Power lines (Representative Image)
Gujarat Mineral Development Corporation (GMDC) could be one of those boring commodity stocks that have given no returns since the last burst of commodity cycle in 2008. In fact, its stock is currently quoting at the same level seen in 2007.
What is interesting in this period is that the net worth of the company has gone up four times from Rs 1,060 crore in FY08 to Rs 4,007 crore in FY17. Moreover, Rs 1,100 crore of this equity is parked in cash, which corresponds to 25 percent of its current market capitalisation of about Rs 4000 crore.
Street’s main worry is about growth and possible misallocation of capital. To put it in perspective, power generation business accounts for merely 19 percent of the total revenue, but it occupies 72 percent of the total capital invested in its two (mining and power) businesses.
Misallocation can also be vouched from the FY17 numbers. The company’s power business made a return (EBIT to assets) of 2.33 percent as against 20 percent returns made by the mining business. Notably, the power business was making losses till last quarter dragging the overall business performance.
Back to Power
Thankfully, of late, the matrix is changing for the better. In Q4FY17, power has started to make profits with the PLF (plant load factor) moving to almost 64 percent. The company operates 250 MW of lignite-based power plant along with 150 MW of wind capacity with expectations that PLF will move up further. Investors can expect this large capital stuck in power business to start contributing to profitability thus generating higher cash flows and better returns ratios (return on equity etc).
Recently, the Supreme Court reversed the order on compensatory tariffs thereby denying power companies the right to charge customers more to recover higher costs from an increase in imported coal. As a result, Tata Power and Adani Power are looking to cut power supply to Gujarat Urja Vikas Nigam, on the grounds of financial viability of plants due to higher international coal prices. GMDC, which holds the monopoly in lignite in Gujarat, could benefit with others ramping up generation, driving higher lignite volumes and prices in Gujarat.
One other area of focus is going to be redeploying the cash in the books to the extent of Rs 1100 crore. Its lignite business makes close to 18 percent on assets deployed in the business. The company now plans to use this cash for land acquisition, development of more mines, technology upgradation and thermal power. Once the low yield cash (interest income as the percent of cash works out to 11 percent) is deployed it should ideally lead to better returns.
With the cash being deployed now in its core lignite business the company is now able to ramp up its production. Lignite production had fallen from 8.7 million tonnes in FY15 to 6.98 million tonnes in FY16. However, there has been a recovery when the lignite output reached 7.5 million tonnes in FY17. At the current quarterly rate of about 2.64 million tonnes (in Q4FY17) the company is expected to go back to 2015 levels of 8.7 million tonnes, which is a growth of 16 percent.
That apart, lignite, which is used in firing power and steel plants and competes with coal, has become attractive with a spike in global coal prices. Recently, Indonesia set its thermal coal price for May at USD 83.8 a tonne, up 63.7 percent on a year-on-year basis.
In Q4 FY17, GMDC made an average realisation of about Rs 1,310 per tonne as against Rs 1,280 per tonne in FY16. In the current fiscal with the spike in coal prices, it is expected to make slightly better realisation of about Rs 1400 a tonne.
Both growth in volumes and realisations provides a good earning visibility, which will be further enhanced because of the implementation of the Goods and Services Tax. The company is currently paying a tax at the rate of 30 percent, but the management is hopeful that under GST, lignite will come under the slab of 12-18 percent and that will bring down its tax rates.
HDFC Securities’ analyst Ankur Kulshrestha, who has a buy rating on the stock, said, “Our thesis on GMDC largely rests on lower taxation in future under the GST. With the inclusion of multiple slabs in the rate structure, there is a likelihood of lignite moving to 12 percent rate, from the current 37 percent. This is because coal and lignite are taxed at similar rates (excise and VAT) elsewhere in the country.”
Management is expecting this move (GST) to add another 10 percent to its profits.
In FY17, the mining business made a profit of Rs 227 crore before interest and tax. While this could boost medium-term profitability and support valuations (stock trading 12 times its FY18 estimated earnings), in the long term company still needs to demonstrate if it is successfully able to put its capital in order to create value for shareholders.