Bad news continues to plague Sesa Goa: Kotak Sec

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Sesa Goa (SESA)
Metals
No respite. Bad news continues to plague Sesa Goa. After delays in approval for
capacity expansion and continuation of ban on iron ore exports from Karnataka, Sesa
Goa has suffered another setback after it was unable to renew Thakurani (Orissa) mine
lease on viable terms with the mine owner. Production from this mine was 2mn tons in
FY2010 and had total reserves and resources of 78 mn tons (total 353 mn tons at end –
FY010. We reduce our volume estimates by 10% for FY2012E and 12-month DCF
based fair value to Rs300 (from Rs320).




Another setback for Sesa
Sesa Goa suffered another setback after it was unable to renew a third party mining contract on
viable commercial terms for the Thakurani mine in Barbil, Orissa. Sesa derived 2 mn tons of sales
(10% of FY2010 tonnages) in FY2010 from this mine. More important, reserves and resources
from this mine was 78 mn tons (22% of FY2010 reserves). Adjusted reserves at end-FY2010 will
reduce to 275 mn, which will reduce further to 254 mn by end-FY2011E. We highlight that Sesa is
operating the Sonshi mine in Goa (3 mn tons capacity, 2 mn tons production) under a third party
mining contract.

Lower iron ore sales estimates; medium-term capacity expansion plans also at risk
We lower iron ore sales to 21.1 mn, 21.7 mn and 25.3 mn tons for FY2011E, FY2012E and
FY2013E from 21.7 mn, 24.1 mn and 29.7 mn earlier. The reduction is entirely attributable to
elimination of volumes from the Orissa mine. Note that the Orissa mine is a high-cost mine and
contributes to 6% of profits, versus 10% to production. Our volumes for FY2012E may be at risk
in case the Karnataka Government persists with its ban on iron ore exports.

Further, Sesa’s plans to expand iron ore production capacity to 40 mn tons by end-FY2013E may
be at risk on account of delays in getting environment clearance from MOEF. Sesa currently has EC
approval to mine up to 25 mn tons per annum. We note that the Goa Government is not taking
up any mine expansion request pending further announcements on the revised MMDR draft.

Lower volumes partly offset by revision in our iron price forecast
Impact of lower volumes is partly offset by increase in our iron price forecast by 5% and13% to
US$126 and US$127/ dmt for FY2011E and FY2012E respectively. Our near-term EPS estimates
change to Rs55.5, Rs53.8 and Rs55.4 for FY2011E, FY2012E and FY2013E from Rs52.5, Rs54 and
Rs61.5, respectively. Our long-term iron ore price assumption remains unchanged. We lower our
DCF-based target price to Rs300 on elimination of 78mn ton reserves of Orissa iron ore mine. We
value Sesa’s core business at Rs180/share and its stake in Cairn India at Rs119/share. We lower our
fair value to Rs300, from Rs320 earlier.


Core business valuations based on generous assumptions
We find Sesa Goa’s valuations expensive even after building in (1) aggressive long-term iron
ore price of US$90/dmt (long-term benchmark price, fob basis) and (2) further reserve
accretion of about 80 mn.

Sesa faces multiple headwinds in the form of (1) imposition of ban on iron ore exports by
the Karnataka Government. Near-term volumes may be hit by this ban, while medium-term
expansion plans may be impacted by a lack of environment clearances (Sesa has EC approval
for iron ore mining up to 25 mn tons); (2) potential changes in MMDR Act that may call for
sharing of 26% of profit generated with the population displaced from the mine and (3)
unrelated and value destructive move to acquire 20% in Cairn India. Not only Sesa is
overpaying for the asset, the move appears to be driven to fund group aspirations.