Sesa Goa Ltd’s decision to buy out the mining assets of Goa’s Dempo Group has been lauded by the stock market, with the company’s shares rising by 5% to more than Rs200 a share. The acquisition includes rights to mineable reserves and resources of 70 million tonnes of iron ore.
The acquisition price of $368 million (Rs1,744.32 crore) translates into a valuation of $5.26 per tonne of reserves and resources. Before the announcement of the acquisition, Sesa Goa traded at a valuation of $6.44 per tonne of reserves and resources of 360 million tonnes, after adjusting for the cash on its books.
These valuations look expensive in light of the recent deal between BHP Billiton Ltd and Rio Tinto Plc., where the implied valuation worked out to $2 per ton of iron ore reserves and resources.
But as brokerage Motilal Oswal Securities Ltd points out in a recent research note, Sesa Goa’s assets will be mined in 18 years, while it will take 97 years for BHP Billiton and Rio Tinto to mine all the assets.
In terms of the enterprise value to Ebitda ratio, too, the acquisition seems reasonable at around four times. Ebitda is short for earnings before interest, taxes, depreciation and amortization, an indicator of a company’s profitability.
Having said that, it’s interesting to note that Sesa Goa’s own valuations are now close to the peak they had reached last year. Although iron ore prices have started recovering lately, they are still about 60% lower than the peak reached last year.
For the company’s stock to trade at close to last year’s peak, therefore, seems rather strange. True, the company has had an increase in its iron ore reserves and the Dempo acquisition will further increase its capacity, but that wouldn’t compensate for the massive drop in iron ore prices.
At the time of its annual results announcement in April, the company had said that it expects contract prices to fall by 35-40%. Based on recent price trends, it looks like iron ore producers may be able to extract some hikes when contracts come up for renewal next year.
Reuters has quoted a research note by Goldman Sachs’ Australian unit that says: “After conceding contract price cuts in 2009 ranging from 28-48%, we believe the balance of pricing power will shift back in favour of the suppliers in 2010 and we have raised our benchmark price forecast for Australian iron ore fines to (an increase of) 10%.”
Even so, since prices are way off their peaks, Sesa Goa’s current valuations of about 12-13 times one-year forward earnings look expensive, especially considering that the stock has traditionally been viewed as a commodity stock and has had single digit valuations.
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