Sesa Goa: TP: INR288 Neutral : Motilal Oswal

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Re-investment drags RoCE
Volumes at risk; Downgrade to Neutral
 Superior RoIC over FY07-11 but business uncertainties suppressed ASR.
 We expect FY12 volumes to shrink due to a mining ban in Karnataka.
 IC/CE ratio fell from 48% in FY07 to 25% in FY11 as SESA did not invest cash
flow in its core business but bought stake in Cairn India. We expect the
ratio to fall further.
 We downgrade the stock to Neutral as risks rise to volume growth in the
merchant mining business.
Best RoIC over FY07-11 but uncertainty hits stock performance
Sesa Goa (SESA) generated INR61b of operating cash flow over FY07-11 and invested
only INR32b. Its RoIC was the best in the metals sector, registering average of 174%
over FY07-11, much above the sector average of 61%. However, annualized stock
returns (ASR) were only 31% with dividend payout of 11.8%. Although average
realization of iron ore increased at a CAGR of 26% to USD93b over FY07-11, ASR
was impacted due to rising uncertainty about the profitability of the merchant mining
business in India and capital employment in the non-core business (acquisition of 20%
stake in Cairn India).
Although the Vedanta management ramped up volumes from 11mt in FY07 to 20mt in
FY11, a further significant volume ramp-up appears ambitious. In an attempt to clamp
down on illegal mining, the issuance of new mining leases and approvals has slowed
drastically in India. The Supreme Court recently banned mining in Karnataka due to
concerns about environment degradation and to investigate illegal mining activities.
Similar investigations have been initiated in Goa by the MB Shah Commission
(appointed by the central government); which might impact SESA's volume growth.
We expect FY12 volumes to shrink due to a mining ban in Karnataka
SESA's FY12 iron ore volumes will be impacted by a ban on mining in Chitradurga
and Tumkur districts in Karnataka to curb illegal mining and prevent further environmental
damage. We expect SESA's FY12 volumes to shrink as production stopped from 27
August at Karnataka. SESA has ~800k tons of inventory, which will be liquidated at
an e-auction, conducted by MSTC. Consequently, we have cut FY12 volume estimates
to 18.2mt from 21.3mt earlier.


IC/CE ratio falls from 48% in FY07 to 25% in FY11, will decline further
Although SESA's invested capital in its core business increased over FY07-11 from INR8b
to INR35b, we expect it to decline, going forward. SESA's cash flow from operations was
strong over FY07-11 but it could not invest into its core business (except investment in
Dempo) for lack of the right opportunity. Purchase of Cairn India's 20% stake to aid the
parent company and diversify its product portfolio raised concerns over management's
capability of efficient usage of capital. IC/CE dropped from a healthy 48% in FY07 (from
over 50% before that) to 25% in FY11 and we expect it to decline to 11% in FY13.
Downgrade to Neutral due to rising risks to volume growth
Although SESA continuously reduced its cost of mining since its acquisition by Vedanta,
rising royalty rates and export duties will drag down EBITDA. An increase in taxes after
the implementation of the MMDR Bill will impact margins over FY11-13.
Chinese iron ore import prices have not softened since six months and continue to rise in
anticipation of supply constraints and strong demand. However deteriorating outlook for
developed economies and apparent slowdown in Chinese manufacturing activity can pull
down ore prices in the near term. Over 4-5 years, ~730mt of iron ore supplies are expected
to add to the existing 1b tons of seaborne iron ore trade, which will ease a tight market.
We downgrade the stock to Neutral as risks to volume growth in merchant mining business
are rising.

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