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 December 12, 2011 2 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 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. 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.