Is Rs 300-350/sh price band for NMDC FPO expensive?

The NMDC stock tanked over 5% today on pricing concerns of its follow-on public issue. Late last night, the government had set the price band for the issue at Rs 300-350 per share, a steep discount to the current market price. The government will also offer an additional 5% discount to retail investors on the final price, which will be decided after the book-building part of the issue closes. 

The NMDC issue will open for subscription on March 10 and close on March 12. The country's largest iron ore producer is coming out with its public issue of over 33 crore shares of face value of Re 1 each. The government is slated to divest 8.38% stake in the public sector undertaking.

The management, however, is bullish and expects to scale up FY11 mining output to 50 million tonne. Rana Som, CMD, NMDC, says, "The company has an excellent domestic market for its iron-ore. With higher production, which is being envisaged, a larger percentage of its output would be going into the domestic market which has a very high demand today. The demand in the domestic market will continue to be high. From April 2010 onwards, we will have a different pricing mechanism which is intended to be give better realisation to NMDC's products. The company's production of 30 million tonne today is going up to 50 million tonne by 2014-2015."

But analysts believe that the NMDC FPO is expensive at the higher end of the price band of Rs 300-350 per share. At the top end of the price band, NMDC has an enterprise value of USD 20 per tonne of its mineral deposits, analysts say. By comparison, Indian iron ore exporter Sesa Goa, part of the Vedanta group, trades at EV/tonne of USD 22. Global mining majors BHP Billiton and Rio Tinto, trade between USD 15 and USD 18 per tonne of mineral resources.

Had the government priced the issue in the Rs 250-275 per share range it would be attractive, says R Venkat Subramanian, CIO, Infina Finance Pvt. "Somewhere in the Rs 250-275 range, it would have made it very attractive. Rs 300 is sort of neither here nor there. The market environment is extremely favorable for NMDC. Generally, there should be a investor appetite."

Even SP Tuslian of sptulsian.com feels the issue should have been priced around Rs 280-300 per share. "Post the increase in float to maybe 9-10%, or 10% if one includes insurance companies also, the price should settle around Rs 300-310-320. First, there should not have been a Rs 50 range beause it creates confusion in the minds of retail investors, especially when they did not receive any reponse to the earlier two issues. Second, this is a very thinly traded stock. Third, the valuation based on pure fundamentals doesn't justify a price beyond Rs 300."

He says NMDC's valuations are far better than that of Sesa Goa. "If the government is likely to discover the price of Rs 300, it would have been better if they had set a price band of Rs 280-300 per share purely focusing on valuations with Sesa Goa. The net profit margin of NMDC is close to about 47% while that of Sesa Goa is about 42%. Going by all these standards, definitely NMDC deserves a better valuation than Sesa."

But Deven Choksey, Chief Executive at KR Choksey Shares, says the stock should be priced around Rs 350 if you consider the value of its mineral resources.

NMDC produced 28.5 million tonne ore in 2008-09, and holds proven reserves of 970 million tonne. It reported earnings of Rs 8.6 per share for the 12 months ended January, with a price to earnings ratio of 57.6 according to its prospectus. The company has justified the high valuation with its high growth potential.

"We will continue to enjoy market support and good price realisations for years to come," Som told reporters at a roadshow in Mumbai last week. "If we had the capacity, we could actually sell 60 million tonne, compared to 30 now," Som says, referring to the strong domestic market, which accounts for 85% of its sales. The miner expects to boost capacity to 50 million tonne by 2014, from 30 million now, with three ore mines expected to be commissioned over the next three years, Som added.

Explaining the rationale for the higher valuation, CNBC-TV18's Nimesh Shah says since NMDC has the lowest cost of production for iron ore, it would get a premium to some of its domestic as well as international peers. "Valuation is close to 22-25 times assuming an FY11 EPS of around Rs 14 per share. NMDC is also expected to come out with new price norms by the next fiscal which is expected to increase iron ore prices by nearly 50%. If that happens, the EPS would be much higher and would get a PE multiple of 17-22 times for FY11, which is a pretty fair valuation for NMDC going forward," he explained.

Will FIIs buy?
Michiel van Voorst, a Hong Kong-based portfolio manager with Robeco Asia Pacific, says NMDC was not high on his radar screen. "We probably need more liquidity. Also, its relevant to compare to regional and global peers, and from our perspective, I would look at better-priced Australian companies."

However, Ambareesh Baliga, Vice President at Karvy Stock Broking, says, "For any follow-on offer, interest is based in relation to the market price. There is a steep discount now and the issue should get a good response from both retail and institutions."

(With inputs from Reuters & CNBC-TV18)