The boom in the steel industry continued to drive the fortunes of industries and companies that cater to the demand for raw materials required by the steel industry. Iron ore is one such raw material, which forms a key input in the manufacturing of steel. This helped Sesa Goa, an Indian iron ore exporter, to continue to register splendid performance in the second quarter of the current fiscal also. After registering a 290% jump in bottomline on the back of a strong 88% growth in topline during 1QFY05, strong iron ore prices helped the company record a 218% growth in topline and significant profits during the September quarter, compared to a loss in the same period last year.
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 currently 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.
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What has driven performance in 2QFY05?
Net sales: The strong topline growth of 218% during 2QFY05 for the company can be attributed to two factors – strong volume sales along with much stronger realisations. The volume sales (including exports) were on the back of continued strong demand for steel globally, led by China, which dominates the global steel scenario with its 25% share of the industry. This led to a sharp rise in demand for iron ore, which in turn led to a shortage of the same, consequently pushing up iron ore prices, both contract and spot prices. It must be noted that after a 9% hike in international contracted iron ore prices for FY04, FY05 saw a sharper increase of 18.6% in the same. Though there was some hiccup witnessed earlier in the current fiscal on the back of reports of Chinese authorities determined to rein in their galloping economy, iron ore prices firmed up again. This has aided the company’s performance in 1HFY05.
Operating margins: On the back of a strong topline growth, the operating margins for the company witnessed a big surge. While during 2QFY05, the company recovered from its losses during the same quarter in the previous fiscal, if we look at the first half performance of the company, the operating margins have shot up from under 15% to over 41%. While all the operating expenses have improved as a percentage of net sales, 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 company’s performance at the operating level. The other income component has also played a small role in pepping up the bottomline of the company.
What to expect?
At Rs 825, the stock trades at a P/E multiple of 8.8x its 1HFY05 annualised 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 countries like India. On the pricing front, though iron ore contract prices are likely to settle at higher levels for FY06 over that of FY05, the scenario post that does not look too encouraging. Further, it must be noted that the exchange rates volatility directly affects the earnings of the company.
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