MOSL: NMDC (Buy)-Some pricing pressure, but fundamentals are strong-Trading at 2.8x EV/EBITDA

​NMDC: Some pricing pressure, but fundamentals are strong; Trading at 2.8x EV/EBITDA; Re-iterate BUY

(NMDC IN, Mkt Cap USD5.5b, CMP INR113, TP INR180, 59% Upside, Buy)

Operations are strong, but book cleaning affected PAT in FY17

NMDC’s business is strongly supported by robust demand growth from its key customers (JSW, Essar, RINL, etc.), high quality ore and strong supply chain. Sales increased by 24% to 35.6mt and adjusted EBITDA by 28% to INR45b in FY17. NMDC also rewarded shareholders with an impressive INR96b in the form of buyback and dividend. However, reported PAT declined 23% YoY in FY17 as the company used the strong financial performance to clean its book aggressively, providing for ~INR9b toward mine closures, capital assistance to the Indian Railways for track augmentation, and disputed debtors and service tax, which are not recurring in nature and do not impact cash flows. Depletion of treasury after buyback also affected interest income and thus PAT.

Some pricing pressure, but volume growth is strong

Indian iron ore prices have softened over past few months in eastern India, as exports of ore and pellets declined due to volatility in the international market. NMDC too has cut prices by INR200/t w.e.f. 1 July 2017. We have trimmed margins, but increased volumes by 2.1mt to 40.1mt for FY19E as the operations remain strong. Sales grew strongly by 18% YoY in 1QFY18E. As a result, EBITDA is reduced by 5% to INR57b for FY19E. The recently commissioned pellet plant in Karnataka is getting stable and thus will add 1.2mt of volumes. A modified pricing policy, which allows different regional pricing, has helped in strong volume growth.

Valuations are factoring in high pessimism

At CMP, the stock is trading at EV/EBITDA of 5.7xFY19E. If we were to adjust CWIP of INR164b toward the steel project, valuations are extremely attractive at 2.8x FY19E EV/EBITDA. NMDC’s board continues to pursue divestment at its steel plant and has appointed a banker. Therefore, we believe that CWIP deserves at least book value. If Indian iron ore exports do not pick up, NMDC may need to take another price cut of INR200-300/t, which can trim EBITDA by INR12b to INR46b. Adjusted valuations will still be extremely attractive at 3.5x FY19E EV/EBITDA.