NMDC: Hold :: Business Line

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Global commodity prices, that rode high in the last few years, have been slipping fast and furiously in the last few months following China’s weak economic outlook.

Metal prices too are in a downward spiral and stocks of the global mining majors are being hammered down. India’s largest iron ore producer NMDC has also seen a reversal, falling from ₹180 on the bourses in September to ₹140 now.

This, despite the company growing volumes and sale price smartly. Revenue in the recent September quarter increased 25 per cent year-on-year to ₹3,102 crore, helped by price hikes and 12 per cent higher volumes.

It helped that exports accounted for only around 10 per cent of its total sales, insulating earnings from international price movements.

That said, NMDC too is likely to feel the heat on the pricing front in the near term. One, local iron ore buyers are finding import prices attractive. Also, more local supply is available with mining bans lifted.

But the company’s long-term prospects seem good. Its leadership position, expansion plans and solid financial position should help it ride out the current turbulence. While sale price may be under pressure, volumes should continue growing.

So, investors with a long-term perspective can retain their investment in the stock. At the current levels, its valuation is cheaper than in the past. Besides, the dividend yield now is an attractive 6 per cent.

Price pressure

NMDC’s enviable net margin of over 50 per cent will take a hit as iron ore prices drop. The company was a key beneficiary in the past when iron ore mines were closed in Karnataka and Goa.

This year too, mining bans were imposed in Odisha and Jharkhand. Ergo, even as global iron ore prices halved this year, the company was able to raise the prices of its lower quality ore (known as fines) by nearly 10 per cent.

But the pricing power is set to change due to two factors. One, more local supply will be available with mining bans being lifted and the company itself slated to raise output by 50 per cent in the next year. Second, NMDC’s price differential with global prices has narrowed to near zero from a discount of 30-40 per cent in the past few years.

This is because global prices have dropped to a near five-year low of $68 a tonne on weak demand. Worse, prices are forecast to touch $60 a tonne next year, says the Australian Government.

Taking these cues, NMDC recently cut ore prices — 1.5 per cent on fines and 4 per cent on higher grade ore (lumps).

Further price cuts are likely to make local ore attractive compared to imports.

Steel demand is yet to pick up, and even when it does in the medium term, ore prices may remain under pressure due to ample supply. A weaker rupee though may provide some stability to local prices.

Good volume growth

Even as sale price and margins may drop, NMDC’s output is set to rise. The company holds 1,300 million tonnes (MT) of mostly high quality ore reserves in Karnataka and Chhattisgarh.

In three to eight months, the company expects its Bailadila mines in Chhattisgarh and Donimalai mines in Karnataka to add an additional 14 MT output to the current production of 30 MT.

Also, the Steel Ministry has asked NMDC to produce 75 MT by 2018-19 to keep up with steel demand. The renewed Government push should help the company get expedited clearances for its mining expansions. When the commodity cycle turns and prices revive, NMDC will be well-positioned to reap the benefits.

Supported by its large cash reserve of around ₹18,800 crore as of March 2014, the company is moving upstream in the value chain by setting up a steel plant in Chhattisgarh with 3 mt annual capacity.

This is expected to start production by the end of 2016.

Valuation not demanding

Jitters over iron ore prices have seen the NMDC’s stock fall 30 per cent over the past three months. This has resulted in valuations being cheaper than before.

The current stock price discounts the company’s trailing 12-months earnings by eight times, lower than the average of 12 times it had traded in the last three years.

Output is projected to increase 30 per cent in 2015-16 and 50 per cent in 2016-17; sale prices may however drop 20-30 per cent. Taking these into account, the stock’s 2015-16 forward multiple is estimated to be at 10 times, cheaper than the historical levels.