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Buy NMDC Ltd For Target Rs.160

Iron ore shortage to drive earnings

* NMDC has raised iron ore prices by Rs1,850/t since May. Meanwhile, primary steel producers took a price hike of about Rs15,000/t in the same period. We believe that the consensus will raise earnings as price hikes sustain through Q4.

* Auctioned Iron ore mines in Odisha continue to lag their production targets. Production from these mines stood at 6.51mt vs. the target of 28.7mt (Apr-Oct’20), resulting in a shortfall of at least 22mt, while merchant miners increased exports to China.

* Reopening of Donimalai in Jan’21 should aid volumes in FY22, while continued shortage from Odisha will support prices, putting NMDC in a sweet spot. Progress on the demerger of the steel plant will also support the stock price.

* We raise iron ore price assumption by 22%/16% for FY21/22, resulting in EBITDA growth of 40%/23%. We raise our TP to Rs160 (from Rs136), comprising Rs132 for core mining business at 5x FY22 EV/EBITDA and Rs28 for steel CWIP. Maintain Buy with OW in EAP. Key risk is a sharp rise in domestic ore production leading to price correction.

Shortage of ore from Odisha to remain despite govt efforts:

The basic problem in Odisha is the high premium paid in the auction, which makes the mines unviable. The average premium in the Odisha auction has been 117% (highest is 154%). We believe that such high premiums make these mines unviable in the long term and short term, unless iron ore prices collapse, which is unlikely in the near term. Hence, we expect a few mines might be surrendered, leading to a further delay in normalcy in Odisha ore production. Govt has allowed SAIL to sell low-grade ore dumps with intimation to the respective state govt, compared to earlier policy of taking prior approval. However, we are skeptical about how many mills will use low-grade ore. JSW, one of the largest buyers of low-grade ores, will try to maximize production at own mines to avoid penalty. Easing operational rules like stacking of ore for inspection will lead to congestion in logistics and possibility of revenue loss to the state as sampling large stacks might be an issue.

NMDC has multiple triggers through FY23:

We expect Donimalai mines to restart from Jan’21. Ore production should ramp up in Chhattisgarh due to commissioning of screening plants at the Bailadila complex, while logistics will improve as Indian Railways continues its work on patch doubling (before completing doubling of entire KK lines) through FY23. K’swamy mines’ EC limit has been increased from 7mt to 10mt. We expect these factors to enable volumes to jump from 32mt in FY20 to 46mt in FY23 on a conservative basis. Demerger of the steel plant by FY22-end should add Rs28 to our TP as we value the steel CWIP at a 50% discount to the BV. Refund of deposits retained by the Monitoring Committee in Karnataka should add Rs21 to NMDC’s cash pool, not factored in our TP

Valuations:

The stock is trading at 3.1x FY22 EV/EBITDA ex of Steel CWIP (valued at 50% BV) and 1x P/B for 16% RoE (23% ex Steel CWIP), which look inexpensive given the strong returns delivered by the mining business. Maintain Buy.

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