While we like NMDC's high quality reserves and long mine life, but we think there are negative catalysts ahead in terms of pricing. The recent surge in the global iron ore prices of ~70% from their lows in December 2015 to US$72/tonne in April 2016 was driven by higher demand despite surplus. However, given the weak fundamentals, the iron ore prices have fallen to US$54/tonne at present. Going ahead, we believe that, the iron ore market is expected to remain in surplus for the next few years as big miners continue to increase production, which would put pressure on iron ore prices. In addition, rising domestic supply would also keep domestic iron ore prices under pressure. Given the subdued demand in the domestic market, pricing iron ore dearer as compared to the domestic miners would impact NMDC's volume growth. We expect NMDC to register a volume led 13% revenue CAGR over the FY16-FY18E period and a modest 3% earnings CAGR. Though, NMDC largely remains a dividend play, but going ahead, we believe that, high dividend payout is difficult to sustain in the absence of recovery in the domestic iron ore prices, huge capex and proposed buyback plan. As a result, we believe that upside from CMP is limited. Hence we initiate coverage with SELL rating and a target price of Rs86. At CMP, stock is trading at 12.6x/11.9x FY17E/FY18E earnings and on EV/EBITDA, it trades at 8.2x/8.0x FY17E and FY18E EBITDA, which is higher than its global peers who are trading in the range of 5.5-7x 1 year forward EBITDA.
Market Strategy
¾ Global markets were rattled in June, due to the unexpected outcome of Brexit, apart from continuing uncertainty over US Fed rate decision. The sharp fall in major European currencies led to cautious sentiments. However, markets have recovered most of the 'Brexit' losses, despite uncertainty over the future events in UK / EU.
¾ Indian markets have also risen post the Brexit-led sell-off. Sentiments have remained buoyant on the back of good progress of monsoons and increased probability of passage of GST bill in upcoming monsoon session of Parliament. Government announcements on FDI relaxations, mining, 7th Pay Commission, among others, supported specific sectors / stocks.
¾ With rate hike in US being pushed back, the immediate focus would now be on - 1. Further progress on Brexit-led events, 2. Impact of Brexit on Indian corporates, 3. Pace and distribution of monsoons, 4. Progress on and passage of GST bill in the monsoon session of Parliament and 5. Quarterly numbers. Q1FY17 numbers will be of interest to us, partly because they will now be as per the new Ind-AS standards. On the other hand, we expect rising utilization levels and lower interest rates to kick start the private sector capex in medium to long term.
¾ We are hopeful of more legislative and executive reforms by the Government in the ensuing months and continue to maintain positive stance on domestic infrastructure and interest-rate sensitive sectors, with medium to long term perspective. Our preference stays for companies having strong balance sheets and ethical managements. We need to be selective on export-oriented sectors, because of the possible Brexit impact. Key risks to our recommendation would come from geo-political concerns globally, decline in foreign inflows, sharp currency movements and spike in oil prices.
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