Sesa Goa - one more setback; event update; Reduce:: Edelweiss

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Sesa Goa (SESA IN, INR 300, Reduce)

Closure of Orissa mine to further impact volumes

Sesa Goa has announced closure of operations at the Thakurani mine at Barbil (Orissa) from December 1, 2010. This mine produced ~1.9 mt in FY10 and we had assumed ramp up to 3.5 mt by FY12. The mine was operated on third-party basis i.e., the company had entered in to a 10-year contract in 1999 with the mine leaseholder on a royalty payment structure. Since 2009 Sesa Goa has been operating the mine based on short-term contracts and was in discussion for long-term renewal. However, these negotiations have failed and the company has decided to exit the arrangement as the offered terms were not commercially viable.

This mine had reserves of 69.3 mt as on March 31, 2009, with average Fe content of 64.1%, the company’s highest grade. Our resource estimate as on March 31, 2010, is ~82 mt, which is 23% of the company’s total resources. The mine produced 70% fines and 30% lump.

Impasse on Karnataka export ban continues

The Karnataka High Court has upheld the export ban on iron ore imposed by the state government. We see risk of this ban prevailing for balance of FY11. However, we expect this issue to be resolved in FY12 and have assumed volumes from the Karnataka mine in our model.

Outlook and valuations: Volume worries; maintain ‘REDUCE’

We have cut our FY12 volume estimate from 25 mt to 21 mt, largely due to cessation of operations at the Orissa mine and partly due to assumption of delay in resolving the Karnataka issue. Led by this, our FY12 EBITDA and PAT estimates have been revised down 11% and 10%, respectively. We have reduced the target EV/EBITDA multiple to 4.5 from 5.0 and excluded Orissa resources in our DCF calculation. We arrive at fair value of INR 300/share (earlier: INR 339/share). We note that the average one-year forward EV/EBITDA is much lower at 3.8x; we see risk of the stock de-rating further due to lack of volume growth. Our FY12 estimates have downside risk if the Karnataka issue is not resolved. Considering this, we see possibility of the stock trading below fair value and maintain ‘REDUCE/Sector Underperformer’ recommendation/rating.