Stock Review: SESA GOA

INDIA'S largest private iron ore miner Sesa Goa reported better-than-expected results for the September 2010 quarter. The growth was driven by higher iron ore prices and increased sales volumes. The company was able to offset the adverse effect of the iron ore export ban in Karnataka, by selling substantially higher volumes from its Goa operations. International prices and the Centre's policy on iron ore mining would play a crucial role in the growth of the company.

   During the September 2010 quarter, the company's topline grew 70% to 918 crore, with net profit more than doubling from a year ago to 388 crore. Increased production from its Goa operation helped the company to improve its operating margin by 470 basis point. With 85% share in revenue, the iron ore division continued to dominate Sesa Goa's product mix. It also witnessed a reversal in the falling sales trend of pig iron, selling its high inventory due to increased domestic demand.

   The company is in a major expansion phase. It aims to double its mining capacity to 50 million tonnes. The company is also expanding its pig iron capacity by twoand-a-half times to 6,25,000 tonnes per annum. But, given the long process of getting clearances and permits, there are concerns about timely completion of these projects.

   Since Sesa Goa sells about 80% of its total volume to China, any slowdown in the Chinese steel production will impact the company adversely. The recent decline in iron ore prices reflects weak demand for the December quarter due to lower Chinese offtake and factors associated to seasonality. The latest economic indicators, however, hint at the changing demand scene. New orders are rising in the backdrop of falling inventory. This signals improved demand from China in the coming quarters and, hence, higher iron ore exports for Sesa Goa.

   Another important factor to watch out for is the company's latest move to acquire 20% stake in the petroleum producer, Cairn India, for $3 billion. Though the deal will not offer any operating synergies, it would still be earning-accretive. To fund the deal, Sesa Goa may have to take a bridge loan of about $700 million. This may not stretch its balance sheet since the company's quarterly operating cash flow is strong. Since the company has defined this deal as a long-term investment, performance of Cairn India is also to be looked at to project the profitability of the company in future. Investors should also pay heed to Sesa Goa's unique initiative to reclaim impoverished mines like the Sanquelim Mine. This makes it easier for the company to renew mining leases. Although these initiatives are not incorporated in valuation models, they certainly help the company to improve its goodwill and to acquire more mining assets with ease.