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Visit http://www.garcabranca.com for details/booking/confirmation. ----------------------------------------------------------------------- http://www.thehindubusinessline.com/iw/2006/06/04/stories/2006060402030900.htm Sesa Goa: Buy Radhika Kamath Firm pricing outlook, likely improvement in met coke division, strong operational and financial contours and attractive valuations offer scope for capital appreciation. China's demand for steel to fuel iron ore exports by Sesa Goa. Firm pricing environment for iron ore, improving outlook for met coke and pig iron, strong operational and financial contours and attractive valuations make the Sesa Goa stock an attractive investment candidate. Business Line has buy recommendations outstanding on the stock at prices between Rs 375 and Rs 800, the latest being in June 2005. The stock, after touching its historic high of Rs 1,613.7 in early May, has corrected by about 25 per cent since. It is trading at a price-to-earnings multiple of about six times its likely FY-07 earnings. We maintain our positive stance on the stock and recommend fresh exposures with one/two-year perspective. Prime beneficiary Recent negotiations between global iron ore miners and steelmakers in Europe and Japan have resulted in a 19 per cent Year-on-Year rise in the price of contracted iron ore. However, China, the largest importer of iron ore, is yet to accept the price hike. Even if the Chinese steelmakers manage to negotiate a lower price, we believe the prices are still going to be higher by 10-15 per cent from the FY-05 level. CVRD, BHP Billiton and Rio Tinto, the three global mining giants which account for over 70 per cent of the global sea-borne trade in iron ore, have announced investment plans of about $2.5 billion for increasing their mining capacity. The global iron ore market, is, however expected to remain in deficit the next couple of years, as the new mines are likely to begin production only in 2008-09. Sesa Goa, India's largest exporter of iron ore in the private sector, will be the prime beneficiary of the price hike, as this is likely to have a direct impact on its bottomline. About 40 per cent of Sesa's iron ore sales volumes in FY-07 is likely to be at higher prices, resulting in higher realisations. Despite repeated attempts by the Chinese Government to check iron-ore import — China accounted for about 60 per cent of global sea-borne iron ore imports in FY-06 — they are expected to rise owing to shortage of superior quality ore in China and growing demand from the steelmakers. This lends an encouraging outlook for Sesa's business as China accounts for over 55 per cent of its sales volume followed by Europe and Japan with shares of 16 per cent and 11 per cent respectively. PROSPECTS FOR Met coke The metallurgical coke division, which has been a drag on Sesa's profitability over the last 12-16 months, is likely to see an improvement in performance. International coke prices, after touching historic high of about $420 a tonne in 2004, have corrected considerably since then. Currently at about $120 a tonne, they appear to have bottomed out. However, prices have gained by $20-30 per tonne over the last month and are likely to stabilise at these levels. On the other hand, prices of coking coal (primary raw material for making coke) are showing signs of softening after remaining firm over the last one year. This is indicated from the recent negotiations between Nippon Steel of Japan and BHP Billiton; long-term prices were contracted 8 per cent lower than the FY-06 level. Sesa is likely to benefit from this development as it sells coke in the spot market and purchases coking coal through long-term contracts. We take a positive view of the pig iron business on the back of revival in demand and the improvement in prices the last two months. The proposed merger of Sesa Industries (Sesa Goa's 88.25 per cent subsidiary that manufactures and sells pig iron) would be accretive to the per share earnings. Firm prices and a healthy rise in volumes — the pace is likely to be moderate compared to those of the past two years — are also likely to bolster revenues and improve margins. The company has been able to maintain its operating profit margins above 45 per cent over the last three-four years. Sesa Goa's investments in wagons to lower logistics costs and the imminent completion of a railway line that would provide a better link to the Paradip port in Orissa are also likely to improve profitability levels. As also the increase in the proportion of ore exports from Karnataka and Orissa, this ore is of superior quality. If Sesa Goa manages to secure more mining licences across several States, it could remove capacity constraints over the long term. Buoyancy in earnings Sesa Goa's earnings are likely to remain robust over the next couple of years though the growth is likely to be moderate. Cash generation from its business operations would stay in the vicinity of Rs 600 crore (as in FY-05) on a conservative basis over the next few years. The company is well placed to step up dividend payments. The level of earnings and cash flows is likely to be healthy and provide a cushion to the valuation level. The concentration in the mining sector compared to metals is likely to place the former in a position of strength when it comes to pricing power; mining majors could also temper production levels to maintain prices at higher levels that could shorten the payback for the big-ticket investment underway in capacity expansion. These factors could ensure that Sesa Goa's earnings are not dented by any sharp decline in prices in the near to medium term. Key concerns Infrastructure constraints that could curtail volume growth and lead to higher logistic costs, restrictions on export of higher quality ores, and a substantial appreciation in the value of the rupee, could affect profitability and represent principal risks to our recommendation. _____________________________________________ Do not post admin requests to the list. Goanet mailing list (Goanet@goanet.org)