Sesa Goa sinks 10% to Rs 228 as Government finally announces Higher Mining Royalty…Worried ?

This Blog Piece is to address the responses of Madhu and P P Jain…welcome Jain…this is the first time you’ve taken the trouble to respond

The New Mining Royalty Policy……It was awaiting Ministerial Approval………10% Mining Royalty on Market Prices before Freight…a move away from a Flat Rate based on Weight

Today,the Ministry finally went by the recommendation of a specially constituted panel of 2007 to impose a higher Royalty rate of 10% and change the basis from weight to Market Price

This announcement had been expected for a long time now…but when it came it sunk Sesa Goa’s Share Price by 10% this morning…It closed at Rs 228

This Rationalisation of the Royalty Policy was part of the 100 Days committment of the UPA Government…it had proposed to adopt wherever possible the advalorem basis

The Last Policy was notified on October 14,2004 and for three years,no change would have been possible…The Study Group formed in 2007 gave their recommendations to the Ministry of Mines in October 2007…However this recommendation was delayed as Global Recession set in and Iron Ore Prices weakened considerably

Under the Old Flat rate Royalty Policy,the highest Rate was Rs 27/T for Iron Ore Lumps that had 65% Fe Content or more

Now under this new market FOB Price,less Transportation and allied costs to Ports,the Royalty will be 10% of the Adjusted Sales FOB Price

From April 2009,the CIF price to China has doubled to US $ 110/T….Adjusted FOB would range between US $ 60 to US $ 80…that’s Rs 2800 to Rs 3800 per Tonne…10% Royalty would range between Rs 280 to Rs 380 per tonne…that’s over a ten fold jump from the earlier Policy basis  

Should we be worried ?…Madhu and Jain queried for my comments….well it will surely affect export competitiveness

Sesa Goa sold over 15 million last last year and has ambitious plans for volumes ahead…50 million tonnes in three years….so we can estimate that incremental  Royalty payments for Sesa Goa will start to be in excess of Rs 400 crs….Though Iron Ore Prices are again rising,the exports market remains competitive and the risk is that Sesa Goa may not be able to pass on the entire incremental to China,it’s major market…Sesa Goa earned  a shade under Rs 2000 crs PAT in FY 09…thus the immdiate impact looks to be 20% of profits

Having said this,Sesa Goa could absorb this on rising volumes and rising Iron Ore Prices

China is the Focus here….It accounted for over half the World Imports of 882 Million Tonnes of Iron Ore last year to part serve it’s Steel Industry of over 600 Million Tonnes Capacity…India exported 101 tonnes last year,most of it to China

The Situation is Volatile….On One Hand you have the Major Buyer,China that’s attempting to take back it’s  GDP Growth rates into the 11% to 13% Zone and is creating huge inventories of Commodities….On the Other hand you have the major Iron Ore Exporters,Vale, BHP Billiton and Rio Tinto trying to negotiate prices on the basis of Spot Market rates and the negotiating skills of the parties involved…The China Iron and Steel Association (CISA) which has 72 members who aggregate 75% of the Steel Capacity in China is trying to bring down the number of Approved Importers from 112,ban Spot Trade in Iron Ore and negotiate a higher 45% discount to benchmark prices for Long Term Contracts…Japan and Korea have negotiated 33%

Given the current situation of rising Prices and with China, facing little option but to compromise with the Suppliers,I don’t see Sesa Goa being significantly impacted…It will be able to factor this additional Royalty Payment into the Selling Price and with ambitious volume growth planned,the future continues to look secure

However,keep an eye on China….Froth seems to be visible and Paul Krugman,the Noble Laureate for Economics and a Professor at Princeton University,fears a bubble developing that a few years down the line may burst.

So if China Stops buying,like it did for a short period last year, where else could Sesa Goa sell significant quantities ! ?…Sesa Goa has flourished because of China’s insatiable appetite for Iron Ore in the past…It’s continuing success depends on this appetite continuing

Sesa Goa has surged brilliantly in months from Rs 60 to Rs 251…Today’s 10% correction because of the new Royalty Policy being notified may just be an aberation..It may take the Share Price below Rs 200….but with a PAT of Rs 2500 crs ( even after considering the incremental Royalty Payments)  expected in FY 10,that gives an EPS of Rs 30, and that I don’t see any multiple less than 6 be applied, see a bottom of Rs 180

It’s a three year outlook Buy for new purchases…Those who hold it can continue doing so for expectations of superior returns in this period too…they should not be concerned with short term corrections,unless they are traders or sense a permanent diminution.

Hope Madhu and Jain,these comments adequately address your queries on this 10% fall today in Sesa Goa’s Share Price ?

Cheers