MOIL Vs. CIL Vs. NMDC Tel: 022- 39357800 Ext: 6821 [email protected] Mining Sector Update MOIL Vs

MOIL Vs. CIL Vs. NMDC Tel: 022- 39357800 Ext: 6821 Bhaveshu.Chauhan@Angelbroking.Com Mining Sector Update MOIL Vs

Sector update | Mining December 12, 2011

Bhavesh Chauhan

MOIL vs. CIL vs. NMDC Tel: 022- 39357800 Ext: 6821 [email protected] Mining sector update MOIL vs. CIL vs. NMDC Recent declines in the stock prices of the three mining companies, viz. Coal India (CIL), MOIL and NMDC, have led to questions in the minds of investors as to which company can provide higher upside from here. We analyzed all the three miners on different factors categorized under the parameters of industry (market share, end-user dependency and mining tax), business (mine life, risk to volume growth, immunity to price declines and staff cost) and valuation (EV/EBITDA). Our analysis points out that NMDC could be a winner amongst the three.

On the industry front, we believe CIL is better placed as compared to MOIL and NMDC as the company is dependent on the power sector, which is relatively stable as compared to the steel sector. However, the upcoming 26% mining tax will hurt CIL the most. However, it should be noted that CIL spends ~5% of its net sales (~18% of its net profit) on corporate social responsibility (CSR), which could be reduced to partially mitigate the impact of mining tax. Further, it could take some price hikes to partially offset the impact of mining tax.

On the volume growth front, NMDC scores the best, as it is poised for the highest volume growth over FY2011-13 compared to CIL and MOIL. MOIL’s volume growth is at lower risk, as its mines are located in Maharashtra and Madhya Pradesh, which have a relatively well developed infrastructure. However, even if NMDC misses its volume growth target, its volume growth would still be higher than MOIL and CIL as per our estimates.

On the pricing front, we believe CIL and NMDC have an advantage, as they sell their products at a significant discount to international benchmarks. Although absence of government intervention in regulating manganese ore prices has given MOIL the leeway to sell its product at market-driven prices, we believe oversupply in the manganese ore market and huge inventory built-up should mute price hikes for MOIL over the coming year.

On the valuation parameter front, NMDC scores over CIL and MOIL. While we have seen significant declines in the stock prices of CIL, MOIL and NMDC, we believe NMDC’s better-than-expected 1HFY2012 performance and robust growth prospects do not warrant a steep decline in its stock price. While risks to NMDC’s financial forecasts are limited, CIL could disappoint on the production front and higher-than-expected wage hikes could dent its profitability. In our view, although MOIL’s valuations are attractive, there is a downside risk to its sales volumes targets; also, the stock lacks near-term catalysts. For NMDC, despite robust 1HFY2012 performance, it is currently trading at a significant discount to its historical trading range. Hence, we recommend investors to Buy NMDC at these levels. Please refer to important disclosures at the end of this report 1

Mining | Sector Update

Exhibit 1: Comparison of mining companies Rating parameters MOIL CIL NMDC Market share

End-user dependency

Mining tax

Rating – Industry 6 7 5

Mine life

Risk to volume growth

Immunity to price decline

Pricing control

Staff cost

Rating – Business 9 9 12

Rating – Valuation

Final rating 17 18 20

Source: Angel Research

Exhibit 2: Rating scale

Most preferred 3 Moderate 2 Least preferred 1

Source: Angel Research

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Mining | Sector Update

Exhibit 3: Rating parameters and definition Definition Comments

Industry factors

We prefer companies having a higher market share. We give CIL enjoys a market share of ~82%. Market share CIL the highest rating. MOIL enjoys a market share of ~50%. NMDC enjoys a market share of 12–15%. CIL sells 80% of its output to the power sector We like companies dependant on sectors that are stable in (stable). nature. CIL mainly sells coal to the power sector, which is End-user industry MOIL sells 99% of its output to ferro alloy less volatile as compared to the steel sector, on which the producers (cyclical). fortunes of MOIL and NMDC are dependant. NMDC sells its output to the steel sector (cyclical). CIL spends ~5% of its retained earnings on CSR. If the proposed 26% mining tax is implemented, CIL will be MOIL spends only 0.5–2% of its retained Proposed mining tax the most affected; but it could be partially offset by lower earnings on CSR. CSR spending and price hikes. NMDC spends ~2.5% of its retained earnings on CSR. Business

Higher mine life is a positive as it gives visibility of the CIL has a mine life of 42 years. company’s future operations. We prefer CIL and NMDC, Mine life NMDC has a mine life of 38 years. which have mine life of over 35 years, as compared to MOIL has a mine life of 22 years. MOIL, which has mine life of 22 years. CIL has continuously missed its sales guidance in the past due to non-availability of railway rakes. MOIL’s mines are located in Maharashtra and We prefer companies that are least affected by infrastructure Risk to volume growth Madhya Pradesh, where road and railway bottlenecks. infrastructure is well developed. NMDC’s operations have also been affected due to Naxal activities. Although coal is a de-regulated commodity, government intervention is likely to restrict CIL’s ability to move towards market-linked price for coal. MOIL has the leeway to increase prices depending on market dynamics. Government Immunity to price We prefer CIL and NMDC as they sell products at a intervention is likely to be least, as manganese declines significant discount to global benchmarks. ore requirement is a very small proportion of overall steel cost. NMDC sells ore at a significant discount to 1) global prices and 2) marginal cost of production of Chinese miners. Hence, it is relatively less affected by the decline in international prices. CIL’s next wage revision was due in July 2011 and it is under negotiations currently. Staff cost as a percentage of sales stands at around 36%. MOIL has a 10-year wage agreement and the We prefer NMDC whose staff cost is relatively a small Staff cost next revision is due in 2017. Staff cost as a proportion of its net sales. percentage of sales stands at around 25%. NMDC’s staff cost as a percentage of sales stands at around 5.0%. Wage revision is due in January 2012. Valuation

CIL: 7.4x On FY2013 EV/EBITDA basis, NMDC and MOIL look MOIL: 2.7x EV/EBITDA inexpensive. NMDC: 3.4x

Source: Company, Angel Research

December 12, 2011 3

Mining | Sector Update

MOIL vs. CIL vs. NMDC

Recent declines in the stock prices of the three mining companies, viz. Coal India (CIL), MOIL and NMDC, have led to questions in the minds of investors as to which company can provide higher upside from here.

We analyzed all the three miners on different factors categorized under the parameters of industry (market share, end-user dependency and mining tax), business (mine life, risk to volume growth, immunity to price declines and staff cost) and valuation (EV/EBITDA). Our analysis points out that NMDC could be a winner amongst the three.

On the volume growth front, NMDC scores the best, as it is poised for the highest volume growth over FY2011-13 compared to CIL and MOIL. MOIL’s volume growth is at lower risk, as its mines are located in Maharashtra and Madhya Pradesh, which have a relatively well developed infrastructure. CIL has lowered its production guidance for FY2012 recently and lower availability of railway rakes could impact its sales volumes targets in our view. For NMDC, even if it misses volume growth target, its volume growth would still be higher than MOIL and CIL as per our estimates.

On the pricing front, we believe CIL and NMDC have an advantage, as they sell their products at a significant discount to international benchmarks. Although absence of government intervention in regulating manganese ore prices has given MOIL the leeway to sell its product at market-driven prices, we believe oversupply in the manganese ore market and huge inventory built- up should mute price hikes for MOIL over the coming year.

On the staff costs front, NMDC has an edge over CIL and MOIL. Staff costs as a percentage of sales for CIL, MOIL and NMDC stand at 36%, 25% and 5%, respectively. Wage revision for CIL was due in July 2011; however, it is still under negotiations currently. NMDC’s wage revision is due in January 2012, while MOIL’s wage revision is due in 2017.

Considering the risks to financial projections, NMDC looks the least at risk. We believe CIL could disappoint on the earnings front due to lower-than- expected production and sales volumes and higher-than-expected staff costs, while we believe MOIL could disappoint on lower-than-expected sales volumes given the slump in demand. In our view, NMDC’s FY2012 estimates are least at risk, considering the recent shortage of iron ore in Karnataka and NMDC’s 1HFY2012 financials.

On the valuation parameter front, NMDC scores over CIL and MOIL. While we have seen significant declines in the stock prices of CIL, MOIL and NMDC,

December 12, 2011 4

Mining | Sector Update

we believe NMDC’s better-than-expected 1HFY2012 performance and robust growth prospects do not warrant a steep decline in its stock price. While risks to NMDC’s financial forecasts are limited, CIL could disappoint on the production front and higher-than-expected wage hikes could dent its profitability. In our view, although MOIL’s valuations are attractive, there is a downside risk to its sales volumes targets; also, the stock lacks near-term catalysts. For NMDC, despite robust 1HFY2012 performance, it is currently trading at a significant discount to its historical trading range. Hence, we recommend investors to Buy NMDC at these levels.

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Mining | Sector Update

NMDC – Investment thesis

Targets production to 50mn tonnes by FY2014–15E

Management aims to ramp up the company’s production capacity to 50mn tonnes by FY2014–15E through increased exploration of its existing mines and development of new mines, i.e., Deposit 11B and Deposit 13 in Bailadila and Kumaraswany, respectively, in Karnataka. The targeted cost for the development of the three mines is `2,400cr. The company targets sales volumes of 30mn tonnes and 33mn tonnes in FY2012 and FY2013, respectively.

However, in the past, NMDC’s production has been impacted by Naxal activities in Chhattisgarh’s Dantewada region.

Strong balance sheet could pave way for overseas acquisitions

During September 2011, NMDC purchased a 50% stake in Australia-based Legacy Iron Ore (Legacy) as a cornerstone investor for `92cr. Also, the company is currently prospecting various mining assets, including an iron ore mine and a phosphate mine in Australia, an iron ore mine in Brazil and a coking coal asset in Russia. With a strong balance sheet having net cash of `20,725cr (September 30, 2011), we do not rule out the company acquiring more mining assets overseas. However, given that NMDC is a government-owned company, we do not foresee a big-ticket acquisition.

NMDC’s realizations are relatively immune to cyclical downtrends

Over FY1997-11, NMDC’s average realizations have registered a 17.6% CAGR, while maximum price decline in a fiscal year was 9.5% (FY2010 – on account of a steep decline in global benchmark price). This is despite international iron ore prices showing huge volatility (ranging from US$60/tonne to US$155/tonne during FY2009-11). In 1HFY2012, NMDC’s blended realization (which includes a mix of lumps and high-grade fines) stood at US$88/tonne, compared to international iron ore fines price (63.5% Fe) of US$155/tonne (FOB). On the volumes front, its sales volumes registered a CAGR of 4.5% during FY1997-11.

Exhibit 4: Iron ore realization trend Exhibit 5: Sales volume trend

5,000 35 4,500 30 4,000 3,500 25 3,000 20 2,500 tonne) 15

`/ 2,000 ( 1,500 (mn tonnes) 10 1,000 5 500 0 - FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E FY2012E FY2013E Iron ore realization Sales volumes

Source: Company, Angel Research Source: Company, Angel Research

December 12, 2011 6

Mining | Sector Update

Seeking to diversify into steel making

Management intends to diversify its operations by moving downstream through establishing steel plants and pellet plants. Accordingly, on December 10, 2010, the company had signed a joint venture (JV) with OJSC Severstal (a vertically integrated steel maker from Russia) to build an integrated 3mn tonne steel plant in Karnataka. This JV will have captive coking coal mine in Russia, while it will have an iron ore mining subsidiary in India. Over 90% of the land acquisition is complete, which gives comfort as land acquisition has been a major bottleneck to greenfield projects in recent times.

Exhibit 6: Chhattisgarh steel project status Capacity 3mn tonnes per year

Capex `15,525cr

Total land required: 1,934 acres. Total land acquired: 1,783 acres. Land Balance land is under allotment process. 42 months from “Zero date” i.e., receipt of all statutory Date of clearance/approvals and placement of orders. completion Targeted period – FY2015 Source: Company, Angel Research

Outlook and valuation

Over the past five years, NMDC has traded at a significantly higher EV/EBITDA and PE range as compared to its current levels (See Exhibits 7 and 8). Given the anticipated volume growth of 10-12% over FY2011-15, we believe there is a strong case of re-rating. Strong balance sheet, presence in sellers market (iron ore), relative immunity to iron ore price declines, low cost of production, high- grade mines, long mine life and compelling valuations make NMDC an attractive bet at these levels. Moreover, inexpensive valuation of 3.4x FY2013 EV/EBITDA and cash per share (`52 as on September 30, 2011) should support any further declines. Valuing the stock at 5.5x FY2013E EV/EBITDA, we derive a fair price of `231 and recommend Buy rating on the stock.

Exhibit 7: NMDC: Historical EV/EBITDA band Exhibit 8: NMDC: Historical PE band

250,000 700

600 200,000 500 150,000 400 (`) (`cr) 100,000 300 200 50,000 100

0 0 May-06 Apr-07 Mar-08 Feb-09 Jan-10 Dec-10 Nov-11 May-06 Apr-07 Mar-08 Feb-09 Jan-10 Dec-10 Nov-11

5x 8x 11x 17x 14x 9x 14x 19x 24x

Source: Company, Angel Research Source: Company, Angel Research

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Mining | Sector Update

Exhibit 9: Recommendation summary Companies CMP Target Reco. Mcap Upside P/E (x) P/BV (x) EV/EBITDA (x) RoE (%) RoCE (%) (`) price (`) (` cr) (%) FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E

MOIL 231 - Neutral 3,880 - 8.7 8.0 1.6 1.4 3.4 2.7 19.4 18.4 21.1 19.7 NMDC 169 231 Buy 67,063 36 8.4 7.5 2.6 2.1 4.4 3.4 35.8 31.0 44.7 38.9 CIL 304 322 Accum. 192,144 6 13.0 12.4 4.3 3.4 8.1 7.4 37.8 30.5 35.2 28.0

Source: Company, Angel Research

Profit & loss statement Y/E March (` cr) FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E Net Sales 5,711 7,564 6,239 11,369 12,701 14,304 Other operating income ------Total operating income 5,711 7,564 6,239 11,369 12,701 14,304 % chg 36.4 32.4 (17.5) 82.2 11.7 12.6 Total Expenditure 1,374 1,726 1,817 2,722 2,552 2,867 Net Raw Materials 145 86 211 123 278 340 Personnel 356 421 420 492 533 572 Other 874 1,219 1,186 2,107 1,741 1,955 EBITDA 4,337 5,838 4,422 8,646 10,149 11,437 % chg 34.5 34.6 (24.2) 95.5 17.4 12.7 (% of Net Sales) 75.9 77.2 70.9 76.1 79.9 80.0 Depreciation& Amortization 60 74 73 125 140 157 EBIT 4,277 5,764 4,349 8,521 10,009 11,280 % chg 36.1 34.8 (24.6) 95.9 17.5 12.7 (% of Net Sales) 74.9 76.2 69.7 75.0 78.8 78.9 Interest & other Charges ------Other Income 671 884 862 1,206 1,905 2,074 Recurring PBT 4,947 6,648 5,211 9,727 11,914 13,354 % chg 41.4 34.4 (21.6) 86.7 22.5 12.1 Extraordinary Inc/(Expense) ------PBT (reported) 4,947 6,648 5,211 9,727 11,914 13,354 Tax 1,696 2,276 1,760 3,228 3,932 4,407 (% of PBT) 34.3 34.2 33.8 33.2 33.0 33.0 PAT (reported) 3,251 4,372 3,451 6,499 7,983 8,947 ADJ. PAT 3,251 4,372 3,451 6,499 7,983 8,947 % chg 40.1 34.5 (21.1) 88.3 22.8 12.1 (% of Net Sales) 56.9 57.8 55.3 57.2 62.9 62.5 Basic EPS (`) 8.2 11.0 8.7 16.4 20.1 22.6 Fully Diluted EPS (`) 8.2 11.0 8.7 16.4 20.1 22.6 % chg 40.1 34.5 (21.1) 88.3 22.8 12.1

December 12, 2011 8

Mining | Sector Update

Balance sheet Y/E March (` cr) FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E SOURCES OF FUNDS

Equity Share Capital 132 396 396 396 396 396 Reserves& Surplus 8,157 11,240 13,876 18,818 24,945 32,037 Shareholders’ Funds 8,290 11,637 14,272 19,215 25,342 32,433 Share Warrants - - - -

Minority Interest - - - -

Total Loans ------Deferred Tax Liability 6 58 85 103 103 103 Total Liabilities 8,296 11,695 14,357 19,317 25,445 32,536 APPLICATION OF FUNDS

Gross Block 1,421 1,669 1,771 2,273 3,273 4,273 Less: Acc. Depreciation 853 923 984 1,174 1,313 1,471 Net Block 568 747 787 1,099 1,960 2,802 Capital Work-in-Progress 112 248 556 677 745 819 Goodwill - - - -

Investments 83 72 76 136 136 136 Current Assets 8,283 11,771 14,264 19,172 24,346 30,567 Cash 7,199 9,740 12,855 17,228 22,371 28,476 Loans & Advances 244 403 519 1,043 1,043 1,043 Other 840 1,628 890 901 932 1,048 Current liabilities 775 1,165 1,348 1,781 1,755 1,802 Net Current Assets 7,508 10,606 12,916 17,391 22,590 28,765 Mis. Exp. not written off 25 22 22 14 14 14 Total Assets 8,296 11,695 14,357 19,317 25,445 32,536

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Mining | Sector Update

Cash flow statement Y/E March (` cr) FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E Profit before tax 4,947 6,648 5,207 9,727 11,914 13,354 Depreciation 60 74 73 122 140 157 Change in Working Capital (661) (785) 926 (525) (56) (70) Others (105) (866) (832) (1,143) - - Direct taxes paid (1,765) (2,292) (1,770) (3,319) (3,932) (4,407) Cash Flow from Operations 2,476 2,778 3,604 4,861 8,066 9,035 Inc./ (Dec.) in Fixed Assets (123) (389) (422) (517) (1,068) (1,074) Other income 640 880 828 1,022 - - Cash Flow from Investing 517 491 407 506 (1,068) (1,074) Issue of Equity - - - -

Inc./(Dec.) in loans - - - -

Dividend Paid (Incl. Tax) (643) (728) (895) (853) (1,855) (1,855) Others - - - (142) - - Cash Flow from Financing (643) (728) (895) (994) (1,855) (1,855) Inc./(Dec.) in Cash 2,350 2,541 3,115 4,373 5,143 6,105 Opening Cash balances 4,849 7,199 9,740 12,855 17,228 22,371 Closing Cash balances 7,199 9,740 12,855 17,228 22,371 28,476

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Mining | Sector Update

Key ratios Y/E March FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E Valuation Ratio (x)

P/E (on FDEPS) 20.6 15.3 19.4 10.3 8.4 7.5 P/CEPS 20.3 15.1 19.0 10.1 8.3 7.4 P/BV 8.1 5.8 4.7 3.5 2.6 2.1 Dividend yield (%) 2.9 1.3 1.2 1.9 2.4 2.4 EV/Sales 10.5 7.6 8.7 4.4 3.5 2.7 EV/EBITDA 13.8 9.8 12.2 5.7 4.4 3.4 EV / Total Assets 7.2 4.9 3.8 2.6 1.8 1.2 Per Share Data (`)

EPS (Basic) 8.2 11.0 8.7 16.4 20.1 22.6 EPS (fully diluted) 8.2 11.0 8.7 16.4 20.1 22.6 Cash EPS 8.4 11.2 8.9 16.7 20.5 23.0 DPS 4.9 2.2 2.0 3.2 4.0 4.0 Book Value 20.9 29.4 36.0 48.5 63.9 81.8 DuPont Analysis

EBIT margin 74.9 76.2 69.7 75.0 78.8 78.9 Tax retention ratio (%) 65.7 65.8 66.2 66.8 67.0 67.0 Asset turnover (x) 6.0 5.2 3.8 6.7 5.2 4.2 ROIC (Post-tax) 293.1 261.7 174.0 336.9 274.2 220.3 Cost of Debt (Post Tax) ------Leverage (x) ------Operating ROE 293.1 261.7 174.0 336.9 274.2 220.3 Returns (%)

ROCE (Pre-tax) 60.6 57.7 33.4 50.6 44.7 38.9 Angel ROIC (Pre-tax) 505.3 454.4 347.9 795.9 577.0 425.8 ROE 46.1 43.9 26.6 38.8 35.8 31.0 Turnover ratios (x)

Asset Turnover (Gross Block) 4.2 4.9 3.6 5.6 4.6 3.8 Inventory / Sales (days) 44 64 60 56 56 56 Receivables (days) 31 50 25 16 16 16 Payables (days) 61 81 105 54 54 54 WC cycle (ex-cash) (days) 23 33 34 11 15 15 Solvency ratios (x)

Net debt to equity (0.9) (0.8) (0.9) (0.9) (0.9) (0.9) Net debt to EBITDA (1.7) (1.7) (2.9) (2.0) (2.2) (2.5) Interest Coverage (EBIT / Interest) ------

December 12, 2011 11

Mining | Sector Update

Research Team Tel: 022 - 39357800 E-mail: [email protected] Website: www.angelbroking.com

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Disclosure of Interest Statement Analyst ownership Angel and its Group companies Angel and its Group companies' Broking relationship of the stock ownership of the stock Directors ownership of the stock with company covered MOIL No No No No CIL No No No No NMDC No No No No Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns): Buy (> 15%) Accumulate (5% to 15%) Neutral (-5 to 5%) Reduce (-5% to 15%) Sell (< -15%)

December 12, 2011 12

Mining | Sector Update

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