District Mineral Foundation (DMF)—some relief likely from lower rates. As per unauthenticated media reports, the central government will soon notify DMF contribution at 30% of royalty rates for existing miners and 10% for new mines. The rates are lower than the maximum possible rate of 100% for existing mines as per MMDR Amendment Act and will be a relief for miners, especially Hindustan Zinc, Vedanta and Tata Steel. We cut commodity price assumptions by 3-11% and incorporate our economist’s revised Fx rate. We maintain BUY on Vedanta with target price of R165 (R185), HZ with target price of R190 (R205) and REDUCE on Tata Steel with TP (target price) of R205 (R225).
District Mineral Foundation: rates for existing mines can be notified at only 30% (of royalty)
As per media reports, the central government will soon notify the DMF rates for existing miners at 30% of the royalty amount and for new mining leases at 10% of the royalty amount (against maximum of 33.3% as per the Act). The lower-than-expected rates will decrease the regulatory cost burden on miners, especially in a weak commodity cycle. We highlight that even on assuming 30% of the royalty payment towards DMF, the burden of regulatory costs on Indian miners is high and it works out to 12-50% of revenues (excluding corporate tax) for different commodities such as zinc, iron-ore, etc.
Cut commodity price assumptions by 3-11%; retain BUY on Vedanta/HZ, REDUCE on Tata Steel
The sharp decline in commodity prices means that even many of the efficient operations globally are operating at losses. The depressed prices and continued operating cash losses should logically end in supply-side response from closure of inefficient capacities and support prices. However, overcapacity, weak demand and high inventories for a few commodities can delay recovery. We discuss commodity-specific fundamentals in detail in later sections.
We cut our commodity price assumptions by 3-11% for FY2016-18e . We revise our (i) zinc price assumptions to $2,050/ton, $2,100/ton and $2,200/ton for FY2016e, FY2017e and FY2018e, (ii) all-in aluminium price assumptions to $1,850/ton, $1,950/ton and $1,950/ton for FY2016e, FY2017e and FY2018e and (iii) crude oil price assumptions to $60/bbl, $65/bbl and $70/bbl for FY2016e, FY2017e and FY2018e. We incorporate our economist’s revised INR:USD rate assumptions of R64.9, R66.5 and R67 for FY2016e, FY2017e and FY2018e. We had baked in 100% of royalty amount as DMF contribution in our assumptions, which we maintain pending a final rate notification.
Vedanta. We cut our FY2016-18 Ebitda (earnings before interest taxes depreciation and amortisation) estimates by 5-7% . The lower Ebitda estimate is due to cut in commodity price assumptions by 3-11% partially offset by lower INR:USD rate. We estimate EPS (earnings per share) of R16.7, R18.1 and R23.4 for FY2016e, FY2017e and FY2018e respectively. We cut our target price for Vedanta to R165 from R185 earlier.
Hindustan Zinc. We cut our FY2016-18 Ebitda estimates by 8-11%. The lower Ebitda estimate is largely due to cut in zinc price assumption by 8-11% for FY2016-18e partially offset by lower INR:USD rate. We estimate EPS of R16.6, R17.6 and R18.8 for FY2016e, FY2017e and FY2018e respectively. We cut our target price for HZ to R190 from R205 earlier.
Tata Steel. We cut our FY2016-18 Ebitda estimates by 1-2%. The lower Ebitda estimate is largely due to cut in our China HRC price assumptions by 5-8% for FY2016-18e partially offset by lower INR:USD rate. We cut our target price for Tata Steel to R205 from R225 earlier.
Lower DMF rates—Hindustan Zinc, Vedanta, Tata Steel, NMDC can benefit
Various companies provided for DMF costs in Q4FY15 and Q1FY16 at rates varying between 50% and 100% of the royalty amount. We note that Tata Steel provided for DMF costs at 100% of the royalty amount, Hindustan Zinc at 50% while NMDC has not provided for DMF costs yet.
On assuming only 30% of royalty as DMF contribution, our Ebitda estimates will increase by 5-15%. We detail the company-specific impact as follows.
Hindustan Zinc. Hindustan Zinc paid royalty of R13.7 bn (9.3% of revenues) in FY2015 given high royalty rates on zinc (9.5%), lead (14.5%) and silver (7%). On assuming 30% of royalty amount for DMF, we estimate royalty and DMF costs of R21 bn in FY2017e against R31.7 bn based on 100% of royalty amount factored in by us. Our Ebitda estimate increases by 15% to R82 bn and fair value by 10% to R210/share from R190/share.
Vedanta. The royalty on bauxite is low at 0.6% of LME prices (metal contained) due to higher conversion costs (energy costs) and hence the impact of higher DMF costs on Vedanta is mostly limited to HZ and increase in coal costs, assuming a pass-on of costs to end-consumers. On assuming 30% of royalty as DMF amount, our Ebitda estimate increases by 5% to R225 bn and fair value by 9% to R180/share from R165/share.
Tata Steel. Tata Steel’s cost will increase due to DMF pay-out at its captive iron ore and coking coal mines. Tata Steel paid a royalty of R11.3 bn/R8.1 bn in FY2014/15. On assuming 30% of royalty amount for DMF, we estimate royalty and DMF costs of R17 bn in FY2017e against R24.5 bn based on 100% royalty. Our Ebitda estimate increases by 5% to R168 bn and fair value to R255/share from R205/share. However, we highlight that
spot steel prices are very low and Tata Steel’s fair value at spot prices works out to R125/share assuming 30% DMF cost of the royalty amount.
NMDC. NMDC paid royalty of R13.9 bn (11.2% of revenues) in FY2015 given royalty rates of 15% on iron ore (royalty rates increased from 10% to 15% from September 2014). On assuming 30% of royalty amount for DMF, we estimate royalty and DMF costs of R17.6 bn in FY2017e against R27.1 bn based on 100% royalty. Our Ebitda estimate increases by 19% to R58 bn and fair value by 14% to R120/share from R105/share.
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