>SESA GOA (ICICI SECURITIES)

Positives priced in...

Though we are confident on Sesa Goa’s ability to push incremental 1-2mnte sales annually in Chinese spot markets on: i) increasing market share at the cost of domestic private miners, ii) leveraging well established dealer and end-user contacts in Chinese markets and iii) given the increased Chinese dependence on imported ore after ~50% closure of domestic capacities, earnings surprise will be hard to come by as: i) margins get diluted since incremental ore is mined from high-cost Karnataka mines and ii) prices remain range-bound in the absence of demand recovery (with Chinese steel makers asking for a 45-50% contract price cut). The stock has run up ~100% in the past three months and trades at historically high FY10E P/E of 7.5x. We downgrade Sesa Goa to HOLD from Buy with revised target price of Rs152/share.

■ While volumes are secured… We do not expect significant downside risk to our FY10E and FY11E volume estimates of 17mnte and 18mnte respectively based on Sesa’s increased market share at the cost of small-scale domestic miners (which form 55-60% of India’s export share). Also, at the current iron ore price, 50% of Chinese iron ore capacities are loss making (operational costs at US$67-70/te). While increased spot exposure due to dealer inventory build-up might be
temporary, the management’s focus to increase contract sales (at ~20% with 3- 4mtpa in long-term contracts) via aggressive marketing push will at least help maintain Sesa’s current market share in Chinese exports.

■ …we expect no positive earnings surprise. We do not expect significant earnings surprise on: i) volumes as incremental volumes will flow in from low margin Karnataka mines (suffering from high transportation costs), lowering the earnings sensitivity to volumes and ii) prices as we expect spot market prices to remain mostly range-bound within ~US$60-66/te with little short-term upside, which translates into a blended realisation of US$44/te for Sesa. However, rupee appreciation (~7% post elections) is a key downside risk.

■ Downgrade to HOLD. The stock has run up ~100% in the past three months and is currently trading at historically high valuations – at FY10E P/E (cash adjusted) and EV/E of 7.5x and 4.7x respectively. Also, rupee appreciation is a key risk to revenues. While we are not lowering our volume estimates, we do not believe there is significant upside risk to our earnings. We maintain our benchmark valuations of 50% discount to global peers and value Sesa at FY10E EV/E of 4.2x. We downgrade Sesa to HOLD with target price of Rs152/share from Rs141/share.

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