Company update: NMDC (Outperformer) - Conducive macro environment; favourable risk-reward

The recent collapse at VALE’s Feijao iron ore mine tailings dam in Brazil has reversed the scenario of expected glut in global iron ore supply in CY19E. This will remove upto 40mt of iron ore from the market, in our view. NMDC, being the only pure play iron ore company in India, will stand to benefit the most, as we expect domestic iron ore prices to rise in FY20E, given our view that the commodity is unlikely be in the oversupply zone. Indian iron ore prices are unlikely to reduce any further in FY19E; in fact, we expect a price increase in FY20E. NMDC provides an attractive buying opportunity at 4.3x FY20E EV/EBITDA. We reiterate our Outperformer rating on the stock with a target price of Rs160, valuing the iron ore business at 5.5x FY20E EV/EBITDA (Rs126/sh) and investments in the steel plant at Rs34/sh (50% of FY20E CWIP).

Global iron ore prices to remain firm: The recent collapse of Feijao iron ore mine tailings dam at VALE in Brazil (top iron ore miner in the world with CY19E production of 400mt) has changed the global scenario for iron ore. VALE has decided to halt operations and expects to decommission those dams over the next three years, causing supply of ~40mt of iron ore to reduce, part of which the company may cover from its other mines. Nonetheless, global iron ore seaborne market is unlikely to be in an oversupply zone in CY19. Global iron ore (62% Fe) price has inched up 13% to ~US$85/t and we expect iron prices to sustain at above US$70/t in CY19E.

Domestic iron ore prices unlikely to see further reduction: We believe high global iron ore prices will restrict the decline in domestic iron ore prices, as risk of imports would subside (NMDC’s iron ore is priced at ~23% discount to import parity at the East coast). JSW Steel, which imported 11.5mt of iron ore in CY18, is expected to buy from Karnataka, as imported iron ore would be unviable for the company. As a result, iron ore prices in Karnataka are expected to inch up. During Q3FY19, higher volume from Odisha miners along with slowdown in demand led to a sharp fall in iron ore prices. With supply expected to regularize in FY20E, and with viability of exports increasing on higher global iron ore prices, oversupply fears in the domestic market would subside, in our view. We expect no further correction in NMDC’s iron ore prices in FY19E, and assume Rs100/t increase in FY20E prices. 

Risk reward favourable; reiterate Outperformer: With the global macro environment turning conducive for iron ore, we expect no further correction in NMDC’s iron ore prices.  We expect the Karnataka High Court to rule in favour of NMDC (on reopening of Donimalai mine without additional premium), which will remove uncertainty on future merchant mining operations in India (next hearing is scheduled on 11 Feb 2019). The company’s 3-mtpa steel plant is expected to be commissioned by FY20-end. We have cut our EBITDA by 1% and 3% for FY19E and FY20E to factor in price cuts taken by NMDC earlier this month. We have also reduced our target price to Rs160 (earlier Rs163), valuing the iron ore business at 5.5x FY20E EV/EBITDA (Rs126/sh) and investments in the steel plant at Rs34/sh (50% of FY20E CWIP). We have introduced estimates for FY21.