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Steel plant divestment/commissioning and rampup can unlock value

Board of directors of NMDC, has approved the scheme of arrangement for demerger between NMDC and NMDC Steel. 2.93bn fully paid up equity shares of Rs10/share each of NMDC Steel shall be issued and allotted to the shareholders of NMDC, against 2.93bn fully paid up equity shares of Rs1/share each held by them in NMDC. Preliminary discussion with the management highlights the following i) six months till listing of NMDC Steel shares ii) Book value of NMDC Steel ~ Rs185bn. Debt of ~Rs19bn will be transferred to NMDC Steel. Face value of NMDC Steel has been fixed at Rs10/share and iii) Steel plant commissioning is scheduled at Sept-Oct 2021. Delay in commissioning can create overhang on valuations. Upgrade to ADD with a revised target of Rs 195/share (previous target price of Rs182/share). We start valuing the steel investment separately at 0.8x FY23 book.

* Demerger and subsequent listing of the steel business is the first step for value unlocking. The steel plant CWIP at P/B of 0.8x can lead to value attribution of Rs55/share (FY23E). The full value can be realised when i) plant commissioning happens and ii) final capex is known. Delay in commissioning can be an overhang in realising the potential value of the steel plant divestment. Expected commissioning of the steel plant is Sept-Oct, 2021. There can be further value unlocking if NMDC/government is successful in finding a divestment partner for the steel plant. Divestment of the steel plant may witness certain difficulties because of the location of the plant.

* Iron ore EBITDA/te normalised to Rs1500/te by FY24E from FY22E expected EBITDA of Rs3352/te. Else, valued on FY22/23E earnings trajectory, the base business will throw much higher valuations. Revised MMDR has mandated an additional 22.5% of advalorem (royalty) incidence for NMDC mines post second and subsequent renewal. To note here, prior to additional incidence, NMDC used to do through-cycle EBITDA/te of Rs1500/te. Thus, we feel our base business DCF factors a (slight) upmove in profitability from the previous through cycle numbers NMDC is accustomed to.

* We upgrade to ADD from HOLD. We believe that the attributed value of the steel plant will be realised when i) commissioning happens or ii) government is able to find a suitable partner to offload stake in the steel plant. Demerger and listing was the desirable first step and has been approved by NMDC board. Elevated iron ore prices and profitability is also leading to higher interim earnings and dividend expectations (we expect FY21 dividend of Rs20+ at 12% yield) and may have a positive ruboff on interim valuations. Q1FY22E expected EBITDA at Rs42.4bn, sets up the stage well for FY22E EBITDA of Rs134bn.

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