NMDC (NMDC.BO) Upgrade to Buy: Bottom Fishing: Citi

 Upgrade to Buy, TP Rs120 — NMDC has fallen 25% in three months (global $ ore
prices down 17%). The stock price seems to reflect one of two scenarios: 1) implied PE
of 6.7x (global peers at 6-10x); or 2) earnings downgrade expectations. We think
NMDC should trade at the global average (~8x) − high margins, rich ore, domestic
exposure, a cash rich balance sheet may warrant a premium; pricing uncertainty
perhaps offsets these benefits. Asset value (20+ yrs life, low costs) and dividend yield
(~6%) suggest upside; even as we lower ore price estimates (-10% vs. NMDC’s current
prices).

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 Pricing: lack of clarity — While it’s hard to ascertain NMDC’s future pricing as it does
not price at export parity, we take a conservative view − lower prices vs earlier. India’s
steel demand is down 1% yoy (Apr-May13). Global ore prices have fallen from $135/t
in Apr13 to $115/t; NMDC’s prices are unchanged (fines $44/t, lumps $77/t). Global
prices could be under pressure in 2HCY13 − 30mt of low-cost production (seaborne
1.1bnt); China’s steel production may have peaked. FY14 est: NMDC’s fines prices
$40/t ($43 earlier), lumps $71 ($77 earlier). PAT would rise by 1% if prices rise by 1%.
 Upside to volumes — We see 2% volume CAGR over FY12-15 (despite NMDC’s
plans to raise capacity from 32 to 48mtpa by 2015). According to press reports, NMDC
is targeting an output of 30-32mt in FY14 (27mt in FY13). We maintain our FY14
forecast at 27.7mt given evacuation constraints worsened by the damage to Essar’s
slurry pipeline. More rakes/availability of the slurry pipeline could result in upside.
 Insulated from royalty — Media reports indicate iron ore royalty maybe enhanced
from 10% to 15%. NMDC is reasonably insulated from any changes in the royalty
regime as it is charged directly to its customers in the domestic market (>90% of sales).
 Lower profits — We cut PAT by 11/10% for FY14/15 as we incorporate trends so far;
lower prices; rise in costs − payment of 10% of the Karnataka sales proceeds to the
SPV (Supreme Court order). We value NMDC on DCF modeling cash flows out to
FY37 based on reserves/resources (no terminal value). Our TP implies 8x Sep14 PE