NMDC: A long-term play on steel cycle; may see decline in FY23 revenues

Words like “China unlock” are beginning to attract speculators. One of the key reasons and areas for the same could be China’s real estate, which contributes almost a third of its gross domestic product.

If there’s a recovery in real estate activity, steel, other industrial metals and cement would be some of the sectors where demand would obviously grow. This could make a positive difference to iron ore prices and, in turn, could mean a rebound in the valuations of NMDC since it is a major ore producer.

In that case, NMDC may be able to increase its production of iron ore and maintain margins. Having divested its steel plant will also strengthen its balance sheet and lead to improved margins. The firm has rolled back the Rs 300 per tonne reduction it had announced in November 2022, as the government has withdrawn export duty on iron ore, pellet, and steel.

More price hikes are possible if China does as expected, and unlocks, since there would be price hikes in the international market -- for pellets, ores, rebars, hot-rolled coils and other steel categories. After the imposition of export duties in June 2022, exports have been negligible but they now show signs of picking up.

NMDC’s formal demerger of the steel plant may be followed by an initial public offering, or the government could look for a stake sale. Additional capex on the plant will no longer impact the company’s balance sheet, either way. NMDC also doesn’t require large capex for the mining business, which is another positive.

Analysts are projecting volume compounded annual growth rate (CAGR) of 11-12 per cent for the period between financial year 2020-21 and 2024-25 (FY21-FY25) with production crossing 50 million tonnes (MT) by FY25. Given strong free-cash flow and less need for capex, the company could declare generous dividends (it has a current yield of over 8 per cent) since the government would wish to tap its profits.

The steel super-cycle has clearly topped out. However, Ebitda (earnings before interest, tax, depreciation and amortiaation) could reduce sharply for FY23, compared to FY22. There’s a case of assuming international iron ore prices have hit rock-bottom since they have declined 35 per cent since March 2022, with some recovery visible in December over November. Domestic prices have moved down in tandem with international prices. The positive impact of a rise in prices would be more visible in FY24, with only one quarter of the current fiscal left.

NMDC stock trades at a significant discount to its international peers, with a current price-to-equity (PE) of 6-7x and an enterprise value/Ebitda of 3.7x. NMDC is likely to see 28-30 per cent decline in FY23 revenues over FY22 and the Ebitda margin will dip to 35 per cent of revenues, versus 48 per cent year-on-year.

Profit after tax will drop by around 45-47 per cent in FY23 over FY22. There’s very little debt on the balance sheet and Ebitda margins are not expected to move up much. So, this is a long-term play on the assumption that steel is close to the bottom of the cycle.

Demand recovery could generate considerably higher Enitda margins and a China unlock may be a near-term trigger. Analyst valuations range between Rs 138 and Rs 160.