>SESA GOA (ICICI SECURITIES)

FRUITLESS OPTIMISM
We raise our FY10E & FY11E EPS estimates for Sesa Goa 5% & 23%, accounting for: i) 2% & 13% increase respectively in iron-ore realisations, ii) increased royalty at 10% ad valorem, iii) lower railway freight (reduction of US$10/te since June), iv) lowered depreciation estimates owing to lower-than-expected rate followed by the company for newly acquired Dempo, and v) dilution on account of the recent FCCB issuance. Increased newsflow on steel-capacity rationing in China in a backdrop of domestic overcapacity weakens short-term price outlook for iron ore. Triggered by expectations of inorganic acquisitions, the stock trades at ~14% discount to global FY11E EV/EBITDA (historical high) leaving little headroom for upside. Downgrade to HOLD with revised target price of Rs 299/share (FY11E EV/EBITDA of 6.4x). Sesa Goa reported lower-than-expected Q2FY10 results with 51% YoY and 61% QoQ PAT dip to Rs1.7bn. While volumes grew 16% YoY to 1.61mnte, realisations disappointed yet again, at US$50.8/te (I-Sec: US$53.6/te). Lower-than-expected topline and operating income for the company’s metcoke division led to reported earnings being 22% below our estimates.

■ Iron ore disappoints for consecutive quarter. Q2FY10 blended realisations at
US$50.8/te surprised negatively as majority of the volume is shipped from high quality mines at Karnataka and Orissa during Q2 (seasonal). Also, for the first two months of Q2FY10, the Indian iron-ore export market share in China touched multiyear lows (at 11%) on account of the increased demand being met by Australia and Brazil, who utilised the spot market to their advantage. This led to subdued volume growth (16% YoY, including Dempo) despite delayed monsoons and strong July imports from China. Based on current 63.5Fe Indian ore at US$90/te, we marginally raise our FY10E realisation estimates 2%.

■ Metcoke ─ Major drag in Q2FY10. Sesa registered Rs32mn PBIT losses in its metcoke business. Subdued performance in metcoke division helped boost operating profit for the pig iron division, with PBIT margin of 28%. The company has undertaken capex of US$125mn to increase pig iron (and commensurately metcoke) capacity to 0.625mnte by Q2FY12.

■ Stretched valuations. Tax rate increased to 23% versus 17% QoQ, as no perceptible benefits flowed-in despite the company being granted EoU status in Karnataka and Amona (pig-iron plant). Sesa’s cash-on-books stands at ~Rs30bn. Short-term risks include inorganic acquisition (on the upside). With the imposition of 10% ad valorem royalty, we revise upward our FY11E target EV/EBITDA to 6.4x from 5x. Downgrade to HOLD with revised target price of Rs299/share.

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