Sesa Goa…Low PAT in Q2 FY10 scares Brokers….why?

Sesa Goa just declared their Q 2 FY 10 results….Consolidated Profit was down 51% from Rs 337 crs in Q2 FY 09 to Rs 166 crs….Revenues have tumbled too by 38% despite Dempo consolidation

Iron Ore realisation in Q 2 FY 10 was a shade below US $ 51/MT…same quarter last year it was US $ 108

Brokers have been quick to change advisories from Buy to Sell or just Hold…..Methinks this paranoia is the inability to see beyond the nose and down a few years…I’m seeing two to three years ahead….

Company has passed at the EGM on October 20,2009 a plan to raise Rs 6000 crs.US $ 500 Million has already been announced through FCCBs with a coupon rate of 5% payable half yearly in arrears and conversion option into equity at Rs 346.88 being 28% premium over base price taken of Rs 271…This will raise close to Rs 2400 crs

The dilution in Equity will merely be under Rs 7 crs for this FCCB…so the current Equity (FV Rs 1)of Rs 82 crs will move to Rs 89 crs and share premium will incrementally add Rs 2300 crs + to reserves…so assuming the Company maintains consolidated profits at Rs 2000 crs (Iron Ore is currently at US $85/90 /MT) we shall have a networth close to Rs 9000 crs at March 31,2010 up from Rs 4716 crs as at March 31,2009….so the Book Value will be @ Rs 100

Even if Sesa Goa raises the remaining Rs 3600 crs + through Equity at the same conversion,the Equity Dilution would be just another Rs 10 crs…giving a possible final Equity of Rs 99 crs…So suppose even in FY 11 the PAT is maintained at Rs 2000 crs,the Networth at March 31,2011 would be over Rs 14500 crs,giving a Book Value of close to Rs 150

Equity Route is recommended because the additional dilution of Rs 10 crs and a maintainable PAT of 2000 crs would mean a downward impact of just Rs 2 to Rs 2.5 on the EPS and on a 15 multiple that would mean a downward impact of not more than Rs 30 to Rs 40 in the Share Price

Now Believe me,with the new funding of Rs 6000 crs,the scale of operations will simply double…so we shall see close to 50 million tonnes annually by 2012

Extent of Profitability will depend solely on continuing Demand from China…this will continue to dictate Iron Ore Prices…Sesa Goa has simply no control here…..Now with China on the verge of returning to double digit GDP growth I don’t forsee any demand issues for the next to to three years…and therefore Sesa Goa would be able to pass on the incremental royalty it now has to pay…for example on Iron Ore with a Fe content of 65 % +from a fixed low amount of Rs 27/T earlier to 10% advalorem basis on adjusted Sales Price FOB…..that’s more than a ten fold jump…..I have blogged on this change earlier on August 12,2009……so I guess the PAT too will move past Rs 3000 crs and towards Rs 4000 crs with Iron Ore Prices hovering around US $ 100/MT…so that’s an EPS in the range of Rs 30 to Rs 40 by FY 12…on a 15 Multiple that’s a Price Range of Rs 450 to Rs 600 inside two years….Now if Iron Ore demand surges,so will the price…. and we can yet again see highs of US $ 140/MT….Sesa Goa will then be able to cross Rs 6000 crs PAT…That’s a EPS of Rs 60…and a price of Rs 750 on a 15 multiple

So keep an eye on China here and monitor Iron Ore prices to gauge Sesa Goa Profits…it’s a direct corelation…However increasing Volumes should set off against any decline in Iron Ore Prices to maintain the PAT …..Don’t judge the Year’s performance by the Monsoon Quarter 2,which traditionally is the lowest perfoming quarter as few or none export shipments take place in the rains…One Institutional Broking House has downgraded Sesa Goa from Buy to Hold  calling it a Fruitless Optimism !…Others are outright recommending a Sale

With a Two to Three Year Outlook,I’m yet recommending it as a Buy at current levels of Rs 320-Rs 325 ,more so on Declines

Cheers !