NMDC - Fines price cut a negative surprise; 1Q to be strong - JM Financial

NMDC reduced prices of iron ore fines by Rs. 100/ton and for lumps by Rs. 200/ton for the month of July due to subdued demand and in anticipation of a poor season with the onset of monsoon. After the reduction, iron ore lumps would now be available at Rs. 4,500 a ton (Rs. 4,961 incl royalty; JMfe FY14E at Rs. 4,788), while fines at Rs. 2,510 (Rs. 2,761 incl royalty; JMfe Rs. 2,599) per ton. While the lumps cut was widely expected given monsoons and low construction activity, fines cut has been surprising given iron ore in rupee terms has held up strong. NMDC continues to be a relative pick in a largely underweight metal sector with as fair value of Rs. 127/share. BUY.

Lumps price cut widely expected; fines price cut a negative surprise: NMDC reduced prices of iron ore fines by Rs. 100/ton and for lumps by Rs. 200/ton for the month of July due to subdued demand and in anticipation of a poor season with the onset of monsoon. After the reduction, iron ore lumps would now be available at Rs. 4,500 a ton (Rs. 4,961 incl royalty; JMfe FY14E at Rs. 4,788), while fines at Rs. 2,510 (Rs. 2,761 incl royalty; JMfe Rs. 2,599) per ton. NMDC, which has been following the practice of evaluating rates on monthly basis since last October, did not tweak the prices of iron ore both in May and June. It, however, lowered the price of lumps by 7% in April and 2.5% in March. However, the company had not changed prices of fines for some time now. While the lumps cut was widely expected given monsoons and low construction activity, fines cut has been surprising given iron ore in rupee terms has held up strong.

1QFY14 PAT can touch Rs. 15.8bn as per our estimates: The company reported 1QFY14 sales and production volume of 7.26mn tons and 6.83mn tons respectively. While the sales growth and inventory liquidation was a positive, a 1% decline in production was disappointing. Analyzing the e-auction data, we feel the company can achieve a blended realization of Rs. 3,800/ton for the quarter given higher proportion of lump sales during the quarter (refer exhibit 3). While Karnataka's production run rate has been good at ~8.7mn tons annualized, Chattisgarh production disappointed at ~18.7mn tons only (annualized). The company achieved 5.03mn tons of sales in Chattisgarh and 2.23mn tons of sales in Karnataka. We estimate a contribution of 10% towards SPV in Karnataka on 2.23mn tons at Rs. 847mn for the quarter. We estimate sales of Rs. 27.6bn, EBITDA of Rs. 18.1bn and PAT of Rs. 15.8bn for the quarter assuming 0.7mn tons of export. Any decline in exports from estimates will positively impact earnings.

Weak pricing power a structural weakness; relative pick in an underweight metal space; BUY: Though NMDC fits into our overall theme of preference to miners with superior return ratios vs peers (17-19%), quality assets, late exposure to commodity cycle ensuring significant cash balance (Rs. 54/share) in a commodity down cycle, advantages are partially compromised by structural weaknesses of weak pricing power in a soft domestic demand environment. We remain cautiously optimistic on the name given the steep correction in stock price. We however prefer Hindustan zinc over NMDC as our top pick in the metal space as it not only fits into our overall theme but also displays no structural weaknesses as in NMDC's case. We currently factor in an iron ore price assumption of US$120/ton at 57INR and factor in ~100% royalty sharing proposal in our FY15 estimates. Positive triggers for the stock could be an increase in volume off-take if MB Shah commission report on Orissa mining (expected shortly) imposes a state wide ban and any delay/dilution in ~100% royalty sharing proposal of MMDR bill. NMDC continues to be a relative pick in a largely underweight metal sector with as fair value of Rs. 127/share.

Source : Equity Bulls

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