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Sesa Goa: It's not over yet!

Feb 8, 2005

Performance Summary
Sesa Goa, the largest private sector iron ore company in the country, recently announced strong December quarter results. For 3QFY05, the company has reported a strong topline growth of 73% YoY, while its bottomline has leapfrogged 278% YoY. Notably, operating margins have more than doubled during the quarter, thanks to the sustained hardening of iron ore prices, thus helping the company garner better realisations.

Company background
Sesa Goa Ltd., the flagship company of the Sesa Group, is India's largest private sector exporter of iron ore. A major part of the iron ore produced by the company is exported and it accounts for 1.5% of world trade in iron ore. Over the last decade, the company has also diversified into the manufacturing of pig iron and metallurgical coke. It also has a presence in shipping, ship building and engineering.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net Sales 1,852 3,212 73.4% 3,414 6,702 96.3%
Expenditure 1,442 1,623 12.5% 2,771 3,672 32.5%
Operating Profit (EBDITA) 410 1,589 287.1% 643 3,030 371.3%
EBITDA margin (%) 22.2% 49.5%   18.8% 45.2%  
Other income 12 26 113.7% 44 120 172.7%
Interest 21 8 -62.5% 58 34 -41.3%
Depreciation 39 41 6.1% 112 119 6.7%
Profit before tax 363 1,566 331.5% 517 2,997 479.6%
Tax 103 583 466.0% 151 1,091 622.5%
Profit after Tax/(Loss) 260 983 278.2% 366 1,906 420.7%
Net profit margin (%) 14.0% 30.6%   10.7% 28.4%  
No. of Shares (m) 19.7 19.7   19.7 19.7  
Diluted earnings per share* 52.8 199.8   24.8 129.1  
Price to earnings ratio (x)   7.0     10.8  
(* annualised)            

What has driven performance in 3QFY05?
Realisations led topline growth: Sesa Goa continues to reap the advantage of the current boom being witnessed in the steel industry. The company benefits from this as it provides one of the key raw materials (iron ore) required in the production of steel. Sustained demand for the metal and a consequent increase in the production of the same has helped the fortunes of iron ore companies like Sesa Goa. The topline of the company increased by 73% in 3QFY05 on the back of a surge in iron ore prices as the demand-supply dynamics of the iron ore industry at the current juncture are in favour of ore suppliers. It must be noted that the contracted and spot iron prices have been on the rise since the last couple of years in wake of higher demand for the same. Just to put things in perspective, after a 9% hike in international contracted iron ore prices for FY04, FY05 saw a sharper increase of 18.6% in the same. Further, going forward, considering the global developments in the steel and iron ore industries, we believe that iron ore prices would be settled at higher rates (about 20%-25% increase YoY) for FY06.

Cost break-up
(% of net sales) 3QFY04 3QFY05 9mFY04 9mFY05
(Increase)/Decrease stock-in-trade 15.4% 4.9% 0.2% -3.7%
Staff costs 3.3% 2.5% 5.4% 3.2%
Consumption of stores 9.0% 6.2% 13.3% 7.8%
Inlands transportation & other services 31.6% 17.6% 38.3% 26.7%
Purchase of ore 8.5% 15.4% 11.7% 14.3%
Other expenditure 10.0% 4.0% 12.2% 6.5%

Operating margins leapfrog: On the back of strong realisations, the operating margins during the quarter more than doubled from 22% in 3QFY04 to about 50% in 3QFY05. With the strong topline growth coming largely from stronger iron ore realisations, the operating costs as percentage of sales have witnessed a considerable decline. It must be noted that logistics cost is a key element in the value chain of the iron ore business. Moreover, since iron ore exports form a major source of revenue for the company, freight rates have a key role to play in deciding the profitability of the company.

Net profits: The bottomline performance of the company is primarily a trickle down effect of the performance at the operating level. It must be noted that the growth at PAT level would have been higher but for the increased tax provisioning during the quarter (up 466% YoY).

What to expect?
At Rs 1,400, the stock trades at a price to earnings multiple of 10.8 times annualised 9mFY05 earnings. Going forward, considering the huge steel capacity expansions, both domestic and globally, the scenario for iron ore demand remains attractive. The company's export markets include Japan, China, Pakistan and parts of Europe. Though China has huge iron ore reserves, it is primarily of lower grade and hence the country imports huge amounts of higher-grade iron ore from India. On the pricing front, iron ore contract prices are likely to settle at higher levels for FY06 over that of FY05. In fact, as per reports, major iron ore producing companies like Brazil and Australia, are contemplating a hike in contract iron ore prices of more than 50% over that of FY05 in wake of strong demand for iron ore on the back of rising steel capacities.

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