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Acquired mining capacities that may deliver substantial volume additions and a likely recovery in iron ore prices over the next two years, make the stock of Sesa Goa a good investment for those with a two-year perspective. At Rs 203, the stock is trading at 8.5 times its fully diluted earnings for 2008-09. That is at a discount to its historic valuations as well as global iron ore majors such as BHP Billiton and Rio Tinto (15 and 18 respectively), making it an attractive investment within metal stocks.

Sustained signs of recovery in China’s steel sector, consolidation in the global iron ore sector and the additional volumes likely from Sesa Goa’s recent Rs 1,750-crore deal to acquire a 100 per cent stake in VS Dempo & Company, point to improved earnings prospects for the company.

A weak trend in spot prices of iron ore led to poor performance from Sesa Goa over the past two quarters, though the year 2008-09 saw a 30 per cent profit growth. Renewed Chinese buying this year and a recovery across the commodities pack has firmed up spot iron ore prices from their lows; though prices still hover far below their peaks.

The medium-term price outlook for iron ore has improved on the back of Rio Tinto and BHP Billiton proposing to join hands to produce iron ore. This, combined with a recovery in steel demand, can reduce China’s ability to bargain for a deep cut in iron ore contract prices.

The Dempo acquisition, funded entirely through internal accruals, will deliver numerous benefits for Sesa Goa. It is expected to give the company access to 70 million tonnes of mineable reserves, adding to its own reserve of 240 mt. Like Sesa Goa, Dempo markets much of its iron ore in the spot market. Apart from Nippon Steel of Japan, which procures a part of its requirement on long-term contracts; three fourths of the output goes to Chinese buyers at spot prices.

Though the acquisition may not help diversify geographical markets for the company, it promises a better position in the existing markets (mainly China and Japan, which account for 87 per cent of total spot market demand).

Dempo’s operations are also said to hold potential for margin optimisation. The 25 per cent addition to Sesa Goa’s sales volumes may offset any impact from lower iron ore realisations that are likely over the next couple of quarters. An unexpected dip in Chinese demand, rising freight rates and regulatory intervention to curb iron ore exports are the key risks to the earnings outlook.

S. Hamsini Amritha

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