Sesa Goa seems to be thriving despite various impositions When the going gets tough, the tough get going. And the Rs3,672 crore iron ore major Sesa Goa (part of the Vedanta group after it acquired 51 per cent stake from Mitsui & Co, Japan, in 2007), seems to be showing that it is made of sterner metal. Year after year and quarter after quarter, the company seems to be churning out a scintillating report card, thanks to the growing appetite for iron ore from countries such as China. And the company has been consistently clocking a 25-30 per cent growth rate over the past couple of years. It has cheered its shareholders with a 450 per cent dividend (RslO paid-up value) and simultaneously came out with a liberal one for one bonus issue and a stock split with a face value of Rel per share. The company's share peaked to Rs4,390 (cum-bonus and stock split) and is now quoting Rsl67 (ex-bonus and split). Despite the regulatory hurdles posed by the government, the company has managed to post a good performance. Firstly, thanks to the lobbying done by the domestic steel industry, the government slapped an export duty on iron ore (Rs50 per tonne for iron ore fines below 62 per cent Ferrous (iron) content and Rs300 per tonne for all other grades). Secondly, in an attempt to curb inflation, it asKed steel companies (a major contributor because of its weightage in the wpi) to delay the impending hike in steel prices and subsequently introduced a 15 per cent ad valorem tax on ore exports. Given the regulatory hurdles, the question uppermost in corporate onlookers' minds is whether Sesa Goa will be able to put up a repeat performance in the coming year. "No sweat," says P.K. Mukherjee, managing director of the company, "We will maintain our growth rates through increased volumes and focus on significantly ramping up internal efficiencies to offset any rise in production costs of iron ore." Commenting on the June quarter end, Vishal Chandak, an equity analyst with Emkay Global Financial Services states that the "effective export tax was around 5.5 per cent as the ad valorem export duty was applicable only for part of the quarter". However, Preeti Dubey, associate director, metals and mining analyst bnp Paribas Securities says, "The profits of companies exporting iron ore will be negatively impacted by the latest levy," and adds that the estimates for Sesa Goa have been pruned by 9 per cent post-announcement of the ad valorem tax. Mukherjee admits that "profits could take a hit". A back of the envelope calculation would be in order. Last year, Sesa Goa produced 12.3 million tonnes of iron ore, of which 90 per cent was exported. If the company has been growing at 25 per cent, the year to March 2009 should see the company producing roughly 15 million tpa, of which around a million tonnes would wend its way in the domestic market. The average long term contract price is roughly around $70/tonne hence the ad valorem duty would amount to around $ll/tonne. So even if one takes an average of $10/tonne, the 14 million tpa of exports would suck up close to $140 million (roughly Rs580-odd crore). According to analysts, iron ore companies may not be able to pass on this incremental cost to the buyers from China, Pakistan, Europe and Japan, as the global market for iron ore has begun softening. The softening is largely because of the slowdown in off-take in China thanks to the tight credit control imposed by the Chinese government and the stoppage of steel production for at least two months within a radius of 300 km of Beijing, to minimise pollution during the Olympic Games. Currently, spot prices are hovering in the $125-130 band, down from $200/tonne in May. The average long term iron ore prices are at $70/tonne. The year to March 2008, Sesa Goa had revenues from spot and contract basis in the 50:50 ratio. For the first quarter of the year to March 2009, the ratio has tilted towards spot at 65:35. According to a study done by the Japan Iron & Steel Federation, with the increasing capacities and demand from emerging markets, global crude steel production is estimated to cross 1.4 billion tpa during 2008 - up by 70 million tpa over the previous year. China alone is expected to see a 10 per cent rise in production over the 490 million tonnes churned out in 2007. (To produce one tonne of steel, one requires approximately 1.66 tonnes of iron ore.) The international benchmark price of iron ore fixed by cvrd of Brazil for the current financial year has gone up 9.5 per cent over the previous year on FoB basis. The other two Australian major ore suppliers, bhp and Rio Tinto have managed to get a higher price increase from steel producers and Sesa Goa is hopeful of getting the price differential. Softer prices With global demand for iron ore expected to be strong, industry sources aver that the prices are unlikely to soften further. In fact, there could be an upward spike given that the curtains are going to be drawn on the Olympic Games in China and production at the steel units around Beijing should resume. Mukherjee is pretty confident in saying that iron ore prices "will not fall in the next two years". It would be interesting to see how he manages to toggle the ratio between spot and long term contracts to extract the maximum price over the next few quarters. One area of concern is the rise in railway freight rates on iron ore. Freight rates have been raised by more than 70 per cent since April this year, say iron ore producers and have risen almost 200 per cent over the past two years. "It is another de facto export duty," says an industry source, who goes on to add that he expects the iron ore industry to face another hurdle in the form of 'quantity-based royalty payments' for iron ore production in the near future. On the one hand, the freight rates are on the upward move on the other the availability of rail rakes continues to be limited and uncertain. Sesa Goa, with its mines in Goa, Karnataka and Orissa, has iron ore contributing about 84 per cent to its total revenues. Sale of pig iron contributes about 13 per cent with the balance being chipped in by its metallurgical coke business. The company put up a 250,000 tpa pig iron plant at Amona in Goa in 1992 in order to move up the iron ore value chain, under the banner Sesa Industries. This subsidiary for the year, to March 2008, saw sales jump 30 per cent over that of last year to Rs503 crore with post-tax profit at Rs63 crore. With sharp increase in prices of iron ore and coke, its key inputs, the pig iron industry witnessed a steep increase in its prices thereby impacting demand for the product. The iron ore from Goa has a low Fe content, which has to be beneficiated in order to increase the iron content. Pig iron manufacture requires ore of high grade quality, which has to be sourced from third parties. Also the increase in metcoke prices had an adverse impact on production costs. However, because of its reputation and brand image in the pig iron market, the subsidiary could manage to hold on to its market, according to Mukherjee. The subsidiary, which would eventually be merged into Sesa Goa once the Bombay High Court approval comes through, is contemplating increasing the production capacity to 1 million tpa "to provide the plant with a globally competitive scale of operations". Sesa Goa also has a facility to manufacture metallurgical coke, a backward integrated project for the pig iron facility. This loss-making facility seems to be showing signs of turning around. For the year to March 2008, on revenues of Rs309 crore, the business generated a profit (before tax, interest, dividend and other nonrecurring income) of Rs87 crore. The previous year, on an income of Rs203 crore, it made a loss of Rs9 crore. This sign of better times is largely due to the unprecedented rise in international coking coal prices thereby raising the price of metcoke. According to Mukherjee, with China controlling 65 per cent of the coke business, the potential for this business is expected to be great, what with prices continuing to harden. The company is still trying to see that it's 'compact charging' methodology stabilises so as to increase productivity. The unit also has a power plant which has been built by Videocon on a build-own-operate basis and commissioned in June 2007. For the year to March 2008, it generated 84 million units of electricity using waste gases from the company's coke ovens and the blast furnaces of the pig iron unit. This should generate income for the units through sale of waste gases and carbon credit. Financially, for the year to March 2008, Sesa Goa raked in a turnover of Rs3,672 crore and a post-tax profit of Rsl,492 crore, a 79 per cent and 146 per cent increase respectively from the previous year. For the quarter to June 2008, revenue stood at Rs 1,301 crore and a post-tax profit of Rs633 crore. The realisation per tonne of iron ore has increased 93 per cent year-on-year to Rs3,437; in metcoke 127 per cent to Rs21,479 and pig iron 69 per cent to Rs28,625. Second quarter sales would not appear exciting as it is the lean monsoon period when there are hardly any ore shipments. The whole year figures should certainly look impressive, with the iron ore major getting past the $1 billion i turnover mark.