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Metals & Mining
Draft MMDR bill - could cut like a knife
The mines secretary has mentioned that the GoI is planning to table the MMDR
bill in the current budget session of parliament. The act calls for sharing 26% of
mining profits subject to a floor of 100% of royalty paid. Coal India, Tata Steel and
Hindustan Zinc could be most impacted.
MMDR bill could be tabled in current budget session
! The Mines and Minerals Development and Regulation (MMDR) bill is expected to be placed
before the parliament in the current ongoing budget session. But we note that the schedule
for tabling the bill has already been postponed at least once already. A final meeting of the
inter-ministerial panel is cited as pending before it can be tabled in parliament.
26% mining profit sharing proposed subject to a floor of 100% of royalty
! The most contentious proposal in the bill is the mining profit sharing clause. Section 43 of the
draft bill states the following: "The holder of a mining lease shall pay annually to the District
Mineral Foundation specified in section 56 of the Act, in such a manner as may be prescribed,
an amount equal to twenty-six percent of the profit (after deduction of tax paid) of the previous
year from mining-related operations in respect of the lease or a sum equivalent to the royalty
paid during the previous financial year, which ever is more.
However, several questions remain unanswered
! The profit sharing clause is intended to compensate the displaced local population due to the
mining activity. However, several important questions remain unanswered. a) Is this applied
only prospectively for new mines or to even existing mines, as there is no mention of
prospective or retrospective application? b) How will the genuinely affected population be
identified? c) Would companies be able to offset what they currently spend on CSR activities?
d) Would the expense be deductible for the calculation of income tax? Unless these questions
are answered, we really cannot fully assess the impact it would have on mining company's
profitability.
Current royalty regime varies between 0.5% - 10%
! Current royalty rate is 10% of sale price for iron ore. Royalty rates are 8.4% and 12.7% of
LME prices based on metal content for Zinc and Lead. For coal, royalty is borne by the
customer and is based on a formula of a fixed component based on grade of coal (Rs50/t for
grade F and G thermal coal to Rs 180/t for coking coal steel grade) + variable rate of 5%
based on pit head invoice price. Aluminium producers like Hindalco and Nalco, due to the
high value addition to bauxite, pay only 0.5% royalty on LME aluminium price. Since profit
margins for the companies are well over these rates, payment of 26% mining profits of
previous year will apply for most of these companies.
Potential additional industry burden of US$2.5bn
! On an industry-wide basis, the most affected industries would be coal and iron ore mining.
About 500mt of coal is mined in India and, if we assume Coal India as a benchmark for the
industry (based on its FY10 profit after tax of US$3.13bn and 26% of profit sharing amounting
to US$569m), it would mean an additional burden of US$700m for the industry on an annual
basis. For the iron ore industry also the impact could be substantial. If we assume industrywide volumes of 200mt and an industry-wide EBITDA margin of 50%, it would place an
additional burden of US$1.3bn on the iron-ore industry. All the other mining activities such as
bauxite, limestone, zinc ore, etc, would add to less than US$500m.
Pure play miners and captive steel producers could be most impacted
! If we assume the mining profit sharing clause is applicable for existing and also for new
mines, then pure-play mining companies such as Coal India, NMDC, Sesa Goa would be the
most impacted. Pure-play mining companies have low value-addition and the 26% mining
profit sharing clause will almost be a direct impact on their bottom line. Coal India
management has in the past stated that the impact could be about 6% of its top-line and
could erode 30% of its EBITDA. We estimate an negative impact of 17% on FY12F earnings.
NMDC and Sesa Goa earn over 90% of their revenues from selling iron ore. For Sesa Goa,
we estimate a profit sharing payment of Rs7.7bn in FY12F or 15% of its estimated earnings.
Aluminium companies to be less hit due to significant value addition
! For non-ferrous metal producers such as Hindalco Industries, National Aluminium, etc, due to
the high value-added nature of these businesses, the impact of the act is less than 5% of the
earnings. For example, bauxite sells for US$50/tonne in the spot markets compared to
US$2,500/tonne for end-product aluminium. For Hindustan Zinc and Sterlite (through
exposure to Hindustan Zinc), incremental profit sharing liability could be Rs12bn or 18% of
HZN's profits.
Impact on steel majors
! Among steel players, those with captive resources of iron ore and coking coal will be more
adversely impacted. Steel Authority of India sources 100% of its iron ore from captive sources
as does Tata Steel's domestic operations. Tata Steel also sources 60% of its coking coal
requirements from captive mines. We estimate a profit sharing payment of Rs10.4bn or 20%
of its FY12F earnings for SAIL and Rs7.8bn or 12% of its FY12F earnings for Tata Steel. JSW
steel in contrast, sources less than 20% of its iron ore requirements and no coking coal from
captive mines and would only have an impact of 5% on its FY12F earnings.
Facing industry opposition, Government may instead increase royalties
! Industry has raised concerns about the impact the proposed act will have on their profitability.
Concerns have also been raised regarding the difficulty in calculating profits just from mining
activity. News reports (Economic Times) indicate that the government could move to a higher
royalty regime instead of the profit sharing clause. We estimate a royalty payment of Rs2.3bn
for Sesa Goa and Rs8.1bn for Hindustan Zinc for FY11F based on the current royalty
structure. These could proportionately increase. Currently, the customers of Coal India bear
the royalty charges and hence prima facie, Coal India will be insulated from a higher royalty
rate. However, we note that if regulated consumers like utilities have to bear the higher
effective cost of coal potentially leading to higher inflation, Coal India's price hikes might be
limited to that extent.
! We have Buy rating on Tata Steel, Sesa Goa, Hindustan Zinc, Sterlite Inds and Hindalco
Inds. We have a Hold rating on SAIL and National Aluminium. We have Sell ratings on JSW
Steel and Coal India.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Metals & Mining
Draft MMDR bill - could cut like a knife
The mines secretary has mentioned that the GoI is planning to table the MMDR
bill in the current budget session of parliament. The act calls for sharing 26% of
mining profits subject to a floor of 100% of royalty paid. Coal India, Tata Steel and
Hindustan Zinc could be most impacted.
MMDR bill could be tabled in current budget session
! The Mines and Minerals Development and Regulation (MMDR) bill is expected to be placed
before the parliament in the current ongoing budget session. But we note that the schedule
for tabling the bill has already been postponed at least once already. A final meeting of the
inter-ministerial panel is cited as pending before it can be tabled in parliament.
26% mining profit sharing proposed subject to a floor of 100% of royalty
! The most contentious proposal in the bill is the mining profit sharing clause. Section 43 of the
draft bill states the following: "The holder of a mining lease shall pay annually to the District
Mineral Foundation specified in section 56 of the Act, in such a manner as may be prescribed,
an amount equal to twenty-six percent of the profit (after deduction of tax paid) of the previous
year from mining-related operations in respect of the lease or a sum equivalent to the royalty
paid during the previous financial year, which ever is more.
However, several questions remain unanswered
! The profit sharing clause is intended to compensate the displaced local population due to the
mining activity. However, several important questions remain unanswered. a) Is this applied
only prospectively for new mines or to even existing mines, as there is no mention of
prospective or retrospective application? b) How will the genuinely affected population be
identified? c) Would companies be able to offset what they currently spend on CSR activities?
d) Would the expense be deductible for the calculation of income tax? Unless these questions
are answered, we really cannot fully assess the impact it would have on mining company's
profitability.
Current royalty regime varies between 0.5% - 10%
! Current royalty rate is 10% of sale price for iron ore. Royalty rates are 8.4% and 12.7% of
LME prices based on metal content for Zinc and Lead. For coal, royalty is borne by the
customer and is based on a formula of a fixed component based on grade of coal (Rs50/t for
grade F and G thermal coal to Rs 180/t for coking coal steel grade) + variable rate of 5%
based on pit head invoice price. Aluminium producers like Hindalco and Nalco, due to the
high value addition to bauxite, pay only 0.5% royalty on LME aluminium price. Since profit
margins for the companies are well over these rates, payment of 26% mining profits of
previous year will apply for most of these companies.
Potential additional industry burden of US$2.5bn
! On an industry-wide basis, the most affected industries would be coal and iron ore mining.
About 500mt of coal is mined in India and, if we assume Coal India as a benchmark for the
industry (based on its FY10 profit after tax of US$3.13bn and 26% of profit sharing amounting
to US$569m), it would mean an additional burden of US$700m for the industry on an annual
basis. For the iron ore industry also the impact could be substantial. If we assume industrywide volumes of 200mt and an industry-wide EBITDA margin of 50%, it would place an
additional burden of US$1.3bn on the iron-ore industry. All the other mining activities such as
bauxite, limestone, zinc ore, etc, would add to less than US$500m.
Pure play miners and captive steel producers could be most impacted
! If we assume the mining profit sharing clause is applicable for existing and also for new
mines, then pure-play mining companies such as Coal India, NMDC, Sesa Goa would be the
most impacted. Pure-play mining companies have low value-addition and the 26% mining
profit sharing clause will almost be a direct impact on their bottom line. Coal India
management has in the past stated that the impact could be about 6% of its top-line and
could erode 30% of its EBITDA. We estimate an negative impact of 17% on FY12F earnings.
NMDC and Sesa Goa earn over 90% of their revenues from selling iron ore. For Sesa Goa,
we estimate a profit sharing payment of Rs7.7bn in FY12F or 15% of its estimated earnings.
Aluminium companies to be less hit due to significant value addition
! For non-ferrous metal producers such as Hindalco Industries, National Aluminium, etc, due to
the high value-added nature of these businesses, the impact of the act is less than 5% of the
earnings. For example, bauxite sells for US$50/tonne in the spot markets compared to
US$2,500/tonne for end-product aluminium. For Hindustan Zinc and Sterlite (through
exposure to Hindustan Zinc), incremental profit sharing liability could be Rs12bn or 18% of
HZN's profits.
Impact on steel majors
! Among steel players, those with captive resources of iron ore and coking coal will be more
adversely impacted. Steel Authority of India sources 100% of its iron ore from captive sources
as does Tata Steel's domestic operations. Tata Steel also sources 60% of its coking coal
requirements from captive mines. We estimate a profit sharing payment of Rs10.4bn or 20%
of its FY12F earnings for SAIL and Rs7.8bn or 12% of its FY12F earnings for Tata Steel. JSW
steel in contrast, sources less than 20% of its iron ore requirements and no coking coal from
captive mines and would only have an impact of 5% on its FY12F earnings.
Facing industry opposition, Government may instead increase royalties
! Industry has raised concerns about the impact the proposed act will have on their profitability.
Concerns have also been raised regarding the difficulty in calculating profits just from mining
activity. News reports (Economic Times) indicate that the government could move to a higher
royalty regime instead of the profit sharing clause. We estimate a royalty payment of Rs2.3bn
for Sesa Goa and Rs8.1bn for Hindustan Zinc for FY11F based on the current royalty
structure. These could proportionately increase. Currently, the customers of Coal India bear
the royalty charges and hence prima facie, Coal India will be insulated from a higher royalty
rate. However, we note that if regulated consumers like utilities have to bear the higher
effective cost of coal potentially leading to higher inflation, Coal India's price hikes might be
limited to that extent.
! We have Buy rating on Tata Steel, Sesa Goa, Hindustan Zinc, Sterlite Inds and Hindalco
Inds. We have a Hold rating on SAIL and National Aluminium. We have Sell ratings on JSW
Steel and Coal India.
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