• In FY 2009, 92 per cent of the company’s iron ore sales were made based upon long term sales contracts, both domestic and in the export market and the balance was sold in the spot market at negotiated prices. Export sales of iron ore accounted for 19 per cent of the total iron ore sales revenues during the nine month period ending December 31, 2009 and 23 per cent in the Fiscal 2009. As significant portion of its sales were based on long term contracts, sharp declines in the spot prices thus did not have a major adverse impact on its revenues. 
  
  
• Operating profit margins have consistently stayed above 70 per cent over the past couple of years. The same has remained high even during the onset of the global recession that resulted into decrease in sales revenue from iron ore due to decline in sales quantities as well as iron ore prices . Near monopoly status in the domestic iron ore and long term contracts helped the company to maintain its margins. 
  
  
• Historically, NMDC has maintained a highly liquid profile. On a consolidated basis, the ratio of current assets to current liabilities in FY 2009 and nine month ended December 2009 stood at 11:1 and 12:1 respectively. It has also maintained a high level of cash positions. Notably the cash and bank balance stood at Rs 1,20,770 million for the nine month period under review. The company is therefore able to fund its working capital requirements (which again is lower) as well as capital expenditure through internal resources and cash flows. This is also evident from zero debt over the years of its operations.
  

Positives
 

• Largest reserves and producer of  high grade iron ore : With total reserves estimated at more than 1360 million metric tonnes and production that accounted for approximately 13 per cent of iron ore production, the company enjoys a near monopoly position in production of iron ore for sale to consumer industries. This has helped NMDC retain pricing power and safeguard its margins even during the recent slump in demand due to recession.
  
  
  However, the fortunes of the company are largely dependent on the demand from the steel sector that is further influenced by the demand from Auto and Infrastructure activities (in short. the country’s GDP). With expectation of 9 per cent GDP for the next fiscal, the company seems well positioned to capitalise on the recovery in the steel sector and any increase in consumption of the user industries.
  
  
• Diversification and forward integration to reduce risk and enhance product base : NMDC plans to expand and establish its presence as an integrated producer of iron and steel through selective value addition projects. Resultantly, it has already signed an MOU with the Government of Chhattisgarh to develop a 3 mtpa steel plant. It also has plans to develop a steel plant in Karnataka. Furthermore, the acquisition of Sponge Iron India Limited involved in the production of sponge iron will enhance its product base. In addition, there are also plans to develop two pellet plants near its reserves. As a result of these expansion plans, the company will be better placed to cope up with the cyclical nature of the business and mineral prices. 
  
  
• Lesser dependence on Chinese market demand and long term contracts reduce price and demand volatility : Export sales of iron ore account for almost one-fifth of the total sales and the balance is sold in the domestic market.  Further, unlike some players (like Sesa Goa), the company does not directly export to China (however NMDC prices its long term contracts based on the price fixed by global players and thus its contract prices are influenced by demand from China).
  
  
  With small exposure to spot iron ore prices (less than 10 per cent of total sales amounting from spot sales), it is exposed to lower volatility in the spot price. However going forward, the company plans to increase this proportion. The demand for iron ore is expected to increase with the improvement and pace of the global economic recovery. This in turn would also lead to higher spot prices for iron ore. Though the strategy may enable it to gain from any sharp surge in spot prices, it will lead to higher volatility in earnings as well as margins.
  
  
• Sound Financial Performance Record : The strong financial performance of the company is yet another positive. This is also reflected in higher margins, zero debt on books and near monopoly status enjoyed by the company. 
  

Concerns 
 

• Long term contracts due to expire in 2010 or 2011 : As per the prospectus, almost 96 per cent of the agreements for domestic sales are due to expire in 2010. The company will thus have to re-negotiate the terms and conditions  along with the price. However as the spot prices have moved up significantly in the last 5 years, the company stands to benefit from the revision in the long term contract rates. 
  
  
• Client Concentration : Rashtriya Ispat Nigam and Essar Steel Limited together accounted for 37 per cent of iron ore sales revenue in Fiscal 2009 and for the nine months ended December 31, 2009. Thus, the company derives more than one-third of its revenues from just two clients suggesting a  client concentration risk. However, as both these clients too significantly depend on NMDC for their iron ore supplies,there seems to be no significant risk in terms of renegotiating contracts or of slippage of clients. 
  
  
• Fortunes dependant on cyclical user (steel) industries : Sales prices and volumes of iron ore are highly dependant  on the demand from the cyclical global steel industry. The fortunes of the company are thus vulnerable to the prospects of domestic as well as global demand for steel which in turn would influence the demand for iron ore.  The demand for the commodity also influences iron ore prices, which being cyclical, is also volatile.
  
  
• Susceptible to Government Regulation : The business and this industry is highly dependent on the policies and support of the Government of India which makes it susceptible to changes to such policies. Further being a government company, it is more vulnerable to government regulations and policies. As the company has to pay royalty to the government for its mining activities, any upward revision to the royalty rates may adversely affect  the profitability of the company.
  
  
• Exchange rate risk : As the export sales are routed through MMTC Limited, the revenues paid are in Indian currency, but based upon the sales price in US dollars. As the company does not follow any hedging policy, any sharp fluctuation in the exchange rate could have an adverse impact on the revenues as well as profitability.
  
  

CONCLUDING NOTES

The FPO issue will not have any impact on the equity base of the company as it is an offer for sale. However, one would do well to note that the high premium commanded by the company can be attributed to the low float.

With the long term contracts are scheduled to get over, the company is expected to revise the pricing norms by the next fiscal. The prices of iron ore is expected to increase by 40-50 per cent. The forward earnings per share could be much higher. By discounting only a nominal hike in the iron-ore prices and on assumption that the company would register satisfactory rate of growth, the valuation for FY 2011 is around 23 times its upper price band and 20 times its lower price band.

The EV/EBIDTA multiple of less than 11 times, though on the higher side remains comparable to peers. Given the fact that NMDC is one of the largest iron ore producers in the country with the lowest cost of production (high operating efficiency) resulting into comparatively better margins, the FPO passes muster at the lower end of the price band.  

Whether the 5% discount to retail investors is enough remains difficult to answer, but given the importance of getting retail investors back to participate in the Disinvestment programme, it might have been worth the Government’s while to offer a larger discount  to retail participants alongside guaranteed allotment.

theIPOguru’s  Verdict  :

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