March 1, 2010

Company analysis - Sesa goa ltd

About
Sesa goa ltd is the largest private sector iron ore producer and exporter. It has access to 240 Million Mt of ore with mines in Goa, Karnataka and Orissa. The company achieved a turnover of around 5221 crs in 2009 with a net profit of 2710 Crs. The company exports almost 85% of its production to china

The company has three divisions with Iron ore accounting for 85% of the revenue, Pig iron representing forward integration represents 12% of the revenue and rest is accounted by Metallurgical coke. The company is principally a mining operations and logistics company.

Financials
The company achieved a topline growth of 30% and a profit growth of around 16% in 2009 inspite of the severe recession in Q3 and Q4 of the financial year. The company was able to achieve this performance due to the increase in volumes and pickup in demand in china, which account for 84% of its total volume.
The company has around 4000 crs in cash and equivalents on an asset base of 4800 crs. This translates to a stated ROE of 60% and 300% on the invested capital.
The company has a 10 year topline growth of almost 35% per annum, with majority of the growth coming in the later years. The net profit has grown by an even higher rate, with the last 5 year CAGR coming to around 33%.

Positives
The company has clearly been able to manage the business well during the downturn. It has been able to keep costs under control and maintain its profit levels. The company has a very strong balance sheet with a lot of surplus cash to re-invest in the business.
In addition, over a 10 year period the company has become fairly efficient and profitable. The net profit margins are close to 50% as the mines are owned by the company and the business enjoys considerable operating leverage (overheads do not increase in proportion to volumes).

Risks
China accounts for almost 84% of the total demand for the company. China currently accounts for almost 40%+ global steel production and hence the demand supply situation in china will have huge impact on the fortunes of the company.
In addition, iron ore export is a sensitive topic and the government can and has imposed export tariffs to favor the domestic steel industry. This can impact the net profit levels of the industry and the company in particular.
Finally, the company at the current rate of production (without growth) will exhaust the reserves in around 16 years. As a result the company needs to constantly explore and add to existing reserves on an ongoing basis. The cash on the books is not really free cash as it will be required to sustain the business in the future.

Management quality checklist
- Management compensation – Fairly low, based on the size of the company. Good for the shareholders.
- Capital allocation record – This is difficult to evaluate as the company has kept the dividend low and retained most of the profits which is now held as cash and equivalents. It remains to be seen how the capital will be deployed. The management has stated that the intention is to acquire mining assets with the excess capital.
- Shareholder communication – The shareholder communication is actually quite good. I have rarely seen Indian companies (outside of some IT companies) discuss their operations with honesty and detail. The company has actually detailed all the risks to the business quite clearly and with complete honesty.
- Accounting practice – appears conservative.
- Conflict of interest – doesn’t look like conflict of interest, but a 1000 Cr intercompany deposit with a fellow subsidiary is not something good over time.
- Performance track record – good in terms of operational performance. Capital allocation (investing the surplus cash) performance needs to be seen.

Valuation
Sesa goa is a mining company and it would be silly to value this company using a PE approach or Discounted cash flow. I have seen valuations where the company is said to be cheap as it sells at a PE of 13-14. That is stupid. The simplified equation should be
Company value = value of current reserves + future value from reserves to be added.
The company achieved a profit of around 130 crs per Million MT of ore . As the existing reserves are around 240 Mn MT, the asset/ cash value of the company is around 19000 crs (if the company were to develop no new reserves). This is the current cash or baseline valuation of the company. If the company sells below this price, it’s a bargain as it was in early 2009.
The company currently sells for 30000 crs which includes the value the company will generate through additions to its reserves and new mines. I need to evaluate the average reserve additions over the years to get a sense of the company’s capability to add to its reserves.
My current thought is that the company seems to be fairly valued till I can get a better sense of how the reserve addition will work out in the future.

Conclusion
The company is performing fairly well and has a strong balance sheet to support additions to ore reserves. At the current price however the company does not look undervalued to me. In addition there was a recent FCCB conversion which has added to around 3% to the equity base. Finally there seems to be some fraud investigation going on regarding the company. I have not been able to find much in terms of details and not sure how it impacts the company.
The company was bargain at any price below 200.

8 comments:

Shiv Kumar said...

The quality of ore from Sesa Goa's mines like others in Goa is very poor. They cannot make steel out of this ore and it is mixed with superior quality ore bought from other countries.

One advantage is that export of Sesa Goa's ore would not be banned for this very reason.

Goa's mining companies enjoy low valuation is because Australian company BNP is pushing very high quality ore at competitive prices. Higher iron content and there are other trace elements of potassium which helps it during the melting process.

If the iron prices in the world comes down for any reason Sesa Goa's margins would simply go down to the low single digits.

That is why Dempo sold its mining business to Sesa Goa.

On the other hand Sesa Goa is poised to buy out other Goan mine owners and reap economies of scale. If ore prices remain strong for the next few years Sesa Goa would be hugely profitable.

But the cylical risks are greater for this play.

Rohit Chauhan said...

Hi shiv kumar
great comment. i think for the margins to drop to single digits the ore prices need to drop by almost 40% from current levels to around 60 dollars ..which does not look as probable.
again the company may see a drop in margin and yet see increase in profits due to the scale it is building up.

all said and done, the biz is definitely very cyclical and has regulatory risk too

rgds
rohit

Anonymous said...

Rohit - One more delisting opportunity announced today - Suzler - your existing holding.

Very recently I started adding this stock- but could not built more than 10% of planned holding.

Thanks
Prashant

Rohit Chauhan said...

Hi prashant
thats true ..i will be putting a post on it soon.

delisting was trigger i was hoping ..luckily it happened

rgds
rohit

Praveen said...

It's trading at around 440 & you want it to come below 200 to buy :)

Rohit Chauhan said...

Hi praveen
well if i could have my wish , i would want to buy at 100 :)

and it was reality for sometime in 2008 and 2009.

the price at which this or any company is selling is just a reference point ..i would only buy if it cheap enough ..my own fair value estimate is around 400-450 ..it may be wrong ..but it is that number now. with this in mind i will not buy above 240

will i ever be able to buy ? i dont know ..but then that will not worry me ..better to buy at an attractive price or not to buy at all

Mahesh said...

The parent company Vedanta Resources is associated with several environmental and human rights violation issues. Not sure how much of Sesa Goa is owned by Vedanta.
Mahesh

JK said...

HI Rohit,

The company achieved a profit of around 130 crs per Million MT of ore. As the existing reserves are around 240 Mn MT, the asset/ cash value of the company is around 19000 crs.

130 * 240 = 19000???
Can you plz explain how you got this 19000 figure?

Thanks