NMDC: A valuable resource

While business prospects look healthy, aided by rising volumes and forward integration into steel making, stock valuation is also attractive at current levels

Unlike its first follow-on public offer (FPO) in the year 2010 which was oversubscribed by a little over one time, the company's second FPO which is expected this year could see far greater demand from investors if priced around current levels. Its last FPO did not excite investors much given the offer price, which was believed to be expensive at that point in time. The issue, wherein pricing ranged between Rs 300 and Rs 350, saw allotment being done at Rs 300 a share. Post-FPO, the share prices corrected to Rs 186 currently — during this period the Sensex has remained almost flat.

Nevertheless, and given the correction in the share price, analysts do not see pricing of the planned FPO as any concern, assuming it is priced at current levels. And, if a discount on the current price is offered, it will only enhance demand from investors. That’s because, at current levels, most analysts have a buy rating and believe stock valuations are attractive. Enam Securities, in its June report on NMDC, valued the stock at Rs 244 per share. In terms of valuations, it is trading at a reasonable price to earnings multiple of nine times its FY14 estimated earnings and four times the estimated enterprise value to operating profits. In this backdrop, investing at current levels with a one- to two-year perspective should prove remunerative.

Sound business
The stock valuation finds support from the company’s strong position in the industry, while the current business environment extends further support. NMDC is one of the lowest-cost producers of iron ore in the world, having an operating profit margin of 76 per cent. It has huge high quality iron ore reserves, of 1,200 million tonnes. This should take care of its growth for many years, as the company produces about 28 million tonnes a year. Even with an annual output of 50 mt a year, the reserves should suffice for 24 years. Further, NMDC is a zero-debt company, earns robust return on equity of a little over 35 per cent and has a consistent dividend paying record.
 

FY13: MARGIN PRESSURE
In Rs  crore	FY12	FY13E	FY14E
Sales	11,166	12,077	13,750
OPM (%)	80.0	70.4	69.7
Net profit	7,323	7,354	8,456
EPS (Rs )	18.5	18.5	21.3
PE (x)	10.6	10.6	9.2
E: Estimates                                      Source: ENAM Securities

Growing volumes
NMDC is expected to be a key beneficiary of the shortage of iron ore in the country, after the ban on iron ore mining in Karnataka and the selective ban on illegal mining in other states. Analysts expect demand-supply to remain favourable for the industry in the near future, good news for companies like NMDC, a leading player.

The company will benefit both in terms of volumes though pricing could be an issue in the near-term. International iron ore prices have corrected almost 30 per cent from $170 a tonne seen in December last year to currently at about $125 per tonne. However, domestic prices still remain relatively firm given the shortage of the commodity. Hence, the impact on this front will be lower, though some impact on margins should be visible in FY13. In terms of volumes as well, the company is ramping up its growth significantly from about 27 million tonnes in 2011-12 to 29 million tonnes in 2012-13 and further to 33 million tonnes by 2013-14. Thereafter, too, there are plans to further ramp up production. These expansions will have a positive rub-off on NMDC’s earnings and cash flows in the coming years.

Road ahead
According to the estimates, the company’s FPO could hit the market any time this year. Wherein, the government might look to offer another 10 per cent of NMDC. Even at the current market price, the size of the FPO works out to Rs 6,600 crore. Analysts do not see any possibility of equity dilution (a fresh issue of shares), as the company has the requisite funds to achieve its growth plans. In fact, NMDC is sitting on cash and cash equivalents worth about Rs 20,500 crore as on March 31. What’s more, its cash flow from operating activities has been consistently rising in the past nine years and was nearly Rs 5,000 crore in 2010-11.

Going ahead, too, NMDC is expected to generate a good amount of free cash flow (after incurring capex for expansion) from its existing business, which should help sustain dividends and reinvest for future growth i.e., forward integration. The company has ambitious plans to unlock value by way of forward integration into steel making, by setting up steel plants. Among such plans is a three million tonnes plant in Chhattisgarh, expected to become operational by the end of 2014-15, and of two million tonnes in Karnataka thereafter.