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Steel plant divestment can unlock value

NMDC has reported in-line EBITDA at Rs31bn. NMDC witnessed additional royalty incidence of Rs23.9bn (H1FY22). Karnataka production continues to clock an impressive run-rate of ~12mtpa. EBITDA/te at Rs3,464/te has reduced ~21% QoQ and we expect the same to normalise at Rs1,200/te by FY24E. With 22.5% additional premium extended to all mines (barring Kumaraswamy), the risks to business model have significantly reduced. We maintain HOLD with a reduced target price of Rs150/share. The steel plant CWIP at P/B of 0.6x can lead to value attribution of Rs38/share (FY23E). We have reduced the value of the steel plant, in keeping with the assumption of an impending downcycle. 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.

* Key notables for Q2FY22. Rs16bn of receivable buildup was witnessed in H1FY22 cashflows. While reported receivables days have reduced from 50 days at end FY21 to 43 days on end H1FY22, (per our analysis) Rs3bn has been provided for doubtful advances (Expected credit loss). Inventory increase is ~Rs7bn. Thus, increase in working capital has impacted cashflows in H1FY22 (~ Rs15bn increased witnessed in working capital). Capex incurred in H1FY22 is ~Rs10bn while increase in CWIP is ~ Rs6bn. ~Rs10bn of net debt reduction has been seen in H1FY22, which was counterintuitive given previous management assessment of gradual increase in debt for the steel entity. The impact of higher royalty (150% of the royalty payable) on all the iron ore mines of NMDC except Kumaraswamy mines at Karnataka is Rs23.9bn for the current period (~Rs14bn for Q2FY22) and is included under Royalty and other levies. Production from Karnataka (Donimalai + Kumaraswamy) continues to maintain ~12mtpa run-rate in H1FY22.

* Iron ore EBITDA/te expected to normalise to Rs1,200/te by FY24E from FY22E expected EBITDA of Rs3,400/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 Rs1,500/te. Thus, we feel our base business DCF factors a (slight) upmove in profitability from the previous through cycle numbers NMDC is accustomed to.

* Maintain 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. Sharp correction in iron ore prices (globally) doesn’t augur well for NMDC. The increased sponge iron margins in India and systemic restocking demand as domestic prices cools off have provided interim relief to domestic iron ore prices.

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