NMDC: Basking in the spotlight as iron ore demand thrives

Steel stocks have been rallying relentlessly nowadays.

The strong demand from major steel consuming regions including India has been keeping steel prices elevated.

In the light of improved government spending on infrastructure and a strong economic recovery anticipated in FY22, Indian steelmakers appear upbeat on their business prospects. On a landed price parity basis, imported steel is costlier than the domestically sourced.  This leaves room for domestic companies to command higher prices.  

 In a note dated March 30, 2021, Care Ratings has estimated that HRC (Hot-Rolled-Coil) prices may shoot up 7%-9% in April 2021 and may touch Rs 59,000-60,000 per tonne to register the highest reading since 2008.

Naysayers say high metal prices are unsustainable and if the second wave of COVID-19 hits India badly, the domestic volumes too might start dropping soon.

Are we in a commodity supercycle? Is the best part of the upmove behind us? Are metal stocks overvalued? Perhaps, nobody knows.
However, taking a more holistic view of the situation might help take well-informed investment decisions.

By the way, any discussion about steel is incomplete without a mention of iron ore—a key raw material used in steel making. Today, we’re covering one of India’s largest iron ore manufacturers, NMDC.  

Production and sales volumes of NMDC in FY21 speak volumes about robust demand for iron ore. The price trend has been strong too. NMDC’s lump ore prices have jumped 65% in the last 6 months and fines have witnessed an escalation of 46%.

NMDC clocks an impressive volume growth in FY21

(Source: Company data)

NMDC accounted for 13% of India’s total iron ore production of 243 MT in FY20. At the time of writing this piece, the industry-level iron ore production figures weren’t available for FY21. Nonetheless, it’s estimated that India’s iron ore production might have reduced to 202 MT in the financial year gone by. In that case, NMDC might have gained market share.

NMDC: report card

(Source: ACE Equity, Company data)

In the first 9 months of FY21, NMDC produced 21.83 MT of iron ore and its sales volume was 22.34 MT. The difference between 9MFY21 volumes and the end-of-the-year volumes suggest how strong Q4 has been for NMDC.

No wonder the stock of the state-owned miner has rallied 70% in the last 6 months.

What does the future look like?

NMDC’s management has indicated that the company aims to increase the iron ore production to 42 MT in FY22, 50MT by FY23, 67 MT by FY25 and 100 MT by 2030.

A public sector company giving volume guidance indicates that at least the management is fairly confident of demand remaining strong even in the future. (By no means are we are suggesting that you should take these estimates at their face value.)

Let’s take a macroscopic and microscopic view.

India is estimated to have produced 102 MT of crude steel in FY21. As you must be aware, India has been eyeing 300 MT production of steel by 2030. The per capita consumption is likely to grow to 158 kgs by then, from 74 kgs in FY19.

Steelmaker are ramping up capacities

In March 2021, AMNS (ArcelorMittal Nippon Steel India) signed an MoU with the Odisha government to set up a 12 MT steel plant by investing Rs 50,000. JSW group committed to invest Rs 1 lakh crore over the next 10 years in Odisha alone.

Considering the objectives of India’s National Steel Policy 2017, the Aatmanirbhar initiative and government’s thrust on infrastructure development, India’s steel sector is likely to remain in the limelight.

So also iron ore mining?

According to BHP, one tonne of steel production requires 1.6 tonnes of iron ore. But as the world is getting more concerned with Green House Gasses (GHG), the preference of policymakers is shifting towards promoting scrapped-based steel production.

Even India’s Steel Scrap Recycling Policy envisages scrapped-based steel production to make up 35%-40% of India’s overall steel production by 2030. At present, India’s scrap steel to crude steel production ratio is more or less the same as envisaged in future; however, with increasing steel consumption (and production) the scrap demand from Indian steelmakers is set to rise in absolute terms.

Are iron ore manufacturers staring at an uncertain future?

Not really, at least for now.

Scrap consumption is chiefly determined by the price differential between scrap and iron ore. Iron ore is abundantly available in India. But in the absence of a large organized market and a clear policy until now, India’s formal scrap market, which can offer a dependable supply to steel plants, may take a while to develop.

At present, India’s total scrap requirement is around 30-32 MT of which ~20% is met through imports. The Country’s projected scrap steel demand is likely to grow to 70 MT by the end of this decade. India is expected to become self-sufficient in sourcing scrap by 2030.

India’s first ever scrappage policy hasn’t gone down too well with some experts and industry players who point out that it lacks incentives. Clearly, it’s an evolutionary process.

Back-of-the-envelope calculation suggests that even if 35% of the total steel produced in India is made from the scrap by 2030, India’s iron ore requirement is likely to grow by ~70-75 MT from FY20 levels. Interestingly, NMDC intends to increase its production by approximately the same amount.

Now the moot question is how does the mining behemoth aim to utilize its incremental production?

The company may increase its market share and may even ramp up its exports; still 100 MT remains an ambitious target.  So far, it’s been a supplier of iron ore to more than 20 steelmakers. Average iron contains 64% makes NMDC’s ore one best grade of iron ores. The company has long term supply agreements with South Korea as well as Japan.

Resumption of mining at Donimalai may help NMDC achieve FY22 output target

In November 2018, the Karnataka Government had agreed to extend the Donimalai lease for a 20 year term i.e. from November 2018 to November 2038. However, it had asked for 80% of the average sales price as the consideration. NMDC made several representations. Finally, the production started in February 2021. Commencement of operations at Donimalai will help NDMC add 7 MT in FY22 and achieve its target production.

The company hasn’t disclosed the terms it has agreed upon to resume the Donimalai site which can have significant implications on the bottom line of the company.

Diversification is the mantra for future growth

It’s noteworthy that, major steel players either prefer to set up plants closer to the source of raw material or their market. And large integrated steel players operate captive iron ore mines. This in turn poses a risk to NMDC’s business. Further, the removal of the distinction between captive and non-captive lets captive miners sell surplus ore in the open market.

In such cases, the premium paid by a steelmaker to get the iron ore mining lease decides how attractive the deal would be.

At present close to 98% of NMDC’s revenue comes from iron ore. Diamonds, pellets, sponge iron and wind power verticals together contribute just 2%. This may change though, in future.

NMDC recently forayed into coal mining and won two coals blocks in Jharkhand. It has invested Rs 5,000 crore to set up coal evacuation infrastructure.

NMDC has global ambitions too. It owns 92.3% equity in an Australian listed company, Legacy Iron Ore Ltd, which mines iron ore, gold and base metals.

NMDC is also planning to venture into battery raw materials which are extremely crucial for the country’s EV prospects.  On this backdrop the meeting between the Ambassador of Kazakhstan to India and the top management of NMDC which took place recently was crucial. And further developments should be watched closely too.

Kazakhstan is a leading producer of Uranium, chrome, copper, manganese, iron, lead and zinc.

The remarks of Sumit Deb, CMD of NMDC, were quite optimistic—“We had very fruitful discussions and have decided to explore mutual collaboration opportunities in many promising prospects of bilateral interest. Kazakhstan is a resource rich country and NMDC would love to share its expertise in this space with Kazakh companies.”

Demerger of Nagarnar Steel Plant (NSP)

At the estimated cost of Rs.23,140 crore, NMDC set up a 3 MT steel plant in Chhattisgarh. This was primarily done to ward off the risk emanating from higher dependence on the iron ore business.

In October 2020, the cabinet committee gave an in-principle approval to demerge NSP from NMDC and sell the government’s entire stake in it to a strategic buyer. It’s been decided that the shareholders of NMDC will also get shares of NSP in the proportion of their shareholding. September 2021 has been set as the deadline for completing the strategic disinvestment.

Valuations

Considering the annualized 9MFY21 EPS of Rs 15, NMDC is currently available at the Price-to-Earnings multiple of 9 and Price-to-Book (PB) multiple of 1.4. The company has a net worth of Rs 28, 885 crore and has a decent track record of dividend payouts. Between 2011 and 2021, the company has distributed Rs 71 on an aggregate basis as dividends.

NMDC: Coming out of years of sideways movement?

Note: Red line denotes a 10-month moving average; green line denotes a 30-month moving average and the red line denotes a 60-month moving average. 10-month average line crossing over the other two lines is considered a positive in trend analysis.

Technical indicators suggest that the investor sentiment has been strong so far. The monthly chart of NMDC depicts a breakout pattern.

Concluding thoughts…

NMDC has the tailwinds of strong fundamentals underpinned by favourable demand-supply conditions. Once the prices drop or stabilize at lower levels, it will be crucial to see whether the volume growth will be high enough to compensate the price corrections. Over the long term, substantial and profitable diversification will be the key to NMDC’s growth because the iron ore production target of 100 MT raises more questions than it answers.

Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

If you are investing in any family run company, besides governance, you may also want to take stock of significant developments in the lives of the promoters. Sometimes, their personal life can overshadow market sentiments. Also pay attention to issues such as pledging of shares by the promoter group and the working capital.

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Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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