Building on a strong base

Rising iron ore prices, mining assets and steel JV are positives for NMDC, but valuations are expensive.

The increase in iron ore prices, plans to acquire iron ore assets and steel expansion have helped the NMDC stock gain 8 per cent over the last one week. Though these developments augur well in terms of future growth, investors need to be cautious in the near term as its shares trade at an expensive valuation of 17 times its 2010-11 estimated earnings.

NMDC recently raised iron ore prices by 5.2 per cent. Further, its plans to acquire mines overseas and a recent JV with a Russian company for producing five million tonnes of steel has kept its stock in the news.

Putting cash to use
As part of its strategy to grow, the company has started to look for iron ore, coal, manganese and fertiliser mineral assets both in India and outside. Also, the company wants the large cash in its balance sheet to be used for its organic and inorganic plans. By the end of the current financial year, it will have Rs 17,000 crore (Rs 42 per share) of cash on its balance sheet. It also plans to acquire coal mines in countries such as South Africa, Russia and Mozambique, among others. Besides coal, the company was also in the news over its plans to acquire iron ore mines in Australia and that is likely to be completed soon.
 

BRIGHT PROSPECTS
In Rs  crore	FY10	FY11E	FY12E
Revenue	6,239	10,979	14,232
PAT	3,446	6,651	8,464
Cash balance	12,855	16,696	22,292
RoNW (%)	24	34	32
NPM (%)	55	61	60
Ebitda (%)	71	82	81
PE (x)	33	17	13
Earnings yield (%)	3	6	8
EV/ Sales	16	9	6
E: Analysts estimates

Backed by reserves
These acquisitions will not only increase its reserves, but will also help its ambitious plans in the steel sector. Captive coal mines and huge reserves of iron ore, which are the key components in steel making, will give it an edge over others. The company has proven iron ore reserves of 1.36 billion tonnes, which are fairly large compared to its current annual production of 30 million tonnes. The company intends to ramp up its production to 50 million tonnes over the next five years, which could give it a volume growth of 10 per cent. In addition to the volume increase, analysts estimate there could be a 5-8 per cent rise in annual iron ore prices, which will boost its revenues.

Expanding steel-making capacity
More importantly, the biggest additional boost could come from its plans in the steel sector. It is developing a 3 million tonne integrated steel plant in Chhattisgarh. Further, it recently inked an agreement with Russia’s mining and steel giant, Severstal, to set up a 5 million tonne (initial capacity of 2 million tonnes) steel plant in Karnataka. Both the projects will have a total capacity of 8 million tonnes, which is very large considering some of the existing steel players like Tata Steel (Indian operations) and JSW Steel have 6-7 million tonnes of capacity each. At the ruling steel prices, the 8 million tonnes of steel capacity means a Rs 28,000-30,000 crore turnover. It will have a significant impact on the net profit as integrated players enjoy operating margins in the excess of 45 per cent. Even a 15 per cent net margin will mean Rs 4,500 crore of net profit, which is more than the 2009-10 reported net profit of Rs 3,446 crore. However, these are indicative figures, as the actual outcome could be even better (depending on the steel prices and volumes later) and there is a fairly long time of 4-5 years before they come on stream.

Outlook
NMDC can grow its revenue and profits at a robust rate on the back of huge reserves and steady demand. Importantly, due to the lack of captive mines most of its customers in the steel sector depend on its supplies. NMDC supplies the raw material at lower than the international prices. Despite this, it makes operating profit margins of 80 per cent and an over 30 per cent return on equity. Not only is its positioning in the industry and returns ratio good, it has many other positives which make it stand apart. It has zero debt, a large free cash flow, high profit margins and a low cost of production, which on the back of firm iron ore prices will only improve its finances further. These attributes make it one of the best investments for the long term. In the near term, the valuations (see table) remain a concern.