Stock Review: Sesa Goa

AFTER enjoying a bull run in merchant mining for the past five years, Sesa Goa is fast realising the environment in India is not conducive for growth. Analysts believe this explains the company's acquisition of a strategic stake in Bellary Steel and Cairn. The stock has come under intense pressure since the government levied 20 per cent duty on all kinds of ore export from March this year. This has substantially hit profitability. The state governments, on their part, are also increasingly turning against export of ore when no value addition has happened. Orissa and Karnataka have been the most vocal. While the government is right in its attempt to ensure the availability of raw material for local steel makers, the timing of the clampdown is not in the best interests of the company. Globally, the demand and supply scenario for iron ore is expected to remain tight for the next two or three years.

Currently, there is a 47 million-tonne deficit in the seaborne ore market, expected to contract to 11 million tonnes by 2013. With supplies expected to ease from 2013-14 onwards, iron ore prices will correct.

Given that 95 per cent of the company's revenues come from iron ore, a change in strategy is a given, as the dream run of the last few years may not continue. Though the company has doubled pig iron production, it's still not a large contributor to overall revenues. Analysts expect earnings before interest, taxes, depreciation and amortisation (Ebitda) to grow only 16 per cent this year due to higher export duty. Also, given the global prices of ore are at a peak, realisations will come down over the next couple of years as prices soften. In addition, the failure to renew mines in Orissa will impact the FY12 volumes by 2 mt, in addition to the 1-mt loss due to Karnataka's ban on export. Analysts are betting more on the Cairn acquisition than Bellary Steel, as steel making is still not a focus area and the acquisition is rather small. From a valuations point of view, Sesa Goa is currently trading at 4.4x & 4.5x of its FY12E earnings and EV/Ebitda, respectively. While the valuation looks attractive at these levels, the company is surrounded by many uncertainties, such as the pending issue of subsidy burden in Cairn India and a lack of clarity on volume growth. Analysts believe these issues will continue to be an overhang on the stock.