NMDC Ltd: Valuations attractive

NMDC has corrected sharply over the last two months on the back of weak iron ore prices globally, subdued domestic steel demand and Government’s plan to divest. NMDC’s iron ore realizations are expected to remain resilient to the slide in global iron ore prices as we estimate the domestic iron ore market to remain tight. Volumes are expected to rise in FY14 led by commissioning of the uni-flow system and the Bailadila 11B mine coupled with higher contribution from Karnataka. We expect earnings CAGR of 6.4% over the period FY12-15 on the back of strong volume growth. 

At the current stock price, the market seems to be building in too much pessimism into the stock. The stock is currently trading at 4x FY14E EV/EBIDTA, which is at a huge discount to its historical one year forward EV/EBIDTA of 12.6. We value the company at 5x FY14E EV/EBIDTA and arrive at a 9-month price target of Rs182. Despite the cut in our earnings estimates and target price, we maintain our BUY recommendation as we see 14.5% upside to our revised target price from current levels.

We believe global iron ore prices would not stay below the US$100/ton level for a longer period due to high cash costs for Chinese miners and slower than expected volume growth in the seaborne market. A slower ramp up in supplies from Australia and Brazil coupled with very low exports from India would keep the seaborne iron ore market in balance. Slowing demand growth from China would continue to remain an overhang and hence would cap the increase in iron ore prices over the next two years.

Iron ore supply in the domestic market has declined sharply over the last two years due to the various regulatory actions taken by the Government to curb illegal mining. We estimate domestic iron ore production would decline to FY05 levels to 140mn tons in FY13 on account of the various regulatory checks setup by the Government. On the other hand, demand is expected to remain firm as we estimate steel capacity addition of ~22mn tons over FY12-14. A combination of declining iron ore supply and rising iron ore demand would lead to a tight domestic market for iron ore over the next two years.