Strong volume growth to offset allocation premium; Reiterate Buy
* NMDC is likely to restart Donimalali mines in Q4 or even earlier. Steel prices rallied by Rs10,000/t in the last six months, while iron ore prices have inched up by only Rs1,350/t. This leaves scope for further iron ore price hikes.
* We expect construction to pick up after Diwali, leading to a rally in TMT prices, which should in turn push iron ore prices even higher. NMDC is likely to achieve at least FY20 volumes, which implies a strong 18% volume growth in H2 coupled with higher prices.
* We do not see allocation premium to dent EBITDA as: 1) volume growth over the next three years will offset the loss in EBITDA and 2) NMDC has the option to raise prices to offset rising costs. We expect the steel demerger process to be completed in FY22.
* We raise FY22/23 volume estimates by 12%/16% and ASPs by 11%/4%. But due to inclusion of allocation premium, we expect EBITDA to reduce by 4%/15% in FY22/23. Maintain Buy with a revised TP of Rs136 (Rs140 earlier) after incorporating the allocation premium for all mines from FÝ22, except for K’swamy which starts in H2FY23.
Allocation premium on mineral - mechanics:
All mines - iron ore or otherwise - under the allocation route to the PSUs will be subject to the premium, to be levied provisionally at 22.5%. The premium is not a pass-through, but NMDC always has the option of raising prices to offset its costs. The premium shall be chargeable on mines coming for second renewal/or already renewed for the second time. Hence, all mines of NMDC in C’garh and Donimalai mines in K’tka should be impacted. K’swamy mines are due for renewal in Oct-22. We have factored in the impact of a 22.5% premium in our earnings estimates.
Domestic iron ore situation to remain tight:
Out of 17 iron ore mines that have been auctioned in Odisha so far, only 7 have restarted. Out of target production of 24.5mt in H1FY21, actual production was only 4mt. In addition, logistics are choked both on railway and at port. We expect the situation to ease in Q1FY22. Till then, production should remain curtailed. The cost of high iron ore will impact integrated steel players in the near term as their costs will be higher than merchant rates, giving merchant miners scope to raise prices further.
Outlook and valuation:
NMDC has already installed two screening lines in Bachheli and Kirandul to increase volumes which should deliver 2-3mt in FY22. The restart of Donimalai mines should add 7mt in FY22. The extension of ML at K’swamy mines from 7 to 10 mt will add another 1.5mt in FY22 and 3mt in FY23. We expect 12%/16% volume growth in FY22/23 at NMDC which will help offset allocation premium expense. The divestment of the Nagarnar Steel Plant should further help boost shareholder value. NMDC’s mining balance sheet will not be impacted by debt taken for the steel plant. Currently in K’taka, in addition to royalty, 10% is deducted on account of R&R (Rs23bn or Rs7.5/share) which is to be refunded to NMDC and could be distributed as a special dividend. Maintain Buy with a revised TP of Rs136 (Rs107/share for mining business and Rs29/share for steel). Key risk is a decline in iron ore prices.
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