EBITDA margin levels above 65+% even at the
current subdued Mn ore price levels.
Mn ore is a raw material in the production of ferro-alloys and therefore, steel
production. Hence, a key driver for Mn ore remains the expected growth in steel
production. MOIL’s business is focused only on the growing steel industry in India
with no exposure to the export markets, therefore, domestic steel production is a key
driver for the company’s business. The planned capacity addition by steel players
over the next 2-3 years will support demand for ferro-alloys and hence Mn ore in the
country. As per the Ministry of Steel, India should achieve a total installed capacity
of 121 million tonnes by FY12 (from ~73MT currently) and further to 200 million
tonnes by 2020. We expect steel production in India to remain strong over the next
few years driven by consumption growth of 8-9% over FY12-13.
A key risk for the stock is a sharp slowdown in Chinese steel production impacting
ferro-alloy and Mn ore prices, potential changes in the mining law in India and
limited levers of volume growth in a growing steel environment.
Investment Positives
Pure play producer with a strong resource base
MOIL has a strong manganese (Mn) ore resources base in India of 61.7MT (16% of
India’s total Mn ore resources) in the 10 mines under operation in the Central India
mineral belt (MP & Mah.). MOIL’s current reserves at 22MT account for nearly 16%
of India's Mn reserves and the company plans to augment its reserves base by ~3-
4MT in FY12E. Based on the current production rate, the average mine life of
MOIL’s reserves is ~20 years. The strong resource base makes the company the
largest and only pure play manganese ore producer in India accounting for
50% of the country’s production. The total leasehold area of the resources
allocated to the company is nearly 1,800 hectares, which in our view, provides
opportunity for reserve addition through exploration. Further, area of 814.7 hectare
has been reserved by the government for MOIL and the company has applied for
prospecting license for the same.
MOIL’s reserves, in our view, remain of high quality with ~55% of proved and
probable reserves with an average Mn content of 40% (remaining are mostly
medium-grade). The company’s Balaghat mine (resources of 9MT) has reserves with
an average grade of 40%, which we consider as high grade ore. The Dongri Buzurg
mine (resources of 3MT) also has an average grade of 42% Mn content. The other
mines with relatively good grade Mn reserves are the Kandri mine and the Ukwa
mine. These mines accounted for 64% of MOIL’s production in FY10.
Domestic steel production remains key to Mn ore demand
Demand and therefore price for manganese ore is directly dependent on the
production of steel (accounts for ~90% of Mn demand globally). Mn ore is used as
an input for the production of ferro alloys, which in turn are used for steel
production.
MOIL’s business is focused only on the growing steel industry in India with no
exposure to the export markets, therefore, domestic steel production is the key
driver for the company’s business. We remain bullish on the multi-year demand
scenario of steel consumption in the country with apparent consumption growth of
8+% over the next few years, which should result in continued strong ferro-alloy
demand and thus Mn ore demand. The strong growth in steel production will be
supported by the government spending on infrastructure, auto sector demand, and
increasing consumption of consumer durables. While Mn ore realizations are driven
mostly by Chinese steel demand, the volume growth for the company could be
impacted by any slowdown in steel demand in India. We would therefore keep a
close eye on the recent slowdown in on-ground demand for steel and sign of recovery
in the domestic market.
The planned capacity addition by steel players over the next 2-3 years will support
the demand for ferro alloys and hence Mn ore in India. As per the Ministry of Steel,
India will achieve a total installed capacity of 121 million tonne by FY12 (from
~73MT currently) and increase it further to 200 million tonne by 2020. The domestic
market focus of MOIL therefore positions it favorably for the strong consumption
trends in steel in India, in our view. Moreover, MOIL’s domestic sales are likely to
be more profitable as the customer pays for the royalty and the transportation cost to
the plant.
Mn ore price – another China story
Mn ore prices, which is the key driver for profitability for MOIL, has seen a step
increase over the last few years, driven by the sharp spike in Chinese steel
production. China’s domestic Mn ore production tends to be of lower grade, and thus
while China is a large producer of the intermediary (ferro-alloys), it remains a net
importer of manganese ore and also the largest consumer of the ore. Chinese steel
production is a key catalyst for ferro-alloy, and therefore for Mn ore prices. The
impact of Chinese demand is evident in the prices of Mn ore last year when prices
recovered during the 1H 2010 (up ~35% from Jan-Jul-10) with increasing steel
production from the country’s stimulus package. However, with the power restricting
impacting steel production in the 2H of the year, prices for Mn ore have declined
~19% since Aug-10. MOIL has cut quarterly contract prices in 3Q and 4QFY11 (by
~10% over the period) given the weakness in global Mn ore prices. Our Chinese steel
analyst expects China steel production to increase by ~5% over the next two years
after 1% growth in 2H 2010.
Low cost producer
MOIL is one of the lowest cost producers of manganese ore in the world, according
to the company, with an average cost of production of $65/MT in FY10. A key
reason for the lower cost is the statutory levies (royalty & cess) and transportation
costs (domestic sales are on "free on truck" or "free on rail" basis), which are borne
by the customers. The company’s mines are located in the Central region of the
country giving it a competitive advantage. The mine location gives MOIL a
marketing advantage with its accessibility to steel and ferro-alloy manufacturing
customers located in the nearby regions (Orissa, Chhattisgarh, Jharkand).
Employee cost remains a key cost component for the company accounting for ~50%
of the total cost of mining of Mn ore. MOIL has a current employee base of 6700
people and according to the company this is expected to decline modestly to ~6500
employees over the next few years as the company takes up mechanization of its
existing mines. The company revised its wages for all employees (except executive
employees) in Aug-09 effective for a period of ten years from Aug-07 (next wage
revision due in Aug-2017). However, the DA component of employee costs is
expected to increase given the higher inflation. We are estimating employee cost/MT
to increase ~5% over the next few years.
Focusing on value addition
MOIL has also diversified into the production of value added products such as ferromanganese and electrolytic manganese dioxide (processing capacity of 900kt). These
segments are still a small portion of the company’s sales mix (4.8% of sales and
3.3% of EBITDA in FY10). MOIL's has undertaken expansion of its ferromanganese capacity (by 55kt) and will also add silico-manganese capacity (add
112.5kt) through JVs with SAIL and RINL to utilize the low/medium grade ores
produced by the company. If the total capacity of the two JVs is operated at full
utilization, it would require 0.33MT of manganese ore (22% of the 1.5MT expanded
production capacity. The JV projects should help the company by providing linkage
to the trends in the ferro-alloy industry and also helps MOIL to maintain relationship
with its end customers (steel companies).
Further, MOIL also has two manganese ore beneficiation plant (total capacity of
900kt each) at Balaghat and Dongi-Buzurg mines. The beneficiation process helps
increase the Mn content in the ore finally sold to nearly 48-49.5%. The entire
production from these mines is handled through the plants.
Expansion project to drive back-end weighted volume
growth
MOIL has outlined mining projects (deepening of existing vertical shafts and sinking
of new shafts) to increase its production capacity. The company is also developing its
open cast mines (by gradual mechanization) by induction of Heavy Earth Moving
Machinery. The capex for the various mining projects is nearly Rs7.7bn, which
would increase production capacity to at least 1.5MT by 2015 (from 1.1MT
currently). However, in our view, most of the volume growth from the projects is
expected to be back-ended (mostly post-FY13). New mines on 814 hectare reserved
were allocated by the government to MOIL in the state in Maharashtra. Some of the
mines are adjacent to the existing MOIL mines and the company has applied for a
prospecting license for the area and management expects to get the PL in the next 6-
9 months. Exploration in this area would help increase the reserve base of the
company aiding long-term production growth.
MOIL has also initiated two key JV projects with SAIL and RINL to set-up silicomanganese plants (that would utilize the low/medium grade ores) given the gradual
shift to this alloy in the production of steel. The expected investment by MOIL in
these project is ~Rs1.5bn. Silico-manganese is used extensively in the production of
long steel products, demand for which is driven by construction spending.
Flush with cash to support capex
Similar to most of the PSU mining companies, MOIL has a strong balance sheet with
no debt (Dec-10 net cash currently stands at Rs18bn or 26% of current market cap)
and robust cash flow generating business. The various mining projects outlined by
the company would require a capital outlay of Rs7.7bn (and the Rs1.5bn investment
in the JV projects), with most of the capex for long gestation projects (ranging from
3-4years). The company’s historical dividend payout is close to 20% and has a
dividend yield of 1.4%. While the company is looking at acquisition of Mn ore mines
overseas and allocation of coal or Mn ore mines in India to use its large cash balance,
we believe these are unlikely in the near-term. We believe that the strong profitability
should help MOIL generate FCF of $130-140MM in FY11-13E.
Investment negatives and risks
Weakness in the value chain: Steel demand
As the steel industry remains the single largest consumer of Mn ore (through Mn
alloy products), Mn ore prices and production tracks the global steel production.
Demand for manganese ore (contributing 94% of MOIL’s FY10 revenue and
EBITDA) is dependent on steel production, consequently linking ore prices to the
state of the steel industry. Slowdown in steel production directly impacts the offtakes
and prices of manganese ore. As seen in the recent global slowdown, global steel
production declined 8% in 2009 leading to a 61% y/y decline in average manganese
ore prices. Chinese demand is critical for Mn ore prices and it remains short on Mn
ore. The country is a producer of Mn ore, mostly very low-grade ore, and the largest
consumer given its ferro-alloy production. Therefore, a key risk to the Mn ore prices
remains a sharp slowdown in Chinese steel production impacting ferro-alloy demand.
MOIL is a mining company with strong leverage to the underlying commodity
prices (Mn ore). For example, while Mn ore realizations increased by 103% in
FY08, EBITDA increased by 280% in the same time period.
Weak ferro-alloy prices could increase alloy imports
The ferro-alloys industry in India remains highly underutilized operating at
utilization levels of 53-60%. The current capacity of ferro-alloys in India is sufficient
to meet steel production of ~220million tones vs. the current annual production of
around 60-65million tones. Additionally any sharp slowdown globally in ferro alloy
prices, could result in increasing imports into the country, which could hurt the
demand for Mn ore and prices. MOIL is undertaking forward integration projects to
expand its manganese alloy capacity to utilize its lower low/medium grade ore.
While expansion in an already underutilized industry could be a headwind for the
company during weak global environment, we think the small contribution of the
segment to MOIL’s profitability (3% of FY10 EBITDA) will limit the earnings
impact.
Regulatory risks on profitability and expansion
While MOIL is shielded from hike in royalties, export tax and freight rate (as these
costs are borne by the customers in domestic sales), any potential changes in the
mining act could impact the company. The proposed draft of the MMDRA calls for
implementation of certain provisions (like profit sharing of 26% with the local
population, etc.) could adversely impact MOIL similar to other mining companies in
India. However, the definitions, details and implementation of the draft are still
unclear.
Any delays in receiving necessary regulatory approvals and clearances from the
government to add new mines and renewal of existing mine leases could delay the
expansion plans and restrict volume growth of the miner. MOIL’s manganese ore
production is dependent significantly on the production in the Balaghat (MP) and
Dongri Buzurg (Mah.) mines. These mines account for 58% of the company’s
reserves and contributed nearly 53% of its production in FY10.
Volume growth dependent on production capacity
MOIL’s expected production for FY11 at 1.15MT nearly caps out production growth
given its current production capacity of 1.1MT. While the company has increased
focus on developing its open cast mines along with increasing capacity in the
underground mines over the medium term, much of the additional capacity will come
post FY13. In the near-term, MOIL expects production to increase in the DongariBuzurg mines and Gumgaon mine (expected to start production from 4QFY12). Any
delay in these capex could lead to lackluster volume growth. We expect
FY11/FY12E production growth of 3.5% and 5% respectively.
Rising cost of production
MOIL has seen significant increases in its mining costs primarily due to the higher
employee costs post the wage revision implemented by the company in FY09.
Employee costs have also been impacted in the last few years due to the increased
competition for skilled labor. As seven of the 10 mines operated by MOIL are
underground mines (which already have higher cost of production vs. open-cast
mines), the costs of mining are also likely to rise as mineral deposits reach deeper
horizons. We expect Mn ore cost/MT to increase by 4% over FY12-13E.
Valuation and share price analysis
MOIL has a limited trading history given its Dec-10 listing. While there are no listed
pure-play manganese companies, we have included companies with significant
exposure to manganese in its peer group. These include OM Holdings, Eramet, Vale,
ENRC and BHP Billiton. Similar companies in India like Sandur Manganese and
Iron Ore, Tata Steel, etc, either have limited trading information or use the
manganese ore produced for internal consumption.
We also broaden the valuation horizon to include the domestic steel player and
mining companies. We include steel companies given the direct linkage of the steel
industry to underlying commodity (steel sector consumes over 90% of Mn ore
produced). While the steel demand and prices have a bearing on the Mn ore prices,
we also include mining companies in the peer group, given the strong margins and
cash flow profile.
We use earnings based metrics for valuation given the underlying commodity price
environment makes DCF metric volatile. We prefer EV/EBITDA over P/E as the
former takes into account the differing financial leverage profile among companies.
Our Mar-12 PT of Rs490 is based on 6x FY12E EV/EBITDA. The target multiple
is at a 20% premium to the global mining peers (with Mn ore exposure)
primarily due to the following reasons:
• Costs of production are at the lower end of the global Mn ore cost curve
(We estimate MOIL is among the lowest cost producers of Mn ore with
a Cost/MT of $65/MT)
• A robust balance sheet with no debt and 26% of its market cap in cash.
We expect MOIL to generate FCF of $130-140mn over FY11-13E
• Focus on the domestic steel market where steel consumption is expected
to grow at 8-9% over the next few years.
We believe that the valuation premium to global peers will hold going forward,
similar to domestic miners NALCO and Coal India, as a key driver impacting MOIL
and its peer group (Assore, OMH and Eramet) is the trend in global Mn ore prices.
NALCO trades at a premium of 40% compared to global peers, while COAL trades
at a premium of 34%. The low cost of production (bottom quartile), combined with
very strong balance sheets, in our view justify a premium for India’s state owned
miners.
We expect global Mn ore prices to improve from current levels as China steel
production increases by ~5% p.a. over the next few years (versus 1% growth in
2H2010), and we expect MOIL's realizations to increase 3-7% over FY12-13E.
Unlike its peers that have various mineral assets, Mn ore is the core operation for
MOIL (contributing 94% of MOIL’s EBITDA) and we believe that a better Mn ore
pricing environment will help the company maintain its profitability given its low
and stable cost structure. Key downside risks to our rating are a slowdown in
Chinese steel demand and subsequent impact on Mn ore prices, or potential changes
in the mining law in India.
