A strong rise in iron ore exports since October had led to smart gains for Sesa Goa Ltd, the country’s largest iron ore exporter. Will the government’s move to hike export duty on iron ore lumps and fines by 5% affect the company’s prospects?

Sesa Goa, which has iron ore reserves of around 180 million tonnes (mt), produced 15 mt during 2008-09. It exports nearly 90% of its production. A change in export duties or international iron ore prices affects its average realizations and profitability.

In the September quarter, Sesa Goa’s operating profit margins (OPM) had plunged to around 28% from 45% in the previous quarter. Although average realizations had dropped due to falling iron ore prices, lower export duty and transportation costs had provided relief of around 15% in operating expenses.

The government’s move to increase export duties is intended to provide relief to steel makers who were crippled by rising iron ore prices. Thankfully for Sesa Goa, though, it has come when iron ore prices have shot up from around $60 (about Rs2,800) a tonne in April to around $100 tonne till date.

Graphic: Yogesh Kumar / Mint

Iron ore exports from India in October this year have doubled to 9.3 million tonnes per annum (mtpa) from around 4.6 mtpa in the previous year. Analysts have forecast a 24-55-mt deficit in supply over the next two years in international markets. The three major global iron ore mining companies are reportedly operating at full capacity, thereby limiting new supplies. But, China, which is the largest importer, has a buoyant steel sector. The World Steel Council projects a 9.2% expansion in steel demand during 2010.

All these factors point towards robust iron ore prices, which are expected to be higher by around 22-30% over the next two years. In a 24 December report, Bank of America-Merrill Lynch states: “We forecast an average spot price of $70 a tonne in FY10, $85 a tonne in FY11 and $91 per tonne in FY12."

Further, for every 1% increase in spot prices, there is an earnings expansion of around Rs1.20 per share for Sesa Goa. Of course, contract prices of iron ore are lower, and hence, to that extent the average impact on Sesa Goa’s earnings depends on the mix of spot and contract prices in its revenues. In recent times, the firm is striving to increase spot price sales, where deft strategies can have a positive impact on profits in a rising market scenario such as now.

But the third quarter ending December could see a drop in volumes in Sesa Goa due to disruption in production due to the monsoon rains.

Also, for fiscal 2010, the firm’s earnings per share is expected to contract by 15-18% compared with the previous year due to lower average realizations. Its share price, though, has gone up from about Rs265 on 1 October to around Rs392 last week.

The impact of the export duty hike would be felt marginally in the fourth quarter of 2009-10 and fully from the following year. The duty hike will lead to higher operating expenses and lower operating profit margins. But higher export volumes and higher iron ore prices are likely to mitigate the impact.

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