Company update: NMDC (Outperformer) - Volume loss at Karnataka imminent; all eyes on court order

NMDC’s share price has been under pressure since Nov 2018 due to fear of loss of iron ore output from Karnataka and expected fall in iron ore prices. We believe the CMP factors in the expected weakness in iron ore prices, while we await the final outcome on the Karnataka mines. Our 15% and 5% EBITDA cut for FY19E and FY20E, respectively, factors in volume loss from Donimalai mines in FY19 and lower iron ore prices. Reiterate Outperformer rating on NMDC with a revised target price of Rs163 (earlier Rs172).

NMDC moves High Court against Karnataka state government: After unsuccessful negotiations between the Central and state governments pertaining to the renewal of NMDC’s Donimalai mines, NMDC has filed a case in Karnataka High Court against the state government. The first hearing is scheduled on 10 Jan 2019, as per sources. NMDC has contested that MMDR Act does not allow the state government to levy additional duty at the time of renewal of mines for PSUs. We note NMDC’s Chhattisgarh mines are due for renewal in Mar 2020 and Karnataka’s Kumaraswamy mine in Oct 2022. The outcome of the above case will decide the future of NMDC’s (merchant) mining in India.

Factors in lower iron ore prices: NMDC has reduced iron ore prices by 14-16% (cut the prices of fines by Rs450 to Rs2,860/t and lumps by Rs600 to Rs3,250/t) in Dec, amid price cut effected by Odisha miners in addition to fall in global iron ore prices. Current prices are at parity to the landed cost of imports in India’s east coast. We have factored in average iron ore price of Rs2,760/t for fines and Rs3,150/t for lumps in FY20E.

Valuation and View: We believe while the final outcome would take time, it is likely to be in favour of NMDC, as the same would set a precedent for merchant mining operations in India.  However, NMDC will not be able to carry out operations at the Donimalai mines in FY19E, as the matter is sub-judice. We have therefore cut NMDC’s sales volumes by 3mt to 31mt for FY19E but maintain our estimate of 38mt for FY20E, assuming a favourable outcome from the proceedings. We have also cut our EBITDA by 15% for FY19E and by 5% for FY20E to factor in loss of volume and weak iron ore prices. As a result, we reduce our target price to Rs163 (earlier Rs172), valuing the iron ore business at 5.5x FY20E EV/EBITDA (Rs131/sh) and investments in the steel plant at Rs32/sh (50% of FY20E CWIP). We expect NMDC to start commercial production of its 3mtpa steel plant at Chhattisgarh from FY20E end. We expect the stock to trade range bound until the final outcome of the Karnataka mine. Key risk: Unfavorable court order in Karnataka mine case.