Sesa Goa: Reversing fortunes

While uncertainty regarding the Cairn-Vedanta deal prevails, analysts remain bullish on the company due to higher volumes and profitability in the core business.The underperformance trend seen in Sesa Goa’s counter vis-à-vis the broader markets since April last year is set to change for the better. Even as there is uncertainty regarding the clearance of Cairn-Vedanta deal by the Central government, which may prove negative for Sesa Goa in the short-term if disapproved, the lifting of iron ore export ban from Karnataka is a big positive, analysts say. That’s because, it will aid volume and profit growth for Sesa Goa.After the Supreme Court’s recent order, lifting the export ban, its stock has risen by a net 7.5 per cent.

In the near term though, expectations of global iron ore prices softening a bit from the current levels of $180 a tonne (China) due to increase in supply from India could keep a check on the stock. Nevertheless, most analysts remain positive on the stock (with price target upwards of Rs. 360) even as they will be closely watching the developments on the Cairn-Vedanta deal.

The Cabinet committee on economic affairs (CCEA) has referred the Cairn-Vedanta deal to a group of ministers for further review due to some unresolved issues including royalty payment dispute with ONGC. Thus, with Sesa Goa already set to commence the open-offer to attain 20 per cent stake in Cairn, it leads to multiple possible scenarios.

In case Sesa Goa goes ahead with the open offer and the government approves the Cairn-Vedanta deal later keeping a status-quo on the royalty issue, it will be just a matter of time before the deal is completed. On the flip side, Religare Securities (in a report) observed that if ONGC’s royalty payment for Cairn’s share become cost recoverable, it has big financial implication on Cairn India’s valuation (about Rs. 33 per share).

It says chances of the government agreeing for non-inclusion of this royalty in cost recovery calculation are quite low and at best the deal may get approved subject to final court verdict on this matter. In the event of the deal not going through, the stake acquired by Sesa Goa will leave it as a minority shareholder in Cairn India and will be looked at negatively.

Chandrani De, analyst at Ambit Capital observes “If the regulatory approval for the Cairn-Vedanta deal does not go through, while it is difficult to quantify the impact on intrinsic value of Sesa Goa, the uncertainty is likely to negatively impact Sesa Goa’s stock .

The ban on iron-ore exports from the state was imposed in July 2010. Since then, even as iron ore prices have moved up, Sesa’s stock has languished (see chart).
The lifting of this ban is certainly a positive given that Karnataka operations accounts for slightly over 6 million tonnes (mt) per annum or about 28 per cent of Sesa Goa’s total capacity. The export ban affected volumes of Sesa Goa from Karnataka, which was being sold in domestic market at relatively lower realisations. In the third quarter, volumes from Karnataka stood at 0.7 mt only.

The company thus was largely dependent on iron-ore produce from Goa, pegged slightly above 15 mt a year. Additional capacities in Goa are still to be cleared while the Orissa mining operations though smaller have already been shut.
Thus, lifting of Karnataka ban improves visibility for Sesa Goa. Analysts at RBS (Royal Bank of Scotland) in their recent report estimate the resumption of exports to add 3 mt per annum of volumes and earnings before interest, tax, depreciation and amortisation (Ebitda) of $150 million (around Rs. 660 crore; almost 15 per cent of 2011-12 estimated Ebitda). Estimated impact on valuations is seen at Rs. 43 a share.
There could be more benefits, albeit in the medium term, if clearances for Karnataka mine expansion to 10 mt per annum are attained, which analysts estimate to come in next financial year.

For now, firm iron-ore prices add to prospects of Sesa Goa. Analysts at Angel broking feel the firm prices are likely to take care of the rising expenses like freight rates on iron ore exports. They too have increased their production and sales volumes estimates for Sesa Goa by nearly 3.5 mt for 2011-12. The stock at Rs. 315.70 trades at 6.7 times its 2011-12 estimated consensus earnings.

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