Why NMDC FPO is an attractive offer for investors

The government's necessity to garner funds to bridge its fiscal deficit has thrown up an opportunity for investors in the form of NMDC Ltd's follow-on-public offering (FPO).

In order to achieve its divestment target, the government is offering 396 million shares (face value Rs 1) of NMDC through the FPO slated to open on Wednesday, at a floor price of Rs 147 per share - a 7.7 per cent discount to Tuesday's closing price of Rs 159.30.

While the discount provides an incentive, the offer price becomes lucrative looking at the future prospects of the company and current stock valuations.

The stock, which had broadly tracked the Sensex since end-2012, has corrected more than 17 per cent since the closing of Rs 193.15 on October 3, 2012 - in sharp contrast to the roughly 10 per cent gains in the Sensex.

While the under-performance is due to concerns on mining volumes, delayed expansion and lower realisations, a part of it is also due to hangover of the FPO. However, now the volume outlook is improving with gains expected from FY14 onwards, given the ongoing capacity expansion.

The mining curbs in various states in the country are also leading to better pricing power for legitimate miners such as NMDC. Thus, most analysts are positive on the stock and also advise subscribing to the FPO.

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Based on the consensus target price (according to Bloomberg) of Rs 196, there is an upside of 25 per cent even from the current price.

Better volume outlook

Though the delayed capacity expansions have led to NMDC seeing lower volumes in the nine months of FY13, the volume outlook for the next financial year is improving, led by completion of various expansion projects.

For instance, the expansion at 11B mines in Chhattisgarh that was running five months behind schedule is now expected to be completed by March 2013. The mechanisation of mines at Kumarswamy in Karnataka, running three months behind schedule, is now expected to be completed by December 2013, according to analysts.

Thus, while analysts at Motilal Oswal Securities peg the iron ore volumes at 26.7 million tonnes (mt) for FY13, lower than 27.3 mt clocked in FY12, their estimates for FY14 stand substantially higher at 32 mt.

NMDC aims to ramp up its production capacity to 48 mt by FY15 through increased exploration of its existing mines and development of new mines namely, Bailadila 11/B, Kumaraswamy and Deposit 10 and 11/A (in Chattisgarh).

Analysts at Angel Broking, looking at the past track record of NMDC, forecast iron-ore production capacity to increase to 40 mt by FY15. Nevertheless, it still means a good increase from the current levels of 32 mt.

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NMDC, India's largest iron-one producer, had total iron ore reserves of 1,361 mt as of January 1, 2010 - equivalent to 45 years of visibility based on estimated annual output of 30 mt. It possesses the world's best quality iron ore with FE content of greater than 64 per cent. More importantly, these are mined at competitive costs.

Improving profits

On the realisations front, even though NMDC's average realisations per tonne during the first half of FY13 are lower compared to FY12 on the back of declining global iron-ore prices, the landscape has changed substantially now.

This is partly due to the bans on iron-ore mining in Karnataka, which has now been extended to mines in Goa. With Odisha mining also facing restrictions, Chirag Shah at Barclays sees India becoming a net importer of iron-ore by FY14 (ex-Goa) from being a net exporter in FY11.

He estimates the domestic iron ore production to fall at a compound annual growth rate of 3.8 per cent during FY12-15, against an 8 per cent increase in domestic demand. Thus, pricing power is shifting in favour of Indian miners and Shah sees the gap between domestic and seaborne prices to narrow from 37 per cent in FY11 to 7 per cent in FY16.

With improving volumes and better realisations, the profitability of NMDC is likely to improve at a faster pace, thanks to its low-cost operations.

In the long run, NMDC's plans of forward integration into steel-making with an integrated 3 mt plant planned at Jagdalpur, Chhattisgarh should only boost its profitability.