Avoid the issue

NMDC Limited FPO opens on Wednesday the 10th of March and closes on Friday the 12th of March. The company is a mineral company and currently almost all of its revenues come from iron ore mining. The company has re-started diamond mining at the “Panna” mines in Madhya Pradesh.

Business
NMDC was set up in 1958 with the objective of exploring and exploiting minerals and then manufacturing from them and selling the same. NMDC as of 1st January 2010 has iron-ore reserves of 1360.6 million metric tons (mmt) of which a predominant share is of iron ore with 64% Fe content. The breakup of the reserves shows that 977.4 mmt are the proven reserves, 182.2 mmt are the probable reserves and the balance 159.8 mmt are mineral resources.  Over the last three years the company has been the largest producer by volume of iron ore in India. NMDC has open cast mines and they are by and large fully mechanised. The company does its own in-house exploration and has the necessary expertise to explore and develop new mines so that the reserves can be continuously increased.

The diamond mines in Madhya Pradesh carry an authorisation to produce 100,000 carats of gem and industrial diamonds per annum. In 2009 NMDC produced 28.5 million tons of iron ore which is 13% of India’s total iron ore production. The company has the Bacheli Mining complex and the Kirandul mining complex in operation in Chhattisgarh and the Donimalai complex in Karnataka. It also has mines at Kumaraswamy in Karnataka which is yet to begin operations.

NMDC has in the last three years from March 2007 to March 2009 mined 26.3 mmt, 30 mmt and 28.5 mmt respectively. In the current year in the first nine months the company has mined 17.2 mmt. The company has long term sales contracts for its iron ore fines, lumps and slimes and almost 92% of its sales in 2009 were through such long term contracts. The remaining sales are through the spot market.

As part of its future expansion, NMDC has signed an MOU to set up a steel plant of 3million tonnes in Chhattisgarh at Jagdalpur. It also plans to develop a steel plant in Karnataka. The company has acquired a sponge iron unit namely Sponge Iron India Limited which produced roughly 30,500 tons of sponge iron in financial year March 2009. This acquisition is likely to be completed in the next few months.     

NMDC is a low cost producer of iron ore. This is reflected in the cost of production which over the last three years starting from March 2007 has risen from Rs 251.8 per metric ton to Rs 296.3 to Rs 351.7 per ton. Its EBITDA for the same period has moved up from Rs 1361.9 to Rs 1670.2 and finally to Rs 2359.5 per ton. The demand for iron ore is expected to increase continuously and it may be mentioned that India was a net importer of finished steel in the financial year ending March 2009. Indian iron ore exports to China have over the last four years grown at 9.7% and are expected to continue to be robust going forward. NMDC’s domestic contracts are for a period of 5 years and are due for re-negotiation in April 2010, which will help profitability. There is a reset clause if prices move by 25% in the interim period and in the block of 5 years the prices have been revised thrice.

NMDC is a cash rich company and has cash balances of Rs 12000 crs. It plans to acquire new mining leases in India and abroad for other minerals, for iron ore and value addition through forward integration into iron ore beneficiation, pellets and sponge iron.

Objects of the issue
There are no objects of the issue as this is an offer for sale by the shareholder who in this case is the Government of India. The entire sale proceeds would go to the selling shareholder.

Financials
The company reported revenues of Rs 4534.04 crs, Rs 6412.01 crs and Rs 8575.46 crs for the three years ending March 2007, 2008 and 2009. The sales turnover for the nine month period ended December 2009 was Rs 4882.49 crs. The profit after tax for the three years was Rs 2320.21 crs, Rs 3250.98 crs and Rs 4372.38 crs respectively. The profit for the nine months ended December 2009 was Rs 2381.67 crs. The earnings per share for the three years are Rs 5.83, Rs 8.29 and Rs 10.97 respectively. The EPS for the nine months ending December 2009 has come down to Rs 6.00 for the nine months and would be Rs 8 for the full year based on nine months annualised basis. The NAV or net asset value per equity share is Rs 34.42 as of 31st December 2009.

Comparison
The best comparison for NMDC within the country is listed player Sesa Goa which is in the same line of activity namely iron ore. Another comparison could be GMDC which is also a PSU and has lignite mines. The price earnings multiple based on March 2009 earnings based on Tuesday’s closing price on BSE of Rs 375.65 is 34.24, while based on the annualised nine months December 2009 is 46.96. NMDC is extremely expensive on all known parameters such as PE or price to book. The share of NMDC has been fluctuating quite a bit and its 52 week high and low is Rs 571.80 and Rs 141 respectively. The floating stock of this company is extremely poor as the government of India owns 98.38% of the equity. A further 1.38% is held by mutual funds, financial institutions, banks, insurance companies and foreign institutional investors. The public holding is a mere 0.23%.

Based on the NAV of Rs 34.42 the price to book value is 10.91 times based on December 2009 and Tuesday’s closing price. In comparison to these valuations Sesa Goa based on March 2009 earnings of Rs 25.34 trades at a multiple of 17.37. The value of the cash on the books of Rs 12000 crs is roughly Rs 30.26 or Rs 30 per share.

Without comparing the foreign companies like Rio Tinto or BHP Billiton, though NMDC is a large and efficient company producing and mining iron ore, the fact that the floating stock is so poor has made proper price discovery most difficult. This poor liquidity has actually created an artificial price and effectively this offering from the government is intended to bring about some better price discovery. Unfortunately the price at which shares are being offered are very expensive and do not merit investment at these prices simply because they are unrealistic.

There is however one big dilemma that is faced by the seller in this issue. If there is poor institutional demand in this issue then there could be yet another situation where the issue needs to be bailed out. One hopes and prays that such a situation is avoided at any cost.

Present valuation of FPO
The present issue is in a band of Rs 300-350. Based on March 2009 earnings the PE at the lower and higher band is between 27.35 and 31.91 times. If however one were to base it on the nine months ended December 2009 annualised numbers the PE would be 37.5 to 43.75 times. Similarly the price to book value would be 8.71 to 10.17.

Conclusion
Investors have made good money in REC and expect that any offering from the government would do so. Even though the present issue from NMDC offers a 5% discount to retail it is still extremely expensive and offers no scope in the medium term for capital security leave aside any appreciation. I strongly believe that investors should simply ignore the stock at the current price band and wait for other issues as and when the opportunity arises.

SEBI disclaimer: – I do not intent to subscribe to the issue.