The follow-on public offer (FPO) of NMDC Ltd opens at a time when rising steel production is translating into higher demand and prices for iron ore. Spot iron ore prices have nearly doubled from a year ago and are up by about 11% over January. Negotiations for global 2010 iron ore contracts are expected to see prices rise by as much as 40-50%. That is good news for NMDC, as its own long-term contracts for domestic and export markets are expiring in 2010 and 2011, respectively. At least 90% of its total output is tied in long-term contracts and domestic sales account for nearly 80% of sales.
Its ability to renegotiate these contracts at better rates will thus determine improvements to its profitability over the next few years. Government policy plays a key role in the sector, with steel companies lobbying to protect their interests. An export duty of 5% is levied on iron ore lumps. NMDC also requires government permission for export of iron ore with above 64% iron content, which accounts for a significant portion of its production. There are quantitative restrictions on exports from its Bailadila mines. In 2008, its mining lease in Karnataka was renewed on condition that the ore will not be exported. This growing trend towards using policy deterrents to ensure iron ore availability for domestic steel consumption lowers the pricing flexibility of domestic ore companies.
In the half-year ended September 2009, NMDC’s average export price realizations were up 7%, while for domestic sales the increase was 4% from the year earlier.
However, financial performance suffered due to lower output. The global slowdown hit demand from steel companies. Sales were also affected due to Naxalites blowing up a supply pipeline. Production was down 14% as a result. In the nine months ended December, sales fell 24% to Rs4,256 crore while net profit dropped 28% to Rs240 crore. The government’s decision to change its royalty calculation from a specific duty to a 10% levy on sales has raised the burden significantly.
Graphic: Naveen Kumar Saini/Mint
The steel industry is projected to grow at around 10% in 2010 and emerging economies, especially China, are expected to be driving this demand. NMDC should, thus, be able to see both production and price realizations improve in the near to medium term. The company is expanding existing capacity and developing new mines. Major capital expenditure plans are on the anvil. Two pellet plants are being set up at a cost of Rs1,300 crore. It will set up two new steel plants with 3 million tonnes (mt) and 2 mt capacity. NMDC’s zero-debt status and net cash generation of Rs2,800 crore give it ample headroom for using internal accruals and debt to fund these projects.
Based on its annualized earnings per share of Rs8, the annualized fiscal 2010 price-earnings multiple seems expensive at 50 times. But its performance in fiscal 2011 will be considerably better than 2010 due to rising output and better price realizations. In the December quarter, adjusted net sales were up 22% over a year ago. More clarity will emerge when domestic contracts are renewed in April. At present, the low public float of less than 3% could also be creating a liquidity premium. This will change after the float goes up to 10% after the FPO. A price band of Rs300-350, as reported, ensures that both the valuation and liquidity concerns are addressed at the lower end of the range.
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