>SESA GOA (CLSA)

Sesa Goa is targeting to increase iron ore output to 50 mtpa by FY14 from ~20 mtpa in FY10, which will make it one of the world’s largest iron ore producers. This will require addition of at least 300 mn tons of reserves from existing mines and/or acquisition of new mines. Our NPV analysis suggests that one needs to be a believer in Sesa adding these reserves at a very low acquisition cost and also in iron ore prices staying at $100/t till FY15 to justify 10%+ returns in stock price. Strong iron ore prices and rising production will ensure a strong 81% profit growth in FY11 but post recent run-up, we view risk-reward as unfavourable. We initiate coverage on Sesa Goa with an Underperform rating and a target price of Rs385.

Reserve accretion is crucial for volume growth
We believe that Sesa needs to augment its iron ore reserves by at least 300 mn tons by FY14 when its output hits 50 mtpa, assuming a minimum 10-year mine life. Sesa is undertaking extensive exploration efforts at existing mines to boost reserves. Sesa is also targeting to acquire reserves via acquisitions of smaller mines, which looks likely given its balance sheet strength and the high degree of fragmentation in India’s iron ore sector. Sesa is also hopeful of getting ~90 mn tons of reserves from the Jharkhand mine in 4 years, where it holds a prospecting lease and has applied for a mining lease.

NPV analysis suggests unfavourable risk-reward
An NPV on Sesa’s existing reserves using CLSA’s iron ore forecasts yields a value of just Rs287/sh. However, we believe that this is conservative as 1) There is a high probability that Sesa will augment its reserves in an NPV-accretive manner; and 2) We see upside potential to CLSA’s near and long-term iron ore price forecasts. If we take a leap of faith and assume that 1) Sesa adds 105 mn tons of reserves from existing mines, acquires another 105 mn tons at a very low acquisition cost of just US$3/ton and the Jharkhand mine comes through in 4 years; and 2) Iron ore prices stay at $100/t (FOB India) till FY15 and use a 30% higher long-term price of US$70/t (real terms) FY16 onwards, we arrive at an NPV of Rs506/sh – just 14% upside.

Initiate coverage with U-PF rating
We see potential delays in Sesa getting the Jharkhand mine and also see a risk of Sesa having to acquire new mines at a much higher acquisition cost. This, combined with the relatively small upside even in our blue-sky scenario, makes us view risk-reward as unfavourable. Put another way, we believe that the current stock price implies a 25+ year mine life or $105/t iron ore price from FY12 till perpetuity – both very unlikely. Stock moves with spot iron ore prices and could outperform for short periods if spot prices rise further. However, we struggle to justify a positive stance on a 12m view. We initiate coverage on Sesa with an U-PF rating. Our TP of Rs385 implies 8.3x FY12 P/E, 4.1x FY12 EV/EBITDA and is at a 34% premium to NPV on existing reserves.

To read the full report: SESA GOA