NMDC

In spite of its strong fundamentals, NMDC looks slightly overvalued and may correct after Government’s stake sale

THEUnited Progressive Alliance government at the Centre has provided a number of hints about its intention to carry out divestment in many public sector units (PSU). National Mineral Development Corporation (NMDC) is one of the listed companies where the government plans to offload around an 8.3% stake. The current public shareholding in NMDC is a mere 1.6%. Such a low shareholding often results in price manipulation and the market price may not reflect the fair value. Once the government offloads 8.3%, bringing the overall public shareholding to 10%, the higher liquidity is expected to reflect the fair value of the stock. Hence it is very important for investors to know more about the fundamentals of the company so that they can take suitable an investment decision on this stock.

Business:

NMDC is mainly engaged in iron ore mining. It produced around 28 million tonne of iron ore last year and sold a similar amount. It supplies raw materials mainly to domestic companies. Last year, domestic sales accounted for around 85% of total annual sales. Its total iron ore reserves stands at more than 500 million tonnes and the quality of the ore is very high. The average iron (Fe) content –an important quality parameter for iron ore –is more than 65%. Most of the non-integrated steel producers in India are customers of NMDC. It also sells diamond worth few crore rupees every year.

Financials:

The company has more than doubled its iron ore production in the past five years to 28 million tonne. Its revenue has also increased by more than five times to Rs 7,564 crore in FY ’09 during the same time period. The operating margin at 80-90% is one of the best in the industry. Even the average return on capital employed for past five years is around 70%. The company has little debt on its balance sheet and is sitting on cash reserves of more than Rs 8,000 crore. This provides it with more than enough resources to finance expansion plans. The company was relatively insulated during the recent commodity downturn, thanks to its strategy of entering into long-term contracts. Its operating margin during the Dec ’08-Mar ’09 period, the bottom of commodity cycle, was an impressive 73%.

Growth Opportunities:

The company has plans to increase its mining capacity to 50 million tonnes by 2014-15. It has been increasing its capacity consistently to achieve this target. In the long term, it is also planning to set up a steel plant with a capacity of 3-million tonne in Chattisgarh at a cost of Rs 14,000 crore.

Valuation:

The stock of NMDC is not widely tracked by many analysts on the street due to its limited number of floating shares and investors. Its enterprise value (EV) per tonne of mining reserve works out to about 3-4 times that of Sesa Goa, its closest competitor. This looks to be on the higher side even after considering the fact that NMDC has better quality of reserve. Both the companies had similar sales realisation in FY ’09 though. Also a discounted cash flow approach to value the stock––assuming 25% growth in cash flow for first 10 years and 15% for next 15 years and a conservative discount rate of 17%–– shows that the stock is overvalued by around 20-30% given the current price level. The company’s current price-to-earning (P/E) multiple of 35 seems on the higher side vis-à-vis its closest peer Sesa Goa with a P/E multiple of 11. Considering all these facts, we believe the stock may lose some steam once the public shareholding increases to 10%.