NMDC: Stiff pricing

Given the FPO price band of Rs 300-350, there is hardly any room for gain in the medium term.

With the government announcing the price band for NMDC’s follow-on public offer (FPO), the hoopla around its pricing has partly eased. That’s because prior to the announcement, with NMDC’s stock trading at over Rs 400, valuations were considered expensive. Nevertheless, many analysts still believe that the price band of Rs 300-350 per share hardly leaves any room for gains in the medium term.

Their estimates of NMDC’s valuation were reached after giving the company a premium over peers, consequent to its relatively high-quality output, large size, low operating costs and future growth plans (including forward integration into steel production and acquiring mines abroad and in India).

The premium appears justified to an extent given that NMDC is the world’s sixth-largest iron ore miner with high-grade (over 65 per cent Fe) reserves of 1,213 million tonnes (equivalent to 40 years of output at current annual production of about 30 million tonnes); of this, almost 90 per cent are proven reserves.

Notably, the company incurs production (operating) costs of just $7-8 a tonne, which is among the lowest in the world. Not surprisingly, it enjoys operating profit margins of over 75 per cent. These are seen rising to about 80 per cent in 2010-11 on the back of firm iron ore prices. While NMDC’s per-tonne iron ore realisations in 2008-09 were $56.3 in the domestic market ($51.2 in 9 months of 2009-10) and $96 in the export market ($67.4), the former is likely to rise significantly to over $80 per tonne in 2010-11, considering that NMDC’s domestic long-term contracts that expire at end-March will be renewed at higher levels.

The benefits will be significant, given that NMDC sells 85 per cent of its iron ore production in the domestic market; 80 per cent of the total production is sold under long-term contracts.

Similarly, while 2009-10 may see production drop to 27-28 million tonnes as a transportation pipeline was damaged, it is expected at 30 million tonnes in 2010-11. Together, higher output and realisations will lead to a sharp jump in NMDC’s profits. CLSA analysts estimate NMDC to report a 96 per cent year-on-year rise in net profit to Rs 6,696 crore for 2010-11 (earnings per share of Rs 16.9). Considering these estimates and the price band of Rs 300-350, the FPO values NMDC at a price to earnings of 17.8-20.7, which is higher than the industry average of 8-12 times. Even on the basis of other valuation tools, the offer isn’t anywhere close to cheap.

In a recent report, CLSA analysts say, “Our base case valuation for NMDC on the basis of the net present value and average global peer multiples results in a valuation range of Rs 152-219 per share. Using more optimistic iron ore price assumptions in our net present value and using 50 per cent premium multiples to global peers results in a higher valuation range of Rs 237-328.”

Meanwhile, in line with other public-sector FPOs, NMDC’s stock has fallen. From Rs 556.15 on January 19, 2010, it slipped to Rs 400 on Monday. Post the announcement of the FPO price band on Monday, the stock fell 6.23 per cent to Rs 375.65 on Tuesday. Investors with a long-term perspective can consider applying at the lower end of the price band.