Concerns priced in

Sesa Goa’s stock tumbled by almost 10 per cent to Rs 319.90 from the time it was announced that the company plans to buy a 20 per cent stake in India’s second-largest crude oil producer, Cairn India (CIL). The news about the unrelated diversification, which would also absorb Sesa’s surplus cash, clearly hasn’t gone down well with the markets.

This decline in its stock price adds to earlier losses (it had slipped from its recent high of Rs 480 in April to Rs 340-380 levels in the last two months), consequent to soft iron ore prices and concerns over steel outlook.

A divided Street
In the last seven years, the Vedanta group has shown its prowess of foraying into new areas and turning around companies by controlling costs and increasing production and mineral reserves’ base.
 

SUBDUED OUTLOOK
In Rs crore	FY10	FY11E	FY12E
Net sales	5,858	9,217	9,922
Ebitda	3,149	5,016	5,233
Net profit	2,629	4,355	4,243
EPS (Rs)	31.6	48.7	47.5
PE (x)	10.1	6.6	6.7
E: Average analyst estimates           Source: Analyst reports

A largely copper player initially, it has acquired companies like Hindustan Zinc (Zinc), Sesa Goa (iron ore) and Balco (aluminium); though these broadly fall in the metals category.

Notwithstanding this track record, the market has not found comfort in its latest move. Experts say that the unrelated diversification into crude oil production, which is being done at a premium to Cairn India’s market valuations, will also fully absorb the company’s surplus cash, which could have been used for its organic and inorganic growth or returned to shareholders in the form of dividends.

Sesa Goa had cash equivalents of about Rs 7,000 crore at the end of March and reported a net profit of Rs 1,300 crore for the June quarter. At that rate, it should end 2010-11 with cash equivalents of Rs 12,200 crore.

However, given that the acquisition is expected to be completed in the March 2011 quarter and that Sesa Goa is estimated to spend anywhere between Rs13,500 crore and Rs 15,500 crore for acquiring the 20 per cent stake in CIL, it will need to raise Rs 1,300-3,300 crore through debt.

While this would increase its consolidated debt of Rs 1,960 crore (as of March), the overall debt-equity ratio would still be at comfortable levels.

The analyst community, however, is divided on the move. While Edelweiss’ analysts estimate that Sesa Goa will need Rs 5,000-5,500 crore of additional debt for the acquisition, they anticipate it may have to provide additional funds to finance CIL’s growth plans. They also perceive the risk of Sesa having to pay a higher dividend to service increased debt at Vedanta Resources. On the other hand, analysts at Angel Broking are neutral, while an I-Sec analyst is actually bullish on the stock. The latter says: “Sesa Goa will treat CIL as an associated. Higher return ratios for CIL assets will ensure handsome accretion of earnings per share (EPS) to the company from 2010-11.”

Outlook
Meanwhile, spot iron ore prices have softened since their recent peak in July, consequent to slowdown concerns over China as well as world over, which does not augur well for Sesa Goa.

While average estimates by analysts peg Sesa Goa’s net at Rs 4,350 crore for 2010-11, the same is estimated to decline two-three per cent in 2011-12.

At Rs 319.90, the stock trades at a price-to-earnings (PE) ratio of 6.6 times its estimated 2010-11 earnings, wherein most of the concerns (over CIL’s stake buy and soft iron prices) seem factored in, and downside looks limited.