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Mining Behemoth

Despite growing competition for mining leases, NMDC, India’s largest producer of iron ore, remains attractive

Size does matter, and this holds true for NMDC, India’s single-largest producer of iron ore by volume, which produces around 12 per cent of the total iron ore produced within the country. Being such a large producer puts NMDC in a strong negotiating position vis-a-vis buyers.

This navaratna company has access to large proven and probable reserves of high-grade iron-ore, consisting principally of hematite ore. Its high-grade ore quality gives NMDC a strong competitive advantage and helps it command premium pricing and strong customer loyalty.

The company’s cost of production compares favourably with that of the world’s leading iron-ore producers. It is seeking to further lower its costs across all its operations. Being a low-cost producer adds to its strengths. NMDC sells its products at a significant discount to international benchmarks. Hence, it is relatively less affected by a decline in international prices.

What could lead to moat being breached
NMDC’s business depends upon obtaining and maintaining leases of mining sites, some of which are up for renewal. Intense competition from the private sector for securing fresh mining leases could affect the company’s profitability and operating margins.

The company’s future results and margins will depend upon its ability to access mineral reserves with geological characteristics that allow mining at competitive costs.

Concerns
NMDC’s operations have been troubled by Naxalite activities in the recent past. Production has been affected by Naxalite activities in Chhattisgarh’s Dantewada region. The company aims to ramp up production capacity by FY14-15, but the Deposit 11B mine, which is expected to be commissioned by March 2012, may get delayed by Naxalite activity in that area. Eventually, the company’s volume growth may get delayed.

The company has been eyeing several acquisitions across Australia, Russia and the Americas, but nothing definitive has emerged yet. Other than Tata’s investment in Riversdale, no other international investment has yet fructified into large valuations for any Indian miner or steelmaker. How fruitful such overseas acquisitions will prove to be for NMDC remains to be seen.

Valuation
The scrip is currently trading at a price-earnings multiple of 9.4, which is at a steep discount of 61 per cent to its five-year median P/E of 24. Its P/E has contracted around 40 per cent over the last six months. Its earning per share (EPS) has grown at a CAGR of 29 per cent, which translates into an attractive PEG ratio of 0.32.

The steep fall in price has not been accompanied by a simultaneous fall in earnings. In fact, earnings have grown steadily over the past few quarters, which explains the significant contraction in P/E multiple.

Price to book value currently stands at 3.03. This is a throwaway valuation compared to the five-year average of 8.09.

The current enterprise value to sales ratio (EV/Sales) of 4.11 is also attractive compared to the five-year average of 12. Its current dividend yield is 1.9 per cent.

Though policy-related issues in the mining sector may act as a drag on NMDC’s price for some time, investors with a three- to five-year investment horizon may start accumulating this stock at its current levels.