NMDC: Buy

The stock of India's largest iron ore producer, NMDC, appears an attractive buy at the current prices. The company has good potential to improve sales volumes by supplying to the steel industry, which is on expansion mode. Working in the company's favour is the fact that steel capacity additions are outpacing those of quality mine additions; this should ensure that demand for NMDC's ore remains robust. The current share price at Rs 209 values the company at around 12.2 times the trailing 12- months earnings, a level which is at a premium to Rio Tinto and Vale but on par with BHP Billiton. The company's valuation appears attractive, given its ongoing efforts to increase iron ore production by 60 per cent over the next three years. Sweetening the deal is its foray into steel production, margins that are the best in the industry, sizable cash holdings and continued efforts to augment its high quality ore base.

STRONG PERFORMER

FY-11 saw domestic steel production rise by over 8.8 per cent to 65 million tonnes. During the same period, NMDC managed to increase its sales volumes by six per cent to 25 million tonnes. 2011 has seen iron ore prices hold firm as a result of the ban on mining in iron-ore rich regions of Karnataka and global constraints on supply.

With global iron ore prices ruling higher in the last fiscal, NMDC's net sales and profits rose by 82 and 88 per cent to Rs 11,400 crore and Rs 6,500 crore respectively. Despite having to sell at rates well below global prices, a low operating cost structure enables NMDC to enjoy net profit margins in the mid-50 per cent range. The recent June quarter also saw a continuation of the momentum.

With the legacy advantage of having relatively low-cost mines and being among the few big domestic players with quality iron ore, NMDC is a veritable cash-generating machine. It has accumulated cash and equivalents of Rs 17,200 crore (Rs 44 per share) and has no borrowings. This should come handy as the company heads into expansion mode over the next three years.

PRAGMATIC EXPANSION

The company's expansion plans include increasing iron ore output from the existing mines to 40 million tonnes from the current 25 million tonnes per annum. The company should be able to capitalise on Indian steel consumption, which is expected to track GDP growth over the next five years. Given that companies in India have had a hard time acquiring domestic greenfield mines, NMDC is reported to be in the final stages of acquiring sizable Australian iron ore assets. The addition of these Australian mines to its portfolio should more than double NMDC’s iron ore resources and lower its EV/tonne. Given its government ownership, economic compulsions force NMDC to price its iron ore at a substantial discount to global prices. To mitigate this handicap, the company plans to increase its rupee earnings per tonne of ore sold by producing steel. With the prices of steel being subject to less ‘restrictive' pricing practices, the company plans to set up two steel plants of three million tonnes each at Chhattisgarh and Karnataka. By FY-15, at least 20 per cent of the company's iron ore output should enjoy substantially higher earnings per tonne of ore sold than current levels.

RISKS

The proposed Mining Bill may require NMDC and other iron ore miners to pay an amount equivalent to royalty. For NMDC, this amount averaged at eight per cent of net sales in FY-11. Given the company's relatively low realisations currently, it may have the wiggle room to pass through increased cost, if any.

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