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NMDC rating – BUY: Demerger of steel plant is a sound trigger

Hence, we raise our TP to Rs 215 (earlier Rs 185) on an unchanged 5x Ebitda as we roll over to Q3FY22e earnings.

We upgrade NMDC to Buy pursuant to the company’s board approving the scheme of arrangement for demerger of its steel plant. In our view, the board’s approval is a definitive step in the direction of possible divestment of the steel plant and the Street has not attributed any value to the plant (CWIP of Rs 186 bn).

Considering that divestment process can be long winding and uncertain, we attribute an option value of Rs 22/share (equivalent to 50% of replacement cost) to the steel plant. Hence, we raise our TP to Rs 215 (earlier Rs 185) on an unchanged 5x Ebitda as we roll over to Q3FY22e earnings.

Steel plant likely to get its due
NMDC’s board has approved the scheme of demerger of NMDC and NMDC Steel in a manner that would mirror the shareholding pattern of NMDC in NMDC Steel. In our view, this is a significant step and within the timeline of July 2021 end as was guided by the management during Q4FY21 earnings call. As of March 2021 end, the CWIP of the steel plant was Rs 186 bn of the total expected outlay of Rs 216 bn. As per our understanding, the Street does not attribute any value to the plant owing to uncertainties regarding divestment/commissioning. We believe the demerger could be a prelude to divestment and hence the value of steel plant could start reflecting partially in the stock price.

We peg steel plant value at 50% of replacement cost
In our view, the location of the steel plant and uncertainty with respect to commissioning are primary bottlenecks for possible divestment. That said, except JSW Steel’s Dolvi expansion (5mtpa), we do not see any major capacity coming on board until FY24. Hence, the 3-mpta steel plant (HRC) could be attractive for incumbents with sufficient downstream capacity or foreign players looking to get a foothold in the fast-growing and low-cost Indian steel industry. Hence, we peg the option value of the steel plant at Rs 22/share– 50% of replacement cost.

Outlook: A sound trigger
With NMDC board’s move, we believe the Street will start attributing value to the steel plant. Besides, NMDC thus far has funded the steel plant capex through internal accruals. All the expenditure made by NMDC on behalf of steel plant post March-21 would be reimbursed by the new entity. Hence, NMDC would focus on the organic, high returns capex in iron ore business.

However, given the arduous location of the steel plant and uncertainties with respect to commissioning, we will attribute an option value of Rs 22/share– equivalent to 50% of the replacement cost of $650/t for a 3mtpa HRC plant. Further, we roll over to Q3FY23e resulting in a revised TP of Rs 215 on an unchanged 5x Ebitda. We upgrade to ‘BUY/SO’ from ‘HOLD/SN’.

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