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Steel plant commissioning nears; demerger in 3QFY23E

Multiple long-term and short-term triggers to propel the stock

After posting the highest ever annual production of iron ore (at 42mt) in FY22, NMDC has raised the bar and is now aiming at 46mt for FY23E and even higher for FY24E. The growth will be driven by both Chhattisgarh and Karnataka sectors.

The Nagarnar Iron and Steel Company (NISP) steel plant is nearing commissioning and we expect the same to be completed by end2QFY23/early-3QFY23.

The company is working on the demerger of the steel plant in parallel and is likely to complete the process in 2QFY23/early-3QFY23.

With more iron ore mines being put on auction and steel companies achieving self-sufficiency, the long-term approach of the government to tax iron ore exports (to discourage the same) may warrant a second thought. This can trigger a re-rating of NMDC as it plans to increase its capacity to 70mt in the near term.

The stock is trading at 3.4x our FY23E EV/EBITDA, excluding the book value of the steel plant. We raise our SoTP-based TP to INR220 (from INR200) valuing NMDC’s: (a) mining business at 5x FY23E EV/EBITDA and (b) steel plant CWIP at 75% of the total capex (from 50% earlier). Our FY23 iron ore fines assumption is at a 10% discount to the CMP. Maintain BUY.

Iron ore prices raised by INR1,100/t in the last four months

NMDC has increased iron ore prices by INR200/t for fines and INR1,000/t for lumps, marking a fourth price hike since the beginning of 4QFY22. It has raised the offer prices to INR5,160/t and INR6,100/t, respectively. The price hikes are driven by higher prices of pellets, DRI and secondary TMT.

These hikes have resulted in a cumulative price increase of INR1,100/t for fines and INR1,200/t for lumps.

Further hikes in iron ore prices will depend on international coal prices, which will fuel the domestic secondary TMT and DRI prices

Commissioning of steel plant and demerger of business in 2Q/3QFY23E

As highlighted in our previous report (link here), NMDC has already initiated the process of commissioning of the steel plant by starting the heating of the coke oven batteries in Jan’22.

We believe the demerger of the NISP, which is likely to be completed by 3QFY23E, will be the key trigger for the stock. Thereafter, the government is anticipated to call for bids from potential suitors, which should likely lead to a sale of the government’s holding in the steel plant to the new owner.

The management highlighted that the demerged financials would likely be presented to the Board in 1HFY23E.

As highlighted in our previous report (link here), the management is likely to split the company vertically with mirror shareholding structure. This means, a person holding one share in NMDC will receive one share in NISP in addition to his/her existing holding of one share in NMDC.

These shares of NISP will be listed on the stock exchanges once they are issued and regulatory approvals are in place.

In the interim, the NISP will have a separate management (post-demerger) team and the required manpower will be working on an MDO basis.

Valuation remains inexpensive; retain BUY with 30% potential upside

Domestic iron ore price is not a true reflection of the international price, as it depends upon several factors including: (a) domestic secondary iron ore price, (b) domestic sponge iron price, and (c) domestic pellet price. A weak pricing in any of these three segments can impact the pricing of domestic iron ore. We believe as long as international thermal coal price remains strong, the pricing for the domestic sponge iron, secondary rebar and pellet will remain strong and so will domestic iron ore price.

The current government has been trying to e-auction more iron ore mines to help steel and other units achieve self-sufficiency. This should reduce the dependence on merchant iron ore for these steel plants. Once the major steel plants achieve self-sufficiency in iron ore, there will be no case for imposition of 30% export duty on iron ore. The government in that case is likely to reconsider this policy and liberalize the sector as well and implement a level-playing field for the Indian iron ore miners in the international market.

 While NMDC has guided for 46mt iron ore production in FY23, we are building in production and sales of 45mt in our estimates. In addition, our price assumption is 10% lower compared with the current price, which leaves headroom for both price as well as volume expansion.

NMDC’s iron ore price is about 30% cheaper on the eastern coast of India and about 20% cheaper on the western coast of India v/s Australian imports on grades adjusted basis. Hence, there is a disincentive for steel makers to import iron ore vis-à-vis buying from NMDC.

NMDC is currently trading at 3.4x/3.1x our FY23E/24E EV/EBITDA for the core mining business.

Our SoTP-based TP of INR220 (up from INR200) comprises: a) INR173 for the core iron ore mining business, factoring in a lower ASP v/s the CMP – valuing at 5x FY23 EV/EBITDA and (b) INR47 for the steel CWIP at 25% discount as the commissioning is likely to happen in FY23 itself.

Key risk to our call is slowdown in China, which could lead to lower steel and iron ore prices

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