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Stock Insight: Wealth Mining

Increasing government focus on core sector augers well for iron ore mining companies like Sesa Goa

As emerging economies mature into developed nations, people grow richer and as a consequence they demand better infrastructure, improved living, more cars and household appliances. These, in turn, generate a huge demand for raw materials. Though China has been growing at a break-neck pace for over a decade now, the demand for industrial inputs is likely to remain robust in the near future. Ditto for other developing countries in Asia, given the size of their populations, their use of raw materials is still modest. By 2010 the global demand for imported iron ore (one of the key commoditied for industrialisation) will be 903 million tonnes, representing a growth of 5.5 oer cent a year.

On the domestic front too, India is expected to see a three-fold increase in demand for raw-materials in 10 years as the focus on expenditure and infrastructure spending increases. All these auger well for companies, like Sesa Goa, operating in the iron ore mining space.

Rising iron ore prices, increasing demand in the international market and the rapid increase in global steel capacities improve the prospects for Sesa Goa. Moreover, the company's strategic location makes it one of the prime beneficiaries of the booming demand.

Established in 1954, Sesa Goa Ltd (SGL), the flagship of the Sesa Group, exports around 5 million tonnes of iron ore, fines and lumps to Japan, China and Europe. The company is engaged in prospecting, mining, processing and exporting iron ore. Traditionally, the company exported only low and medium-grade ore from its mines in Goa. However, with the development of mines in Karnataka and Orissa, it now exports +64%Fe high-grade ore.

Global steel capacities are expected to shoot up by 144 million tonnes in 2006 and 2007 with most of it being built up in the Asian region. The capacity increase in the Asian region is expected to be at around 80 million tonnes. Global iron ore giants like CVRD, Rio Tinto and Billiton are expanding capacities rapidly. However, the demand is likely to outpace supply with steel output expected to grow at a robust 7.3 per cent in 2006 and 5.8 per cent in 2007 ensuring higher price realisations for players like Sesa Goa, which accounts for 1.5 per cent of the global iron ore trade. Iron ore accounted for more than 67 per cent of revenues of Rs 1763.55 crore in 2005-06. The company derives 70-80 per cent of its iron ore revenues through long-term contracts.

China, Taiwan and Japan collectively account for 69 per cent of the company's iron ore revenue. The company is likely to do good in the future given the increase in global demand and an expectation of higher price realisations.

The company diversified into manufacturing pig iron and metallurgical coke in the early 90s. Its current capacities stand at 280,000 tonnes for metallurgical coke per annum and 220,000 tonnes for pig iron per annum. The group's pig iron business is run by its 88 per cent subsidiary, Sesa Industries Ltd (SIL), which is currently in the process of amalgamating itself with Sesa Goa Ltd (SGL). As a result, the raw materials used for making pig iron like met coke and iron ore, will be transferred at its cost instead of market prices and will significantly boost the profits of Sesa Goa Ltd.

The company's coke and pig iron business contributes around 25 per cent to the total revenue. Increase in coke prices is likely to pare losses in this segment. Prices of pig iron are also firming up with an increase in demand from user industries like automobiles and engineering.

Moreover, Sesa Goa has developed and employed its own technology for non-recovery coke oven plants that are non-polluting and produce high quality coke. By patenting this technology, the company has entered into technology-licensing agreements with different licensees for marketing this technology. Logistic expenses form a large proportion of the operating costs of any company in mineral ore business. Logistic costs account for around 54 per cent of Sesa Goa's total operating costs and optimisation is a key driver for competitiveness. The river transportation in Goa has historically assisted the company in achieving international competitiveness. However, mines in Karnataka and Orissa depend on the railways to transport ore from the mines to the port, the cost of which is comparatively higher. A new railway line from the mining belt in Orissa to the Paradip port is likely to be commissioned this year. This would lead to a significant increase in profitability of the Orissa mines. Moreover, the company is also undertaking cost-cutting initiatives to bring down costs for the met-coke business. The pig iron business is also likely to witness significant cost cutting with the commissioning of hot blast stoves.

The top line is expected to grow at a CAGR of 20 per cent over the next two years and bottom line at 35 per cent. However, it recorded a 22 per cent decline in sales to Rs 599.35 crore and a 32.3 per cent decline in net profit to Rs 184.05 crore during the quarter ended March 2006 due to lower iron ore volumes and higher freight costs.

The metallurgy coke business also recorded losses because of higher coal prices and operating costs. However, for the year ended March 2006, its sales moved up 16.8 per cent year-on-year to Rs 1,763.55 crore and net profit was up 14.9 per cent to Rs 531.34 crore.

Poor infrastructure is a major impediment to the company's operations leading to higher transportation costs and demurrages at ports. Strong lobbying by certain groups for a ban of iron ore exports is another cause for concern. The slow pace of clearances for prospecting new mines by the government may also restrict its growth.