Cheap for a reason

Despite a bearish consensus, NMDC is gaining ground. But, it's still early days

About 22%, 30%, 48% — that's how the bets are placed on the state-owned iron ore mining company National Mineral Development Corporation (NMDC). Of the 23 analysts tracking the stock, the first percentile comprises the most bullish lot, who expect the stock to touch ₹158 against its current market price of ₹128. The second and third percentiles are the bearish folks who expect the price to tank to ₹91 and ₹67, respectively. In short, the Street is voting with its feet on the PSU.

And it’s not without reason. After sinking in ₹10,000 crore in setting up a 3 million tonne per annum integrated steel plant in Bastar district of Chhattisgarh, the miner now wants to pull the plug on the diversification. In FY16, the company had made a return on capital of 14%, the lowest in its history as international iron ore prices fell from a peak of $155 a tonne in 2013 to $40 a tonne in December 2015. The prices have since recovered to $75 a tonne.

But despite consensus stacked against it, the stock has been gaining ground from around ₹108 a month back to ₹128. The reasons for the same appear to be multi-fold. While NMDC still supplies iron ore at relatively lower prices compared to international prices, it has been hiking prices. In October, it raised iron ore lump prices from ₹1,700 a tonne to ₹2,100 a tonne. Further, if NMDC manages to sell the steel plant, which is almost one third of capital employed and yields nothing, the proceeds will improve its return ratios significantly. To put it in perspective, after adjusting for capital work in progress and cash in the books, the return on capital will more than double to 29% as against 12% expected in the current fiscal. The realisable per share value of the plant, which is expected to start trial production by mid-2017, is worth ₹32 a share and considering there is no major capex in the iron ore mining business, most of it could be paid back to shareholders.

Further, domestic steel production is seeing an uptick post the safeguard duty on cheap Chinese steel imports. As a result, in November, NMDC reported 82% year-on-year growth in dispatches. During the first eight months of FY17, it dispatched 28% more iron ore. As against 28.8 million tonne in FY16, this year the company is expected to clock volumes of about 35 million tonne, a growth of 22%. It has significant room for utilisation in case the demand pick-up continues. Besides, NMDC recently increased its mining capacity by 14 million tonne to 46 million tonne a year.

While a section of the market is worried about the growth in steel demand post demonetisation, the impact is expected to be marginal and fleeting. “Demonetisation has hurt secondary steel producers, which has forced Odisha mines to cut prices. However, NMDC’s key customers such as Essar and JSW Steel are less affected due to product mix and a buoyant export market,” mentions Sanjay Jain, who is tracking the company at MOSL

Higher volumes and better realisations would mean that the company would report better margins and earnings which plummeted last year. NMDC’s operating profit per tonne fell to around $700 a tonne in Q4FY16. However, the past two quarters have seen a significant recovery to $1,100 a tonne. Higher volumes are likely to have a positive impact on earnings, which is likely to move up from ₹8.4 a share to ₹11 a share.

After spending for ₹7,530 crore on a buyback, NMDC is still sitting on cash and equivalents of close to ₹5,000 crore or ₹16 a share. The stock is currently trading at 12x estimated FY17 earnings and, based on dividend expectations of ₹6 a share this year, the yield, too, works out close to 5%. But valuations appear attractive, investors need to be cognisant of the risks in case the steel sale fails to materialise though reports suggest that the management is in talks with an MNC and prominent domestic steel makers. In such a scenario, the share price will heavily rely on core earnings growth, which will take time to play out. Secondly, the 10% stake in the PSU early next year could act as a dampener on the share price in the near term.