For Sesa Goa Ltd, the country’s largest private sector iron ore exporter, the revision in global benchmark price of iron ore, coupled with strong demand from steel mills, has set the stage for higher realizations and profits during fiscal 2011.
The importance of global prices for the five-decade-old company stems from the fact that it exports around 90% of its production. With a production capacity of around 21 million tonnes, Sesa Goa’s annual revenue is around Rs6,000 crore.
The recent price negotiations between the three largest global miners, BHP Billiton Ltd, Rio Tinto Plc and Companhia Vale do Rio Doce (Vale), and the Japanese steel mills set benchmark prices for the first quarter of FY 2011 at around $110 (Rs4,961) per tonne. This is 90% higher than the previous year. Average iron ore prices for fiscal 2010 will remain at around $70 per tonne, although prices scaled $135 per tonne since February.
Sesa Goa exports around 70-80% of its production to Chinese markets, where price contracts for FY11 have not yet been struck. Yet, the benchmark augurs well for the company, as Chinese steel makers normally toe the line of Japanese counterparts.
Graphic: Ahmed Raza Khan/Mint
In fact, the price revision will overshadow Sesa Goa’s lacklustre performance in the first half of fiscal 2010. As iron ore prices fell to a low of $60 per tonne, realizations in the September quarter fell by about 51% over the year-ago period. From the December quarter, realizations improved due to higher volumes and better prices. As a result, Sesa Goa’s share price has been moving up since February this year.
With China’s steel production increasing every year, the demand for iron ore has been rising too. Between January and February 2010, China imported 22% more ore over the year-ago period at 96 million tonnes. Spot prices, which account for around 70% of Sesa Goa’s revenue, are ruling at a premium to contract rates at around $140 per tonne. Logically, therefore, the fourth quarter should see higher volumes and revenues both on a year-on-year and sequential basis.
But more importantly, higher benchmark prices will improve realizations and revenue for the company from the first quarter of 2010-11 onwards. A report by ICICI Securities Ltd says: “With higher spot price exposure, we raise Sesa’s FY11E and FY12E blended realization by 35% and 25% to $85/tonne and $73/tonne, respectively.”
Also, the recent negotiations will change the rules of the game, whereby steel makers are agreeable to a quarterly review of contracts in a departure from a 40-year-old tradition in which prices were reviewed annually. According to metal and mining experts, while this is favourable, it could increase speculation and, hence, volatility. So, Sesa Goa’s high exposure to spot markets will increase earnings volatility.
Nonetheless, the direction of iron ore prices has been firmly reset for at least the first half of FY11. Analysts have revised earnings estimates for FY11 by around 30%-plus to about Rs60 per share.
Following the revision of iron ore prices, shares of Sesa Goa increased by around 3% to Rs470, which discounts the forward earnings around eight times. A lower discounting is, perhaps, a reflection of the volatility in earnings given the commodity play.
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