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Value unlocked; now what? Initiate with BUY

* Strength to weakness: NMDC spent ~Rs200bn in setting up a 3mtpa steel plant at Nagarnar which has not only been draining cash from the high-margin iron-ore business, but also impairing return ratios. Demerging the steel asset has been the right strategy in our view which, apart from unlocking value for shareholders, will also materially improve NMDC’s return profile, now that the big-ticket item has moved off its balance sheet.

* Iron-ore business remains attractive: : NMDC’s mines have high-grade, low-impurity iron-ore which, when coupled with favorable geological conditions, are placed among the lowest cash-cost mines globally. At current production rate, NMDC’s reserves can last for ~40 years, although further drilling would establish more reserves. NMDC can grow its mining/evacuation capacity, from ~48/51mtpa now to ~67/80mtpa over the next 3 years, although we have built-in only 48mt volume in FY25E. Management is also considering setting-up a sizeable pellet business, which is low capital cost (~US$400mn for 10mtpa capacity) forward integration. Further, pellets have good global demand. A large foray by NMDC into the pellet business would act as a natural hedge for any volatility in its iron-ore sales volume due to business cyclicality, etc. Price of NMDC’s current iron-ore fines is at a 20% discount, as per the export parity pricing method, implying scope for price to increase from the current Rs3,900/t for iron-ore fines (Fe: 64%).

* Minor foray into coal mining: : NMDC was allocated Tokisud (2.3mtpa)/Rhonne (8mtpa) coal blocks by the GoI in 2020 which it can use for merchant sales. While commencement of production at Rhonne is not yet in the offing, that at Tokisud is nearer at hand (FY24).

* The high-quality, seaborne iron-ore sector – An oligopoly, in our view: : Majority of the high-grade, global seaborne iron-ore is supplied by a handful of players, mainly from Australia and Brazil; to that extent, we believe the industry is a snug oligopoly, with inherent pricing power. Iron ore in India (and more so for NMDC) is sold on an export-parity basis. While export parity pricing by itself is not advantageous for NMDC, there is a good correlation with global seaborne iron-ore prices; hence, NMDC too would indirectly benefit from this oligopolistic setup. China and the developing world’s reliance on steel scrap increasing to a point where it dominates iron-ore usage is still quite some distance away.

* Steel asset value: : NMDC has demerged its steel asset of 3mtpa, with a record date of 28-Oct-2022. Shareholders, as on the record date, have been allotted shares in the resultant company (i.e. its steel asset, namely NMDC Steel), equivalent to their stake in NMDC. Hence, for existing shareholders as on record date, valuation of the steel asset is also important (refer to Pages 5-6 ahead). The GoI has also initiated the process of divesting its entire stake of 60.8% in the steel asset to a strategic investor

* Valuation methodology: : We value NMDC on FY25E EV/EBITDA multiple of 4x, at fair value of Rs180/share, which implies FY25E P/E of 8.5x and FCF yield of 12%.

* We initiate coverage on NMDC with BUY and 1-yr fwd TP of Rs180/sh. Key downside risks: 1) disruption due to instability in the Chhattisgarh region; 2) regulatory uncertainty, in terms of potential higher royalty demand from State governments.

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