Event update: NMDC (Downgrade to Underperformer) - Lacks earnings visibility

Event

Govt. of Karnataka did not renew the mining lease of Donimalai mine of NMDC and starts preparing to put the mine under auction.

Details

• Earlier, Karnataka Govt had renewed the lease in Nov 2018 with imposition of a special condition that NMDC has to remit 80% of sales value as lease rent which was being contested by NMDC. Later, Karnataka High Court ruled in favour of NMDC and set aside the special condition imposed by Karnataka Govt.
• Post this, Karnataka Govt. has decided to cancel the lease of 7-mtpa Donimalai mine and put the mine under auction. NMDC may contest this in the court but looks unlikely that it will receive the mine back.
• This act poses a serious threat to NMDC’s future lease renewals: 1) majority of Chhattisgarh mines due for renewal in Mar, 2020 and 2) Kumaraswamy mine in Karnataka in Oct, 2022.
• There exist a possibility that Chhattisgarh Govt. may not renew the mines in favour of NMDC. It can either renew the lease in name of NCL (JV between NMDC-CMDC) as the mines in Chhattisgarh mines may not be put for auction as the mines are located in naxal-hit areas. Further, it rules out the possibility of renewal of Kumaraswamy mine in Oct, 2022. In any of the scenario, this will create uncertainty on future profitability of NMDC.
• This event will completely change the profit dynamics of NMDC as it may have to compete with private miners and captive producers resulting in huge premium outgo.

Valuation & view: Downgrade to underperformer with TP of Rs72

NMDC does not provide any earnings visibility beyond FY20 as majority of its Chhattisgarh mines are due for renewal in Mar-20 (~15mt of production) and Kumaraswamy mine in Karnataka are due for renewal in Oct-22. We are not sure about the outcome of future lease renewals. We remain cautious on the stock until further clarity emerges on renewal of Chhattisgarh mines. We change the valuation methodology and value it on P/B basis. We value the iron ore business at 0.5x P/B FY20E (Rs46/sh) and investment in steel plant at Rs26/sh (50% of CWIP). Accordingly, we revise downward our target price to Rs72/sh (earlier Rs158/sh). Downgrade stock to underperformer.