Stock Review: SESA GOA

The recent Supreme Court order to ban the mining of iron ore in Tumkur and Chitradurga districts of Karnataka, in addition to the earlier order for Bellary, will impact Sesa Goa. About a fourth of its production comes from these mines.

Analysts believe the ban would significantly impact its volumes over the next two years leading to lower sales and profits. Factoring this in, analysts have reduced their earning estimates for the company. Additionally, the muted outlook for the user industry, steel, has added to the woes.

Not surprisingly, Sesa Goa's share price has dropped almost 30 per cent since the start of the current month. At `213, it is trading at about six times its estimated earnings for 2012-13 and at an enterprise value to operating profit of 1.6 times. Though these are reasonable valuations, they reflect the absence of revenue visibility and earnings growth over the next two years.

VOLUME SQUEEZE

Due to the SC order, Sesa Goa's operations at its iron ore mine in Chitradurga will be hit. Of its total production of 20 million tonnes expected in the current year, analysts were expecting about 4-4.5 mt from Chitradurga. After the court order, the company said, "In view of this, activities in the Chitradurga mine will have to be stopped with immediate effect and, thus, it will adversely affect to some extent the performance of the company. The annual permitted capacity of the said mine at present is six 6 million tonnes." Since the order has come around the middle of the financial year, the company has already extracted about two mt of ore and is estimated to have another million tonnes of inventory. This effectively means the company could lose about 1-1.5 mt of sales volumes, as against the estimates. Based on 2010-11 realisations, this translates into an impact of about 650 crore on sales and `370 crore on operating profits.

However, compared to the impact it could have on the company's 2012-13 estimated numbers, when the full impact would be felt, this is still marginal. Analysts have reduced their volume estimates from about 23 mt to just about 18 mt or equal to what it did in the last financial year. A five mt cut in volumes translates into a `2,000 crore cut in estimated sales. This is also why analysts say revenues and profits over the next two years could even decline till more clarity emerges or if the company manages higher volumes from the other mines. Earlier, analysts were expecting it to report about `12,000 crore sales in 2012-13. They now peg this at `9,000-10,000 crore.

HIGH EXPORTS

Sesa Goa exports 90 per cent of its iron ore production. And, China takes almost 85 per cent.

This suggests any slowing in the Chinese market and any softening of iron ore prices could impact earnings in the coming months. In July, the country's iron ore exports declined 11.4 per cent. However, there are no immediate signs of slowing in the key Chinese market. Monthly crude steel production in China has remained at about 60 mt for the past seven months. And, iron ore prices have corrected marginally from nearly $200 a tonne around February to $180 atonne at present. The outlook, however, remains cautious, given the tightening in the Chinese economy, appreciation in its currency and the impact of the global slowdown on its demand for exports.

Part of the impact pertaining to these issues is already seen in the first-quarter results, wherein the company reported a 11.3 per cent decline in volumes, leading to lower sales compared to the year-ago period. Further, lower realisations and higher export duty (already up from five per cent to 20 per cent) had impact on profitability, leading to net profits declining 40 per cent in the first quarter of 2011-12. And, if talk of a further increase in export duty on iron ore materialises, it will impact Sesa Goa's performance.