Stock to remain subdued on falling spot iron ore prices, moderating Chinese demand.
Sesa Goa acquired an additional 1.5 per cent stake in Cairn India at an average price of Rs 325 a share on Wednesday, taking its overall holding in the latter to 20 per cent. Based on the current price, Sesa Goa's stake in Cairn is valued at Rs 9,800 crore or Rs 113 per share (after applying a 20 per cent holding company discount, which analysts typically do). While the gains from this investment (in the form of an increase in its value or otherwise) will only reflect in the long term, it also means the company will lose out on interest income in the near term.
Meanwhile, the valuations suggest the market is valuing the core business (and remaining investments) of Sesa Goa at Rs 67 per share, given its current price of Rs 180. Though these look attractive from the long-term view (considering the company’s huge iron ore reserves), they reflect the absence of significant revenue growth and the pressure on earnings over the next two years. The stock has been consistently declining from its all-time peak of Rs 494.30 in April 2010, and the deteriorating fundamentals will keep the share price under pressure, believe analysts.
Pricing woes
Considering the global economic headwinds, especially moderation in Chinese demand, analysts expect spot iron ore prices in the international markets to correct further to about $120 a tonne from the current $130 a tonne. They are already down 20-23 per cent since September.
| EARNINGS PRESSURE | |||
| Rs crore | FY2011 | FY2012E | FY2013E |
| Sales | 9,205 | 7,299 | 7,942 |
| Ebitda | 5,112 | 3,352 | 3,504 |
| Ebitda (%) | 55.5 | 45.9 | 44.1 |
| Net profit | 4,223 | 2,154 | 2,395 |
| EPS (Rs ) | 47.4 | 26.9 | 26.9 |
| PE (x) | 4.0 | 7.0 | 7.0 |
| E: Estimates Source: Barclays Capital | |||
Sesa Goa, which exports a little over 90 per cent of iron ore production (a majority of it to China), could thus see pressure on realisation. "We have cut our FY12-13 estimated EPS by three to seven per cent, as we incorporate the lower spot price estimate, lower volumes and a weaker rupee. We believe iron ore prices could correct further and re-test recent lows of $120 per tonne in the near term," says Bhaskar N Basu, analyst with DSP Merrill Lynch, in a recent note on the company. Analysts expect realisations to be lower by about eight per cent at Rs 4,050-4,060 per tonne in the next financial year, as compared to FY12.
| THE CAIRN INVESTMENT | |
| Cairn India total shares (bn) | 1.90 |
| Sesa Goa stake (%) | 20.00 |
| Sesa Goa shares (in bn) | 0.38 |
| Cairn scrip CMP (Rs )* | 322.35 |
| Value of stake (Rs cr) | 12265.93 |
| 20% holding company discount (Rs cr) | 2453.19 |
| Per share for Sesa Goa (Rs ) | 113.00 |
| *Current market price as on Dec 7 | |
Mining ban, volumes
Apart from the pressure on realisations, analysts are concerned about volume growth, given the ongoing mining issues in Chitradurga (Karnataka) after the Supreme Court order to ban mining activities. Of the expected total production of 20 million tonnes in the current year, analysts estimated about 4-4.5 mt from Chitradurga. However, due to the ban, in the current financial year they now expect total volumes to come at about 18.5 mt. This will mean an impact of about Rs 650 crore on sales and Rs 370 crore on operating profits, estimate analysts.
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Notably, they see a risk to volumes for the next financial year as well and, hence, have lowered estimates accordingly. Although the company management claims the Karnataka mine has been examined and cleared by the authorities, analysts expect the operations here to resume only in the March 2012 or June 2012 quarter. Any delay beyond this would lead analysts to cut their 2012-13 earnings’ estimates further.
Besides the mining ban in Karnataka, there are concerns on output from other mines, too. "The ongoing Shah commission investigation, logistics issues and the fact that the erstwhile Dempo mines need to become compliant with new regulations are key risks to volumes in Goa (90 per cent of Sesa’s volumes). New approvals in Goa are anyway on hold," says Chirag Shah of Barclays Capital, in his note on the company.
No wonder, next year's profits are expected to remain at the current year’s (FY12) level. Nevertheless, there are other risks to earnings. For instance, the new draft mining bill, which seeks a mining tax equal to the royalty, if approved, could lead to erosion in earnings to the extent of 12-15 per cent in 2012-13 (since these are not yet factored in by analysts). Also, as the steel industry is seeking an export duty rise to 30 per cent from the current 20 per cent, it may add, if approved, to the pressure on earnings.