>Sesa Goa (MERRILL LYNCH)

Weak iron ore outlook = earnings pressure

Remain bearish on iron ore, cutting estimates, Maintain U/P
Iron ore outlook remains weak as global steel cutbacks continue to take hold. Our global team has cut iron ore contract price forecasts to factor in weaker iron ore fundamentals. We have cut our FY10e EPS by 15% as we incorporate lower contract prices and higher spot sales mix in FY10. We forecast Sesa’s EPS to decline 36% in FY10. Valuations at 2.5x FY10E EBITDA appears reasonable but weak iron ore outlook, earnings downgrade risks will weigh on stock valuations, in our view.

Spot prices to remain weak
India - China spot prices (cfr.) had rallied 30% from Oct lows to US$81/t in Jan led by restocking activity and production restarts at small/mid Chinese mills (a key market for Indian iron ore exporters). However, spot prices has recently declined to ~US$67/t on weaker Chinese demand as restocking is largely over, port inventories are rising and small/mid sized mills are cutting back production.

FY10 contract price expected to fall 30% vs. 20% earlier
BAS-ML expects steel cutbacks to push iron ore market into a surplus of 117-183 mn tons over 2009-11. BAS-ML forecasts Aust. contract prices of US$64/t (US$73/t) in FY10. However, current China cfr spot price of US$67/t implies a ~ 40% fall in contract prices for landed cost of contract ore to match China cfr spot prices. Assuming 40% fall in contract prices, Sesa’s FY10e EPS falls by 44%.

Key takeaways from Sesa’s operations visit
We recently visited Sesa’s mines in Goa and also met the Mgmt. Key takeaways were 1) iron ore demand has dropped sharply in March and are now similar to Oct lows; 2) Mgmt. reiterated 20-25% vol. growth guidance over next 3 years; 3) Sesa is implementing a number of initiatives to ease logistics bottleneck; 4) Mgmt expects to announce reserves upgrades soon given positive exploration results.

To see full report: SESA GOA