Value trap: NMDC has cut iron ore prices by 14-16% for September 2021 after a sharp 40% correction in seaborne prices in the past three months. A drop in Chinese steel production and risk of increasing supply restrictions have been the key catalysts. We see further downside to iron ore prices given absence of cost support, ramp-up of India’s domestic supply and lower Chinese steel volume. NMDC, despite inexpensive valuations, should remain under pressure amid declining margins and limited growth visibility. SELL.
Seaborne iron ore prices collapse with increasing demand risk from China: Seaborne iron ore prices have corrected by 20% in the past one month and 40% since the peak of US$235/ton in May 2021. The weakness was expected by us, although the collapse has been steeper than anticipated. The key catalyst has been 7% yoy drop in July 2021 Chinese steel production. The iron ore market is fearing weaker demand in China in 2HCY21 led by (1) lower steel margins, (2) upcoming maintenance shutdowns by steel mills and (3) the risk of increasing supply restrictions for China to have flat production in CY2021 (production was +13% yoy in 1HCY21 and 2HCY21 needs to be -10% over 1HCY21). We estimate marginal cost at ~US$100-110/ton for seaborne supply and a bearish demand outlook should keep seaborne iron ore prices under pressure. We forecast downward trending seaborne prices – US$150/ 125/100/ton for FY2022/23/24E.
Domestic supply recovering at a fast pace: Iron ore supplies in India got impacted in FY2021 (production -17% yoy) due to transition issues. With strong seaborne prices and ramp-up of auctioned mines, iron ore production is recovering. In YTDFY22 (April-July 2021), production is up 10% versus FY2020 levels led by Odisha. Moreover, with more 10 mines lined up for auction, we expect supply to increase further. Currently, NMDC prices are at 25% discount to import versus the past two-year average at 35%. With increase in supply, we expect domestic iron ore price discount to increase further and domestic prices to correct further.
NMDC – down-trending iron ore prices and earnings downgrades to keep stock under pressure: NMDC has reported sales of 15 mn tons (+46% yoy) in April-August 2021 and is on track to achieve 39 mn tons (+17% yoy) in FY2022E. However, we see NMDC struggling for volume growth from FY2023E, similar to the previous decade, as primary steel producers acquire captive mines. On prices, we see further downside from current levels led by weaker seaborne prices and widening domestic discount with ramp-up in domestic supply. We forecast NMDC’s fines realization at Rs 4,500/3,030/ton versus spot at Rs 5,160/ton in FY2022/23E. Our EBITDA estimate is 5%/29% lower than consensus for FY2022/23E. We maintain our Fair Value of Rs 155 on September 2023E at 5X EV/EBITDA.