NMDC-a great buy at current levels!

After a hiatus of 2 years, I have started looking at the markets once again. Somehow, I get the feeling that there are plenty of opportunities waiting to be explored, when the mood on the street is pessimistic and everyone is selling. Of course, the turbulence prevalent in the market cannot be ignored, there are some serious implications of the falling rupee and rising current account deficit, due to which the high beta and cyclical sectors like realty, infra, metals along with banks have been severely punished. The most severe impact is shared by companies that carry high leverage on their books and undertook huge debts to fund ambitious projects.

However, amid the panic prevalent on the street, one cannot ignore the fact that in times like these, solid companies with very healthy business and strong balance sheets are also punished just because of exodus of investors from the equity markets. This throws up a good opportunity for value investors. One may doubt if that is the case why have investors not already capitalized upon the opportunity. We need to understand that investor psychology is the most important force driving the markets. The 'Mr. Market' analogy of Benjamin Graham aptly explains this psychology when he compares the market to an imaginary person 'Mr Market' who tends to be very emotional. When he is optimistic, he tends to buy everything that is offered, at a premium and when he is sick he is ready to offload whatever he has with him at a discount. With careful fundamental analysis, we can choose which stocks offered by Mr Market are priced below their intrinsic value.

After scanning a large number of companies, I selected few stocks which are worth considering from point of investing, best among them is National Mineral Development Corporation Ltd. (NMDC). It is a public sector company and the largest producer of Iron ore in the country (appx 27 million tons annually!). Without going through the pain of writing a detailed research report, I have listed down some reasons which I think make this stock a stealing buy.

1) Monopolistic business - NMDC has exclusive rights for Iron Ore mines with more than 1,360 million tons reserves - Bailadila and Donimalai being the largest and most important ones. Bailadila is known for its high Iron content ore, more than 65%, with best physical and metallurgical properties required for making steel. The company is hopeful of getting some more mining leases, making it one of the few companies which have access to such huge natural resources. The market price of Iron ore (avg of lumps and fines) is INR 3,500 per ton at present. The price has been subdued for more than a year now due to poor demand from steel makers. However, as we see an uptick in the economic cycle, the demand in automobiles and Infra would lead to a demand of Steel and in turn demand for Iron ore. It is interesting to know that NMDC is among the world's lowest cost produces (appx USD 20 per ton including royalty payments!). Don't you think it makes absolute sense to invest in a company which is running a simple business, having monopolistic control of the industry, no dearth of customers, and good operating margins ,appx 65% in NMDC's case?

2) Strong Balance Sheet - In times like these when companies one after the other are opting for Corporate Debt Restructuring or defaulting on their debt obligations, here we have a company which has cash reserves of 21,000 crores! At the current market price of INR 97 per share, the total market cap stands at appx 38,000 crores. In a  way, we can say that out of the price we are paying to buy NMDC, 55% is HARD CASH, almost INR 54 per share. To put it simply, being a debt free company, if the company gets liquidated tomorrow and we don't get back any money from the debtors or from selling the company's assets, we still would be left with 54 rupees cash! The company doesn't need to spend much on expansion and we can assume that the cash rich company would continue to be so in foreseeable future.

3) Good Operating Performance - The company has doubled its turnover from 5,000 crores in FY08 to 10,000 crores in FY13. The operating margins have been consistent during the period about 75% in FY08 to 78% in FY12 and lower at 68% in FY13 (due to lower production and poor demand scenario compared to previous year). I think the operating margins showcase the solid business potential of the company. Of every 100 rupees worth of material it sells, it pockets 75 rupees as cash operating profit. Even after paying 35% income tax, we still get a Profit after tax margins of appx 50%, a very healthy figure not many companies of such scale are capable of posting year after year. This adds significantly to the cash reserves of the company and I see no major downside to the company going forward.

4) Cheap Valuations - The Earnings per share works out to be INR 16 for NMDC. At INR 97 per share market price, it is trading at a price earnings ratio of 6.06. Put simply even if the company continues with the same performance without growing an iota in earnings, it would accumulate enough cash to double its value in 6 years! It is considerably cheaper than the Industry ratio of 12-13 historically. The book value (value of assets - liabilities) stands at INR62 per share. We can safely assume this price to be the bottom where the stock can fall to, given the high cushion its cash reserves offer.The price to book value multiple is appx 1.5, again very cheap. The compounded annual growth in PAT has been appx 15% from FY08 to FY13, the PEG ratio (ratio of PE to historical 5 yrs growth)  stands at a mere 0.4. By market standards, for a stable company like NMDC, a PEG ratio below 1 represents that the company is undervalued. To supplement the above research, it is important to look at another important parameter often used to value metals and mining stocks - EV/EBITDA. The Enterprise value (total of mkt cap and net debt) of NMDC is 38,000-20,000=18,000 crores for NMDC, and EV/EBITDA miltiple of 2.0x. NMDC came up with a FPO in March, 2010, post which the shares have traded at P/E of 10x and EV/EBITDA of 6x, reiterating the fact that compared to the historic valuations, the current valuations are extremely cheap.

5) Good Dividend Yield - The company has a history of giving regular dividend payout. It has been paying more than 20% of the PAT as cash dividends to shareholders for the past many years, increasing substantially to 25% in FY12 and 40% in FY13. The dividend per share was INR 6.50 in FY13 and is expected to be 7.50 or more  going forward. The dividend yield turns out to be ~8% for NMDC, one of the highest among companies of its size. Bank FDs are currently paying 9% as interest, it makes complete sense to buy NMDC shares and earn 8% dividend yield and a fair chance of price appreciation instead of earning 6.3% post-tax return on bank FDs.

Possible Negatives
Being a Government enterprise and administered by the Steel Ministry, we know the potential disadvantages the PSUs are sometimes subjected to - whether it comes to bearing the subsidy burden (like Oil refiners) or bearing the price of extending undue benefits to private sector companies. 
Another possible negative may be the plans of venturing into steel making. The company has already started manufacturing sponge iron 2 years back and is setting up a 3MT per annum steel plant. It may seem that the move would benefit the company by integrating it forward. However, it might deviate from its 'core competency' of mining and divert its excess cash into highly capital intensive and cyclical steel production.

Besides the negatives surrounding the metal and mining industry, I am convinced that the cheap valuations, strong balance sheet and good dividend yield are compelling reasons to take a plunge and buy this stock. It has a considerable 'margin of safety' to safeguard the interests of investors in case the downtrend continues for a prolonged period and has the potential to deliver very good price appreciation when the economic cycle improves.