NMDC: falling iron ore prices signal tough times

NMDC Ltd has cut iron ore prices by about 12% over September. This continues a trend of falling prices seen in FY15. Weak demand conditions for steel and iron ore, as a result, are making life difficult for iron ore producers.

This falling trend in price realizations is accompanied by weak demand conditions, leading to weak trends in output and, as a result, sales growth is likely to get affected in both value and volume terms. Provisional data till September 2015 shows that sales are down by 17.3% over a year ago.

Prices have been falling continuously. Lump prices are down by 18% so far since April and down by 45.6% over a year ago. Prices of iron ore fines have fallen further, down by 25.5% since April, and by 53.8% compared with a year ago. Lumps accounted for about 36% of its output in FY15, according to a Motilal Oswal Research report.

A decline in volume sales will see certain variable costs such as freight and royalty decline. But this is partly offset by higher royalty rates and also the imposition of new cesses for the district mineral foundation fund and for mineral exploration. These levies were not provided by the company in the June quarter, as they had not been notified by the government. Once provided, they will eat into profit further.

But other costs such as employee costs and depreciation remain relatively steady and may even increase as new capacity comes on line in FY16.

Apart from iron ore mining projects, NMDC is setting up pellet and steel projects to capture more value in the steel-making process. While these projects were viable when both iron ore prices and steel prices were shooting through the roof, the fundamentals look very different now.

Iron ore producers may get some breathing space from the fact that international iron prices, which had fallen to near $40 per tonne levels, have recovered to above $50 per tonne and are holding relatively steady. But last week, Citigroup raised a red flag, saying that new supply from Australia’s Roy Hill iron ore mine in 2016 will send prices below $40 per tonne. This mine is expected to start shipping ore in October and a ramp-up will add to low-cost iron ore supply.

Low-cost large-scale iron ore production does two things. It makes it unviable for smaller companies to produce ore at a competitive price. It also drives down the iron ore price, which in turn exerts downward pressure on the price of steel. Thus, even the value that NMDC is seeking by branching out into steel-making is not an easy picking.

Even in domestic iron ore markets, domestic iron ore production is expected to improve, as the regulatory roadblocks to mining are being resolved. That may see steel makers get the upper hand in price negotiations for ore supply as well. Not surprisingly, NMDC’s price is down by 40.6% over year ago, and by 26.5% since April.

The writer does not own shares in the above-mentioned companies.