Published on 22/02/2020 11:57:37 AM | Source: ICICI Securities Ltd

Metals Sector Update By ICICI Securities

Posted in Broking Firm Views - Sector Report| #Metals Sector #Sector Report #ICICI Securities #

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Indian iron ore auctions - Part 1

Iron ore auctions are increasing the cost curve of eastern India iron ore mining. The premiums have ranged from 90% to 135% for the seven mines bid for till date. Expectantly, JSW Steel has played the role of an aggressor winning 4 mines (2 captive + 2 merchant). And its refreshing to see Tata steel/SAIL/JSPL not bidding aggressively in the ensuing auctions. Even Arcelor Mittal has been relatively measured in its response to lap up mines. Both state and especially centre has been proactive in changing the norms of the auction wherever necessary and few last roadblocks need to be cleared. Yet, we see the distinct possibility of Odisha ceasing to transmit deflation within states, post the auction. The environment we see playing out will i) reduce the margin profile of the unintegrated steel players and ii) will be beneficial for merchant miners of the other states. Maintain BUY on NMDC, Tata, JSPL.


* Cost curve increasing for a sizeable chunk of Eastern India iron ore production. This is particularly true as the merchant miners are going to co-exist along with captive miners (as Serajuddin has won ~15mnte in the auction). The coexistence of merchant mining on such a scale post the auctions will i) not allow Odisha to virtually export deflation in iron ore prices across states -- one of the main reason that India has for long seen domestic prices at ~40-50% discount to import parity is Odisha playing truant and ii) correspondingly we expect Indian iron ore prices to move up relative to import parity i.e. the 40-50% discount existing till date will narrow. Key takeaway -- Odisha merchant ore can no longer transmit deflation to other states like Chattisgarh, Karnataka, and Maharashtra.


* Yes, as Odisha merchant ore exists and stop playing truant in terms of pricing, other merchant miners will benefit! No longer does NMDC need to supply ore to Chattisgarh sponge iron players at the Odisha Chattisgarh border keeping in mind the pricing differential that Odisha brings. Over a period of time, as these auctions take shape, there will be more localisation of Odisha ore (merchant) in terms of consumption. Interestingly, while cost curves in Eastern India is moving up, NMDC Chattisgarh mines just got renewed at no premium. We see, eventually, a similar predicament for NMDC Karnataka ore as well.


* Increase in costs for JSWS; still better-off compared to an unintegrated steelplayer post auctions. With ~30mnte of EC won, JSWS has decided to secure major part of their existing steel portfolio with Odisha ore and thereby inadvertently add to the existing cost structure. But, still given the scenario that we see unfolding, JSWS will be better off compared to an unintegrated steelplayer in India.


* Despite bidding 118% as premium, Serajuddin can still make money. We place this claim with following underlying assertions i) premium that miners will pay, won’t form a part of IBM base price. It’s a regulatory payment and will be handled separately and passed onto the buyers ii) iron ore price still has to be commercial and hence Odisha’s ability to export deflation to other states goes out and Indian discount to import parity price narrows and iii) Odisha/Indian iron ore production will meander down from here on and scrap becomes more and more prevalent as forms of sponge iron making in India. Serajuddin has definitely shown the way for many more merchant miners to follow.


* No, the advalorem premiums bid don’t alter the base price of ore for Indian bureau of mines in the region! The high premiums bid for the mines don’t make way to the base price which miners will supply to IBM (which is taken to calculate royalty and the premiums). However, there is an element of Mineral concession rules (MCR 2016) that needs revision in our view. MCR 2016 has introduced a cascading impact of royalty for the miners, by including royalty in the base price which goes back to IBM and which IBM publishes as base price and on which miners pay royalty. This particular provision has created unnecessary confusion and needs to be amended (and we append the FAQs where miners have raised this question prior to auction). Having said that, this doesn’t entail that the premiums currently bid by the players also get added in the base price.


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