The credit profile of the appointed MDOs during the mine development phase is perceived to be risky, owing to high capex and negative-to-low free cash flow. The credit profile is likely to improve gradually over the mine operating period as the cash flows are negative to low till the annual production reaches the peak production capacity, and thereafter turn positive. Given the high capex during the development phase, it becomes extremely important for the operator to achieve the envisaged strip ratio and/or operational efficiencies to recover the capex along with a reasonable return.
As of May 2017, one out of the four MDOs appointed by central and state power utilities in the last 21 months has commenced mining operations and another two are likely to commence operations in FY18. The remaining MDO will commence mine development in FY19. The slow pace of appointment is attributed to the delay in securing requisite clearances and collection of techno-commercial data by the awarding authority for inviting prospective bids. Nevertheless, 14 captive coal mines owned by central and state power utilities with geological reserves of 6.8 billion metric tonne (MT) are under various stages of bid invitation and evaluation while techno-commercial bids for 19 mines with geological reserves of 9.3 billion MT are in the pipeline.
MDO is a specialised operating leverage play and attracts limited competition, given the risks and reward involved. MDO projects offer multi-year revenue visibility which strengthens the overall order book and imparts diversification benefits to the appointed EPC players. Successful operations require robust mine designing and engineering capabilities as well as the financial strength to sustain viable operations over the long haul.
MDOs need to make significant upfront capex in equipment and infrastructure during the mine development phase, followed by recurring replacement capex for machinery every five years during the mine operation phase based on asset usage. The overall investment outlay is in the range of 8 per cent to 10 per cent of project revenues over the MDO tenure. After the commencement of mining operations, it generally takes two to five years for the mine to achieve peak production capacity and EBITDA margins of 25 per cent to 30 per cent. Return ratios are likely to be moderate in the range of 11 per cent to 14 per cent over the operating period, owing to high capital intensity. The ability of an MDO to maintain the scheduled production timelines; maintain, or operate below, the stipulated strip ratio; and keep asset utilisation at the optimum level are key monitorables.
Ind-Ra expects EPC contractors with an experience of excavating more than three million metric tonne per annum of mineral or overburden in mining belts, moderate free cash flow, low leverage translating into high financial flexibility to be strong contenders for MDO appointment. However, given the amount of investment and length of the gestation period involved in mine development, most moderately leveraged private contractors can only operate two mines under development phase at the most to maintain their credit profile in a comfortable range.
Despite the promising benefits, MDO projects are fraught with operational challenges with respect to delay or inability to achieve the peak production capacity, risk of an increase in strip ratio, variability in off-take, challenges in incremental land acquisition and conflicts from inhabitants. These impediments can spiral costs and weaken the financial metrics of appointed contractors.