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Underperformance factors in sentiment headwinds; attractive valuation
Sesa's 25% underperformance since Aug'10 likely factors in the deterioration in
investor sentiment on account of the Cairn deal. Sesa's iron ore business is
available at a ~30% discount to the global miners, which we believe is excessive
and expect to narrow as we move into FY12. Further, we believe that with an
improving longer-term outlook for oil, the overhang on account of the Cairn
acquisition is likely to recede. We raise our target price by 2.9% to INR360 to
factor in the revised valuation for Cairn India and reiterate Buy.
Deutsche Bank global commodities team bullish on iron ore pricing outlook
Our global commodities team remains bullish over the medium term outlook for
iron ore spot prices. We believe that over the course of the next two years, iron
ore may remain somewhat scarce due to various constraints in ramping up the
iron ore supply. This is partly because of bottlenecks as mining companies
struggle to build infrastructure. Our global commodities team forecasts a deficit in
the global iron ore seaborne market in both 2011 and 2012, which will likely help
sustain spot iron ore prices at current levels.
Decision on Karnataka iron ore export ban – a key stock price trigger for Sesa
The Supreme Court’s next hearing on the Karnataka iron ore export ban is slated
for April’11. We have been conservative in our forecast and factored in resolution
of the Karnataka iron ore export ban only by the end of 1H’FY12. An earlier-thanexpected
resolution is likely to be a strong positive for the earnings outlook as well
as stock sentiment. We believe the Street is yet to fully factor in the positive
earnings impact of an improving iron ore spot price outlook, thus providing an
attractive investment opportunity.
Trading at 30% discount to global mining majors; target price of INR360
We value Sesa Goa using SOTP methodology. Sesa’s iron ore business, valued at
4.6x FY12E EV/EBITDA, contributes INR185/share; the Cairn India stake, valued
using DCF and a 15% holding company discount, contributes INR175/share –
leading to a target price of INR360/share. Risks: export regulation and proposed
mining tax
Attractive valuations;
receding overhang
Raising target price to factor in higher valuation of Cairn India
stake
We are increasing our target price for Sesa Goa to INR360/share to incorporate the upward
revision of Cairn India’s target price (driven by Deutsche Bank’s new oil price deck), where
Sesa Goa is in the process of acquiring a ~20% stake. The deal has moved one step closer to
completion with receipt of the long-pending regulatory approval for Sesa’s open offer for a
20% stake in Cairn India. However, successful execution of the deal still hinges on getting
the requisite government approvals.
Investor concerns captured by stock underperformance; iron ore business trading at
30% discount to global peers
With the Cairn acquisition acting as a key overhang since announcing the deal, Sesa’s share
price has broken its historically strong correlation with spot iron ore prices, with the two
diverging significantly. While iron ore spot prices (63.5% Fe CFR China) are up 23%, Sesa’s
stock price is down 18% since August 2010. We firmly believe that this disconnect further
illustrates that the stock price underperformance is primarily driven by deteriorating
sentiment. Despite all the adverse news flow, we believe that a 30% discount to the global
miners is unreasonable and we expect this discount to narrow as we move into FY12.
Overhang of the Cairn acquisition likely receding with an improving oil price outlook
We believe that with the recent spike in oil prices and an improving longer-term outlook for
oil (our global commodities team has increased the long-term oil forecast from US$105/bbl to
US$125/bbl), the overhang on the stock on account of the Cairn acquisition is likely receding.
The use of Sesa Goa as a vehicle to partner with Vedanta in its Cairn India bid has raised
investor concerns on its group structure and interest alignment between its promoter and
minority shareholders in all group companies. Though we concur with investor concerns
regarding the use of Sesa’s cash by its promoters for pursuing their interest in oil, we believe
that the stock underperformance since the acquisition of the deal already factors in the
deterioration in investor sentiment. Further, with an improving oil price outlook, investors are
likely to be more amenable to the acquisition of a stake in Cairn India, provided there is no renegotiation
and Sesa acquires the Cairn shares at INR355/share as per the original
communication.
Remaining bullish on iron ore price outlook
Deutsche Bank’s global commodities team remains bullish over the medium term outlook for
iron ore spot prices. We believe that over the course of the next two years, iron ore may
remain somewhat scarce due to various factors. In part this is because of bottlenecks as
mining companies struggle to build infrastructure. A further consideration is that as iron ore
prices rise, iron ore reserves become more valuable or strategic; this can have political
consequences. Our global commodities team forecasts a deficit in the global iron ore
seaborne market in both 2011 and 2012, which will likely help sustain the spot iron ore prices
at current levels.
Steel production in China has grown strongly in the first two months of 2011 with YTD
growth of 12%. As per the data available from CISA, this trend seems to be continuing in
March’11 as well with the average daily crude steel production in China touching an all time
high of 1.945m tonnes from March11-20, surpassing the earlier record levels touched
towards the end of Feb’11. Historically, there has been a very strong correlation between the
Chinese average daily crude steel production and the monthly iron ore imports. With the
rebound in Chinese crude steel production, we expect a recovery in the Chinese iron ore
imports as well.
… spot iron ore price have stabilized after 14% decline over 1M
Iron ore prices have been under pressure over the past month primarily driven by destocking
in China and demand concerns on account of temporary steel capacity shutdowns in Japan.
The stabilization of Chinese steel prices is likely to provide support for spot iron ore prices as
well. In fact, spot iron ore prices seem to be stabilizing around US$175/tonne levels. The
continuation of strong import demand from China coupled with supply constraints from iron
ore supplying regions across the world continue to bode well for the iron ore spot price
outlook.
Valuation and risks
Target price of INR360 based on SOTP methodology
We use SOTP valuation to arrive at our target price for Sesa Goa as we have factored in the
completion of the proposed acquisition of the minority stake in Cairn India by 1QFY12. We
value Sesa Goa’s iron ore business at 4.6x FY12E EV/EBITDA, in line with the corresponding
valuation of global iron ore miners, leading to a value of INR185/share for Sesa’s iron ore
business. Deutsche Bank Oil and Gas analyst Harshad Katkar has assigned a DCF-derived fair
valuation of INR450 for Cairn India stock, which values Sesa’s minority stake in Cairn India at
INR175, after incorporating a holding company discount of 15%. Our SOTP valuation leads to
a target price of INR360/share.
Downside risks
Regulatory overhang: The imposition of additional export duty, mining tax, iron ore
royalty or other regulatory measures by the government of India without a commensurate
rise in the iron ore spot prices, forms a key risk to our earnings and recommendation.
Capacity ramp-up lower than expectations: We have factored in a resolution of iron
ore export ban from Karnataka in 1H’CY12. Should there be any delay in the resolution of
the export ban or ramping up of mine capacities, our earnings would be adversely affected.
Iron ore price weakness: We have assumed an increase of ~6% in blended iron ore
spot prices in FY12E and another 3% in FY13E. Though our FY12E price assumption is
below the current prevailing spot price, there could be downside risks to our estimates and
recommendation, in case the iron ore spot price weakens significantly from present levels
Cairn India valuation and risks
Valuation: Cairn India is valued at INR450/sh using DCF to estimate the NAV of
Rajasthan block, Ravva field and the Cambay block. The WACC of 11.1% is based on
Deutsche Bank's assumptions for India (risk-free rate 6.7% and risk premium 8.1%). The
DCF model is based on cash flows (from FY13) over the life of the fields and assumes no
terminal value. DB also puts risk weight potential upside from CAIL's exploration prospects
at 10%. Additionally, exploration prospects are likely accretion to reserves based on further
exploration by the company in its blocks.
Risks: Downside risks include a weaker than expected oil demand outlook and excess
crude oil supplies which may pose a downside risk to the oil price. Every US$1/bbl fall in
long-term Brent crude price reduces valuation by 0.7%. Other risks include any change in
the regulatory environment of the Indian Oil and Gas sector and policy issues such as the
dispute on cess in Rajasthan. Exploration and production activities face risks such as
operational, financial, geological and meteorological issues.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Underperformance factors in sentiment headwinds; attractive valuation
Sesa's 25% underperformance since Aug'10 likely factors in the deterioration in
investor sentiment on account of the Cairn deal. Sesa's iron ore business is
available at a ~30% discount to the global miners, which we believe is excessive
and expect to narrow as we move into FY12. Further, we believe that with an
improving longer-term outlook for oil, the overhang on account of the Cairn
acquisition is likely to recede. We raise our target price by 2.9% to INR360 to
factor in the revised valuation for Cairn India and reiterate Buy.
Deutsche Bank global commodities team bullish on iron ore pricing outlook
Our global commodities team remains bullish over the medium term outlook for
iron ore spot prices. We believe that over the course of the next two years, iron
ore may remain somewhat scarce due to various constraints in ramping up the
iron ore supply. This is partly because of bottlenecks as mining companies
struggle to build infrastructure. Our global commodities team forecasts a deficit in
the global iron ore seaborne market in both 2011 and 2012, which will likely help
sustain spot iron ore prices at current levels.
Decision on Karnataka iron ore export ban – a key stock price trigger for Sesa
The Supreme Court’s next hearing on the Karnataka iron ore export ban is slated
for April’11. We have been conservative in our forecast and factored in resolution
of the Karnataka iron ore export ban only by the end of 1H’FY12. An earlier-thanexpected
resolution is likely to be a strong positive for the earnings outlook as well
as stock sentiment. We believe the Street is yet to fully factor in the positive
earnings impact of an improving iron ore spot price outlook, thus providing an
attractive investment opportunity.
Trading at 30% discount to global mining majors; target price of INR360
We value Sesa Goa using SOTP methodology. Sesa’s iron ore business, valued at
4.6x FY12E EV/EBITDA, contributes INR185/share; the Cairn India stake, valued
using DCF and a 15% holding company discount, contributes INR175/share –
leading to a target price of INR360/share. Risks: export regulation and proposed
mining tax
Attractive valuations;
receding overhang
Raising target price to factor in higher valuation of Cairn India
stake
We are increasing our target price for Sesa Goa to INR360/share to incorporate the upward
revision of Cairn India’s target price (driven by Deutsche Bank’s new oil price deck), where
Sesa Goa is in the process of acquiring a ~20% stake. The deal has moved one step closer to
completion with receipt of the long-pending regulatory approval for Sesa’s open offer for a
20% stake in Cairn India. However, successful execution of the deal still hinges on getting
the requisite government approvals.
Investor concerns captured by stock underperformance; iron ore business trading at
30% discount to global peers
With the Cairn acquisition acting as a key overhang since announcing the deal, Sesa’s share
price has broken its historically strong correlation with spot iron ore prices, with the two
diverging significantly. While iron ore spot prices (63.5% Fe CFR China) are up 23%, Sesa’s
stock price is down 18% since August 2010. We firmly believe that this disconnect further
illustrates that the stock price underperformance is primarily driven by deteriorating
sentiment. Despite all the adverse news flow, we believe that a 30% discount to the global
miners is unreasonable and we expect this discount to narrow as we move into FY12.
Overhang of the Cairn acquisition likely receding with an improving oil price outlook
We believe that with the recent spike in oil prices and an improving longer-term outlook for
oil (our global commodities team has increased the long-term oil forecast from US$105/bbl to
US$125/bbl), the overhang on the stock on account of the Cairn acquisition is likely receding.
The use of Sesa Goa as a vehicle to partner with Vedanta in its Cairn India bid has raised
investor concerns on its group structure and interest alignment between its promoter and
minority shareholders in all group companies. Though we concur with investor concerns
regarding the use of Sesa’s cash by its promoters for pursuing their interest in oil, we believe
that the stock underperformance since the acquisition of the deal already factors in the
deterioration in investor sentiment. Further, with an improving oil price outlook, investors are
likely to be more amenable to the acquisition of a stake in Cairn India, provided there is no renegotiation
and Sesa acquires the Cairn shares at INR355/share as per the original
communication.
Remaining bullish on iron ore price outlook
Deutsche Bank’s global commodities team remains bullish over the medium term outlook for
iron ore spot prices. We believe that over the course of the next two years, iron ore may
remain somewhat scarce due to various factors. In part this is because of bottlenecks as
mining companies struggle to build infrastructure. A further consideration is that as iron ore
prices rise, iron ore reserves become more valuable or strategic; this can have political
consequences. Our global commodities team forecasts a deficit in the global iron ore
seaborne market in both 2011 and 2012, which will likely help sustain the spot iron ore prices
at current levels.
Steel production in China has grown strongly in the first two months of 2011 with YTD
growth of 12%. As per the data available from CISA, this trend seems to be continuing in
March’11 as well with the average daily crude steel production in China touching an all time
high of 1.945m tonnes from March11-20, surpassing the earlier record levels touched
towards the end of Feb’11. Historically, there has been a very strong correlation between the
Chinese average daily crude steel production and the monthly iron ore imports. With the
rebound in Chinese crude steel production, we expect a recovery in the Chinese iron ore
imports as well.
… spot iron ore price have stabilized after 14% decline over 1M
Iron ore prices have been under pressure over the past month primarily driven by destocking
in China and demand concerns on account of temporary steel capacity shutdowns in Japan.
The stabilization of Chinese steel prices is likely to provide support for spot iron ore prices as
well. In fact, spot iron ore prices seem to be stabilizing around US$175/tonne levels. The
continuation of strong import demand from China coupled with supply constraints from iron
ore supplying regions across the world continue to bode well for the iron ore spot price
outlook.
Valuation and risks
Target price of INR360 based on SOTP methodology
We use SOTP valuation to arrive at our target price for Sesa Goa as we have factored in the
completion of the proposed acquisition of the minority stake in Cairn India by 1QFY12. We
value Sesa Goa’s iron ore business at 4.6x FY12E EV/EBITDA, in line with the corresponding
valuation of global iron ore miners, leading to a value of INR185/share for Sesa’s iron ore
business. Deutsche Bank Oil and Gas analyst Harshad Katkar has assigned a DCF-derived fair
valuation of INR450 for Cairn India stock, which values Sesa’s minority stake in Cairn India at
INR175, after incorporating a holding company discount of 15%. Our SOTP valuation leads to
a target price of INR360/share.
Downside risks
Regulatory overhang: The imposition of additional export duty, mining tax, iron ore
royalty or other regulatory measures by the government of India without a commensurate
rise in the iron ore spot prices, forms a key risk to our earnings and recommendation.
Capacity ramp-up lower than expectations: We have factored in a resolution of iron
ore export ban from Karnataka in 1H’CY12. Should there be any delay in the resolution of
the export ban or ramping up of mine capacities, our earnings would be adversely affected.
Iron ore price weakness: We have assumed an increase of ~6% in blended iron ore
spot prices in FY12E and another 3% in FY13E. Though our FY12E price assumption is
below the current prevailing spot price, there could be downside risks to our estimates and
recommendation, in case the iron ore spot price weakens significantly from present levels
Cairn India valuation and risks
Valuation: Cairn India is valued at INR450/sh using DCF to estimate the NAV of
Rajasthan block, Ravva field and the Cambay block. The WACC of 11.1% is based on
Deutsche Bank's assumptions for India (risk-free rate 6.7% and risk premium 8.1%). The
DCF model is based on cash flows (from FY13) over the life of the fields and assumes no
terminal value. DB also puts risk weight potential upside from CAIL's exploration prospects
at 10%. Additionally, exploration prospects are likely accretion to reserves based on further
exploration by the company in its blocks.
Risks: Downside risks include a weaker than expected oil demand outlook and excess
crude oil supplies which may pose a downside risk to the oil price. Every US$1/bbl fall in
long-term Brent crude price reduces valuation by 0.7%. Other risks include any change in
the regulatory environment of the Indian Oil and Gas sector and policy issues such as the
dispute on cess in Rajasthan. Exploration and production activities face risks such as
operational, financial, geological and meteorological issues.
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