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.