In Q4’09, Sesa Goa’s EBITDA plunged 38% to Rs7,399 million and net profit declined 32.5% y-o-y to Rs5,476 million, primarily on account of a 32% y-o-y decline in the average iron ore sales realization.
Further, prospects for global growth have weakened, as in April 2009 IMF cut the world GDP projection for FY10 by 110 bps to 1.9%. Thus, we expect even lower sales realisations and decline in volume growth for the industry.
However, Sesa Goa hold’s key competitive advantage over its peers because of its proximity to China, which is the largest importer of the iron ore, and in FY08 contributed 66% to the Company’s sales volume.
We believe that the steel production growth in China will be greater than the other countries; hence, we have assumed slight volume growth for the Company.
We expect the sales volume growth to be 10–12% in FY10 as compared to 20–25% guidance of the management.
We expect the Company’s cost of production to fall by 5–10% in FY10 due to the decline in freight prices and the abolition of 8% export duty on iron ore fines (since December 2008).
However, we believe that the contraction in margins on account of the expected lower sales realisation will overshadow the benefits resulting from the decline in the cost of production. Thus, we expect the EBITDA margin to fall from 51% in FY09 to 36–38% in FY10 and FY11.
As of March 2009, the company had ~Rs4,100 crore cash and cash equivalents on its balance sheet, which translates into Rs. 52 per share. It has indicated that it has plans to use this huge cash balance to grow inorganically.
At Rs121.6, the stock is trading at a forward P/E of 8.9x and 8.7x for FY10 and FY11 earnings, respectively.
We have valued Sesa Goa by using the DCF method, assuming a WACC of 17.7%, and have arrived at a target price of Rs132. As the stock seems to be fairly valued at the CMP, we give a HOLD rating.
Our valuation is sensitive to the assumed iron ore sales realisation for Sesa Goa; as such, we have performed a sensitivity analysis for the same.