Sesa Goa Ltd (SESA IN) N(V): Value unlocking from new bauxite source some time away  HSBC Research,

Sesa Goa Ltd (SESA IN)
N(V): Value unlocking from new bauxite source some time
away
 Sterlite Industries signs bauxite supply agreement with
companies holding mining concessions
 If mine eventually starts, we look at upsides based on
various scenarios; value unlocking will be time consuming
and contingent on several approvals
 We are N on SESA with TP of INR210

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For a background on the company and the proposed merger between Sesa Goa and Sterlite
Industries, please refer to our Feb 27 note Group consolidation – many issues resolved…
Sterlite signs bauxite supply agreement with companies holding mining concessions
Sterlite Industries mentioned in its recent 6K filing to the SEC that it has entered into a tripartite
agreement with Larsen & Toubro Limited (L&T) and Raykal Aluminium (Raykal). L&T holds
certain prospecting licenses for bauxite mines located at Sijmali and Kurumali of Rayagad and
Kalahandi districts of Orissa. STLT will acquire 100% of equity share capital of Raykal in a
phased manner at a total consideration of INR18bn in a milestone based acquisition. We
understand from the Directory of Geology, Government of Odisha, that the mines have c250mt
of reserves and parts of land are under 'village forest' category, thereby requiring Forest Clearance
under Stage 2 of Ministry of Environment & Forests (MoEF) approvals.
If mine eventually starts functioning after 3-4 years, we look at upsides in various scenarios
Since L&T has a Prospecting License only, we understand that it would take significant
amount of time for the company to finally sign a Mining Lease, if it manages to get the
requisite approvals. Assuming that it takes 3-4 years for the mine to start, and STLT incurs
additional exp of INR15b, we calculate potential upsides to our TP on a DCF-to-firm basis,
based on these scenarios. Please refer exhibit 1 for a detailed summary of our assumptions
A) Assuming current capacities at Vedanta Aluminium (VAL) alumina (1mtpa) and
aluminium (0.5mtpa) are only functional we derive a potential upside of INR1 per share of
SESA STERLITE.
B) Assuming that eventual approval from is obtained for operating expanded alumina
capacities (alumina expansion currently put on hold), and accounting for the incremental
USD1.5bn capex which VAL will have to incur, we derive a potential upside of INR14 per
share of SESA STERLITE.
.Valuations & risks: We value SESA on an SoTP basis at INR210 per share and rate
SESA Neutral. Please see page 3 for detailed valuation & risks.


Valuation & risks
We value Sesa Goa as a merged entity (as Sesa Sterlite) given our belief that the merger has a very high
likelihood of going through. We believe that the market is already valuing Sesa Goa on the assumption
that the merger will be successful. Recently the Competition Commission of India approved the merger
and the next leg of approval rests with the Foreign Investment Promotion Board. We value SESA on
SoTP basis on a blend of DCF and EV/EBITDA. We roll over the EV/EBITDA valuations to FY14e
(from FY13e earlier)
 Sesa Goa’s core business on a SoTP basis with iron ore operations on a DCF-to-firm basis (5% D:E,
15% WACC) and the pig iron business on 5.0x FY14e EV/EBITDA
 BALCO (Bharath Aluminium Co.) on FY14e EV/EBITDA of 5.5x
 Hindustan Zinc on FY14e EV/EBITDA of 4.7x
 Sterlite Energy’s projects on invested book given low visibility on earnings growth
 International zinc on FY14e EV/EBITDA of 4.0x


 MALCO (Madras Aluminium Co.) on FY14e EV/EBITDA of 4.0x
 Vedanta Aluminium (VAL) on FY14e EV/EBITDA of 5.0x (discount to Balco given low earnings
visibility)
 CAIRN India based on Kumar Manish’s target price of INR370/share
We derive a target price of INR210 per share for Sesa Sterlite (and Sesa Goa) and rate Sesa Neutral (V).
Under our research model, for stocks with a volatility indicator, the Neutral band is 10 percentage points
above and below the hurdle rate for Indian stocks of 11%. Our target price of INR210 implies a potential
return of 15.8%, within the Neutral band of our model; therefore, we are reiterating our N(V) rating on
Sesa Goa stock. Potential return equals the percentage difference between the current share price and the
target price, including the forecast dividend yield when indicated.
Risks to our rating and estimates
Higher (lower) than expected volumes and iron ore prices form basic upside (downside) risks. In addition,
regulatory overhang on the iron ore mining sector is another important downside risk. While investment in
CAIR forms a significant portion of SESA’s valuation, upsides (downsides) arising from this investment could
have a significant bearing on SESA’s valuation too. Also, profit sharing equal to royalty expense as envisaged
in the proposed Indian Mining bill could negatively impact FY13e PBT by 16%.


In the event that the SESA STLT merger is vetoed by shareholders and SESA yet exercises the option to go
ahead with the CAIRN stake purchase from Vedanta Resources [VED LN, OW(V)], the debt burden of
cUSD5.9bn could rest heavily on SESA’s operations, which is under stress due to the mining impasse in India.
Also, with CAIRN cash not being fungible (consolidated as a subsidiary), dividend payments in future will be
critical to mitigate the debt burden. With cash draining Vedanta Aluminium (VAL) being merged with cash
generating SESA STLT, the performance of VAL will be critical for stock performance and upside/downside
to our estimates. Delays in bauxite mine allocation/commissioning will continue to impact VAL’s profitability
thus having a stronger impact on the merged entity as compared to the current scenario where VAL is an
associate of Sterlite Industries.