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Sesa Goa: Sailing on high ore prices!

Mar 12, 2007

Performance summary
Sesa Goa Ltd, the private sector mining company, reported 15% YoY topline growth and 24% YoY bottomline growth during 3QFY07 on account of buoyancy in steel, its end user industry. Riding on the back of high ore prices, operating profits surged by almost 20% YoY. Reduced interest costs (declined by 84% YoY) and higher other income (surged by 125% YoY) led to net margin expansion of almost 230 basis points (2.3%). If the other income is excluded, the net profit has grown by 20% YoY (instead of 24% YoY).

Financial performance snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 5,104 5,879 15.2% 11,133 12,450 11.8%
Expenditure 2,790 3,096 10.9% 6178.894 7,507 21.5%
Operating profit (EBITDA) 2,313 2,783 20.3% 4,954 4,943 -0.2%
EBITDA margin 45.3% 47.3%   44.5% 39.7%  
Other income 53 120 124.5% 199 320 61.4%
Interest 4 1 -83.6% 13 3 -74.0%
Depreciation 62 82 31.7% 183 222 21.3%
Profit before tax/(loss) 2,301 2,820 22.6% 4,957 5,039 1.6%
Exceptional Items 79 64 -18.0% 230 179 -22.2%
Tax 801 935 16.8% 1,714 1,676 -2.2%
Profit after tax/(loss) 1,579 1,949 23.5% 3,473 3,541 2.0%
Net margin 30.9% 33.2%   31.2% 28.4%  
No of shares (m) 39 39   39 39  
Diluted EPS (Rs)*         136.7  
P/E (times)         11.6  
*trailing twelve month earnings            

What is the company's business?
Sesa Goa is a 51% owned subsidiary of Mitsui, Japan and is India's largest private sector exporter of iron ore. Besides mining activities in Goa, the company has mining operations in Karnataka and Orissa. Ore from Karnataka is exported through the ports at Goa and Chennai, while ore from Orissa is exported through the ports of Haldia and Paradeep. The company's primary business is iron ore mining and exports, however it is also engaged in the production of metallurgical coke and pig iron. The iron ore business segment contributes almost 80% to the total revenues of the company. In FY06, the company sold about 9.6 m tonnes of iron ore, out of which only 6% was for domestic sales and the balance 94% was exported.

What has driven performance in 3QFY07?
Favourable scenario: Continued high ore prices, good demand for Iron ore (mainly driven by exports) coupled with optimum sales led to robust topline growth of 15% YoY. Another driver for higher price realisations is the increase in long-term contract prices. The company has secured a price increase of 9.5% for all its grades of Iron Ore from all the Japanese customers for the year 2007-08 over the previous fiscal year's prices. Buoyant steel sector led to a sharp rise in demand for iron ore, consequently pushing up iron ore prices, both contract and spot prices. Iron ore division is expected to continue its sterling performance on the back of growing demand.

Rising cost a concern: Recent surge in global prices of iron ore, coke and pig iron coupled with the cost reduction initiatives taken, has enabled the company to post higher profits. On account of better realisations, the company's operating profits grew by 20% YoY. The company has participated in the Wagon Investment Scheme of railways, as uncertainty with regards to availability of railway capacity and the high tariff structure is one of the reasons of increasing cost pressures. Though costs as a percentage of sales have reduced, in absolute terms, they have gone up. The company managed to lower raw material costs by almost 3% YoY, however, other costs such as staff costs (increased by 18% YoY) and transportation costs (increased by 28% YoY) have increased considerably. The operating margins of the company would have been better had not it been affected by rising freight, higher oil prices and lower exchange rate.

Cost break-up (% of sales) 3QFY06 3QFY07
Consumption of raw material 14.9% 12.6%
Staff cost 1.9% 1.9%
Consumption of stores and spares 5.9% 5.2%
Transportation and other services 16.9% 18.8%
Other expenditure 15.1% 14.1%
Total Cost 54.7% 52.7%

Other income effect: The company is almost a zero debt company and has consistently lowered its gearing by repaying debt. The reduced finance charges and higher other income helped company report 23% YoY growth in net profits. Had not the other income increased by 125% YoY, the net margin would have witnessed 120 basis points expansion instead of 230 basis points.

What to expect?
At the current price of Rs 1,591, the stock is trading at a price to earnings multiple of 11.6 times trailing twelve month earnings. Considering the investments or capex planned by steel companies, the scenario for iron ore demand remains attractive. However, it must be noted that exchange rate volatility has a direct impact on earnings of the company. Moreover, export duty announced in Union Budget 2007, will lead to reduced competitiveness and hence might impact export volumes of the company. Further, the company is highly dependent on transport infrastructure, which remains rather inadequate. Also, the current growth is price than volumes driven. Though there is visibility in terms of demand on account of expansion in the steel industry, caution needs to be exercised as risks outweigh rewards currently.

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