Sesa Goa Ltd

PROJECT COMPLETION CERTIFICATE

This is to certify that project titled Equity Research Report Sesa Goa Ltd is successfully done by Mr. Nirav Joshipura during the Semester IV of his MMS course in partial fulfillment of the Master's Degree in Management Studies recognized by the University of Mumbai through the Prin.L.N.Welingkar Institute of Management Development & Research, Matunga, Mumbai.

This project in general is done under my guidance.

___________________________

Name: ___________________________________ Date: ________________________

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ACKNOWLEDGEMENT
I express my gratitude to Prof. Shaivalya Thakkar for giving me the opportunity to complete semester IV project under his guidance. I am greatly thankful to him for his outstanding support in the accomplishment of this project. His practical knowledge and experience helped me understand theories and relate them to practice. Any suggestions towards further improvement will be acknowledged and appreciated

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Contents
Indian Economy 2009-10............................................................................................................................... 4 Economic Outlook 2010-2011 ................................................................................................................... 7 Mining in India ........................................................................................................................................... 9 Industry Overview ....................................................................................................................................... 10 Regulatory Environment .........................................................................................................................12 Competitive scenario ..............................................................................................................................13 Company Overview:- Sesa Goa Ltd. ............................................................................................................14 Shareholding Pattern ..............................................................................................................................15 SWOT Analysis .........................................................................................................................................16 Investment Arguments ............................................................................................................................17 Valuation .....................................................................................................................................................19 Calculation of the market price of the stock by Discounted Cash Flow method ....................................20 Conclusion ...................................................................................................................................................22

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Indian Economy 2009-10

According to the Economic Survey 2009-10, tabled in Parliament on February 25, 2010 by the Union Finance Minister, Mr Pranab Mukherjee, the economy is expected to grow at 7.2 per cent in 2009-10. The expected growth comes on the back of the growth momentum witnessed in Q2 2009-10 estimates, when the economy recorded a GDP growth of 7.9 per cent as against 7.5 per cent in the corresponding quarter of 2008-09. The industrial and the service sectors are growing at 8.2 and 8.7 per cent respectively, as per the advance estimates of gross domestic product (GDP) for 2009-10, released by the Central Statistical Organisation (CSO).

The Economic Survey estimates: Growth rate of GDP at factor cost expected to be 7.2 per cent. Growth in the manufacturing sector has more than doubled from 3.2 per cent in 2008-09 to 8.9 per cent in 2009-10. Growth of private investment demand picked up in 2009-10. Savings rate as a percentage of GDP in 2008-09 stood at 32.5 per cent. Growth rate of capital formation as a percentage of GDP in 2008-09 stood at 34.9 per cent. Foreign Exchange Reserves in 2009-10 as of December 31, 2009 stood at US$ 283.5 billion. Financing, insurance, real estate and business services have retained their growth momentum at around 10 per cent in 2009-10. The main highlights of the survey are: The recovery in GDP growth for 2009-10, as indicated in the advance estimates, is broad based. Seven out of eight sectors/sub-sectors show a growth rate of 6.5 per cent or higher. Sectors including mining and quarrying; manufacturing; and electricity, gas and water supply have significantly improved their growth rates at over 8 per cent in comparison with 2008-09. The construction sector and trade, hotels, transport and communication have also improved their
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growth rates over the preceding year. Strong growth was witnessed in automobiles, rubber and plastic products, wool and silk textiles, wood products, chemicals and miscellaneous manufacturing; modest growth in nonmetallic mineral products. The opening of the telecom sector led to rapid growth in subscriber base. From only 54.6 million telephone subscribers in 2003, the number increased to 429.7 million at the end of March 2009 and further to 562 million as of October 31, 2009 showing an addition of 96 million subscribers during the period from March to December 2009. There has been improvement in the balance of payments (BoP) situation during H1 of 2009-10 over H1 of 2008-09, reflected in higher net capital inflows and lower trade deficit. Net capital flows to India at US$ 29.6 billion in April-September 2009 remained higher as compared to US$ 12 billion in April-September 2008. During fiscal 2009-10, foreign exchange reserves increased by US$ 31.5 billion from US$ 252 billion in end March 2009 to US$ 283.5 billion in end December 2009. Growth rate of gross fixed capital formation in 2009-10 has recovered, as per the revised National Accounts Statistics (NAS). Turnaround in merchandise export growth witnessed in November 2009, which has been sustained in December 2009.

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The following is the sector wise GDP distribution of Indian Economy for the last 5 years

Source: Central Statistical Organization (CSO)

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Economic Outlook 2010-2011

There is a growing consensus across the world that the worst of the financial crisis is over. Economies globally have started to stabilise and recover either from the recession or severe slowdown in the past 2 years. After having contracted in 2009, the global economy is expected to expand by 3.9 per cent this year (International Monetary Fund, January 2010). The Indian economy has displayed remarkable resilience over the course of the downturn and is expected to have grown at a rate of 7.2 per cent in 2009-10 (Central Statistical Organisation, February 2010). Since 2008-09, the government had engineered a substantial increase in demand through fiscal measures to compensate for the decline in private and export demand. The focus has now shifted to private consumption and investment, which are being viewed as key drivers of growth in 2010-11. A timely and orderly exit from the fiscal stimulus is crucial to maintain the credibility of government finances, and thereby, the potential growth in coming years. If the fiscal stimulus has to generate net long-term gains, and not merely end up as a transfer of expenditure from the private sector to the government, a realistic fiscal tightening plan is essential. This would be the most important economic challenge facing India over the next few years. The budget of 2010-11 made some progress on this account by partially rolling back the reductions in indirect taxes. The real boost to sustainable fiscal correction, however, would have come from expenditure reforms, which are largely missing in the budget, with government expenditure expected to rise by around 8.5 per cent in 2010-11 (over revised estimate 2009-10) over the exceptionally high growth of 15.5 per cent in the previous year.

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The following is the outlook of the Indian Economy is 2010-2011

Note: Industry includes mining and quarrying, manufacturing, electricity, gas and water supply, construction Source: CRISIL Research

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Mining in India
India is a major mineral producer in Asia and globally. It is currently a global producer of chromite, coal, iron ore and bauxite. India has been enjoying economic growth during the nineties. Several of Indias current state owned mining and beneficiation companies have been faced with drastic production cuts, resulting in operations becoming uneconomical. This has resulted in the closure of several mining operations. Reasons for poor results have been given as lower grade reserves and excessive manpower quotas. Since the enunciation of the National Mineral Policy, 1993, India has made good progress in attracting foreign investment in its mining sector, with attractive incentives. The National Mineral Policy was revised in 1994 and as a result, private investment (both domestic and foreign), has been permitted for the exploration and exploitation of the following minerals: Iron ore, Copper, Manganese, Lead, Chrome ore, Zinc, Sulphur, Molybdenum, Gold, Tungsten ore, Diamond, Nickel and Platinum group of metals. As a result, several foreign companies have begun investing in India, with the majority coming from Canada and the USA, followed by Australia, the UK and South Africa. Most interest has been shown in the base metals, diamond, mineral sands and gold sectors. India has several governmental agencies that have been set up to assist in the development of the countrys mineral resources. The Geological Survey of India (GSI) is the principal agency responsible for the assessment of geological and regional mineral resources of the country. GSI was established in 1851 and is one of Indias oldest investigative agencies in the field of earth sciences. Its areas of operation encompass scientific surveys and research, for locating mineral resources. GSI operates through six regional offices and four specialised wings - marine, coal geophysics, airborne surveys and training. The Indian Bureau of Mines (IBM) is the principal government agency responsible for compiling exploration data and mineral maps and for providing access to the latest information is respect of mineral resources in the country. IBM has both regulatory as well as service functions.

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Industry Overview
The iron ore industry depends almost entirely on the condition of the steel industry as approximately 98% of iron ore mined globally is used to produce steel. In turn, the steel industry is a bellwether for the overall economy, as it is a key material for the construction, automotive, engineering and consumer durables sectors. As a result, the iron ore sector is cyclical. China, the key market for iron ore, Currently, China is the largest producer and consumer of iron and steel. Fueled by a growing economy and strong emphasis on infrastructure projects, China's demand for steel more than doubled between 2002 and 2008, boosting its share in global steel production and consumption. As a result, annual contract negotiations between iron ore miners in Australia (Rio Tinto and BHP Billiton) & Brazil (Vale) and Chinese steel producers (represented by Baosteel and the CISA) have come to act as a global benchmark. Chinese steel mills agreed to a hike of approximately 60% in iron ore contract rates for delivery in 2008, in reflection of the country's ambitious infrastructure plans. However, the onset of the recession in the second half of 2008 led to a slump in demand for steel. Accordingly, Chinese steel producers are demanding significant cuts in iron ore prices for delivery in 2009.

Source: World Steel association

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Key Indicators of the Iron Ore Market The following figure shows the Domestic production of iron ore during the year 2009

Source: Bloomberg, World Steel Organization The following figure shows the domestic steel production during the year 2009

Source: Bloomberg, World Steel Organization

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Indian mining and minerals industry is one of the rapidly developing sectors. The metallurgical and mineral industries in India provide a foundation for the country's industrial growth and development. India has a vast base of metals and minerals. It includes all the atomic minerals, metallic minerals and non-metallic metals, ferrous minerals and non-ferrous minerals, industrial minerals and fertilizer minerals, i.e. minerals like gold, silver, diamond, iron, chromium, copper, lead, zinc, aluminium, mica, bauxite, graphite, tin, platinum, cobalt and limestone. The metals, minerals and mining is one of those sectors in the Indian economy which attract the highest FDI. The Indian mining industry currently employs over 1.1 million people. The opportunities are knocking at the door of skilled professionals in this sector. With amendments in the Mines and Minerals (Regulation and Development) Act or MM (R&D) Act, October 1996, the Government of India had opened up the sector to the private players and has taken various steps to encourage the investments in the sector. And now, with the new National Mining Policy in place, the Ministry of Mines plans to attract investments of Rs 1,00,000 crore in the mining sector. India has already established itself as the major exporter of various raw materials in the industry to the outside world. Both raw and processed minerals, along with diamonds, are the major constituents of India's exports to other countries. But due to increase in population and subsequent increase in the demand for energy and other minerals, India also imports many such products, major constituents of its imports being crude oil.

Regulatory Environment
The mining industry is constrained by government regulations, including mining licensing, royalties and excise & customs duties. Miners in emerging economies tend to be even more tightly regulated due to government control of pricing, official programs to discourage exports of strategic resources (in order to facilitate local infrastructure projects) and relative bureaucratic inefficiency in relation to issuing licenses. Moreover, governments in major emerging markets tend to own or control significant mining and transportation assets, giving them greater leverage over private firms. For example, in addition to conventional regulatory instruments, the Indian government influences mining sector directly through public-sector entities such as the Steel Authority of India Limited (SAIL), and the National Mineral Development Corporation Limited (NMDC). These entities tend to enjoy economies of scale and government patronage in

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preference to private-sector firms. Furthermore, the Indian government holds a monopoly over rail services, giving it great influence over inland transportation costs.

Competitive scenario
The global iron ore market is dominated by highly-diversified miners such as BHP Billiton, Vale and Rio Tinto, which serve major steel producers such as Arcelor Mittal, Baosteel, and Pohang Iron and Steel Co. (POSCO). A number of steel producers source iron ore from their own mines, however, as mentioned earlier, the steel industry is fragmented. These firms tend to purchase iron ore on the spot market or by entering into contracts with smaller iron ore miners, such as Sesa. Sesa sells around 60% of its iron ore in the spot market, and the balance at annually negotiated contracted prices. On the spot market, Sesa enjoys a relative cost advantage over larger miners given its proximity to Chinese ports. Sesa is even well-placed compared to other Indian exporters such as NMDC, which mainly produces higher grade ore suited for the Japanese and South Korean markets. Domestically, Sesa competes with various private and public-sector companies, dominated by NMDC. As a small player in the global iron ore market, Sesa is a price taker; however, it is able to sell as much as it can produce.Barriers to entry in the Indian iron ore industry are relatively high, considering government regulation, difficulties in securing new mines, large capex requirements and long lead times.Reflecting this, Australian miner Fortescue Metals Group (FMG) is the only new entrant in over a decade.There is no direct substitute for iron ore in the manufacture of steel; however, there has been an upward trend in recycling of scrap steel since the late 1990s. Moreover, iron and steel products face competition from lighter and cheaper materials made from plastics, aluminium, glass and paper in the packaging, construction and automotive industries. The automotive industry stands out as a strong case of preference for aluminium over steel in recent years wherever possible (aluminium is lighter and therefore more fuel-efficient).

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Company Overview:- Sesa Goa Ltd.

Sesa was founded in 1954, and was incorporated as a public limited company in 1981. Sesa is India's largest private-sector exporter of iron ore. Besides mining iron ore, the company also produces pig iron and metallurgical coal. The company's primary business Iron ore contributed approximately 85% of total consolidated revenues from operations in FY 2009. In April 2007,the UK's Vedanta took a 51% stake in Sesa for Rs. 40.7 bn (US$981 mn). Vedanta has interests in a number of other Indian mining companies, including Sterlite Industries India Limited and Hindustan Zinc Limited. Sesa is headquartered in Goa, and has mining operations in Goa, Karnataka and Orissa.Currently, Sesa has iron ore reserves of approximately 310 mn tonnes. Sesa generates most of its revenues from China, India and Japan. China accounted for approximately 84% of the company's overall iron ore sales in FY 2009 (which ended March 2009). Sesa's low-to-medium grade ore is well-suited to the Chinese market, where steel mills are set up for lower-grade ore. Further, the company enjoys significantly higher realizations in the export market compared to the domestic market. In June 2009, Sesa Goa acquired 100% of V S Dempo & Co (VSD), an iron ore producer based in Goa. VSD owns/has access to 70m tones of iron ore in Goa and its mining assets include processing plant, barges, jetties, transhippers and loading facilities in Goa. Sesa Goa is targeting a production/sales volume of 50m tpa of iron ore in the next four years. In addition to iron ore, Sesa Goa manufactures coke, while its 88% subsidiary Sesa Industries produces pig iron. In FY09, iron ore accounted for 85% of Sesa Goa's consolidated net sales, pig iron 12% and met coke 3%. 89% of PBIT in FY09 was from iron ore, 8% from met coke and the rest from pig iron.

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Shareholding Pattern
The following is the shareholding pattern of the company

Source: Company website

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SWOT Analysis

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Investment Arguments
1) Capacity expansion to support top-line growth: Sesa aims to achieve 50 mn tones of iron production within next 3 years (FY 2009 production was 15 mn tones) through organic and inorganic strategies. However, we assume a more modest production target of 36.1 mt in FY 2012 due to a lack of clarity on acquisition plans and regulatory uncertainty relating to new mine leases. The company's Management informed us that they continue to scout for iron ore assets domestically as well as overseas. Further, the company continues to increase production at its existing mines. The company plans to raise its reserves of iron ore to ~500 mn tons from current levels of 310 mn tonnes over the next 2-3 years. Eventually the company aims to raise annual production to 100 mn tonnes per annum in the long run. With significant cash on its balance sheet, low cost mines and huge appetite to raise debt, we believe that the company can achieve these targets. 2) Iron ore prices bottomed out Iron ore industry is witnessing fresh wave of consolidation just when it appeared that iron ore miners are losing pricing power. We believe the prices of iron ore have bottomed out. The consolidation of BHP Billiton and Rio Tinto will result in higher bargaining power for the iron ore suppliers as the industry remains dominated by top few suppliers accounting for approximately75%-80% of sea-trade of iron ores. Rio Tinto Ltd. and BHP Billiton Ltd. will combine to form equal joint venture company, which together produce 246 mn tons, second only to Brazilian giant, Vale. Consolidation amongst the major suppliers will increase the pricing of power of miners. As can be seen in the chart below, the price of Indian 63.5% Fe iron ore has dropped recently on account of huge inventory pile up by China. However, we are of the view that this inventory forms a only ~I month of inventory requirements given our expectations that China will produce atleast 500 MT of steel in 2009. Hence, looking at the overall demand-supply dynamics, we do not expect prices to decline significantly from the current levels. Nevertheless, the upside risks to the iron ore prices remain if the Chinese demand increases higher than expectations.
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3) Dempos acquisition, demand recovery to boost volumes: In June 2009, Sesa Goa acquired Dempo for a total consideration of Rs. 17.5 bn. Dempo is one of the largest producers of iron ore in Goa with total reserves of 70 million tonnes. We expect, Dempo to contribute ~ 4 mn tonnes to the Companys total sales volume in FY10. In addition, with the strengthening of iron ore demand from China and the recovery in steel production and prices, the Company should be able to achieve higher sales volume growth. Accordingly, we have increased our sales volume estimates and expect sales volumes to be around 20.7 mn tonnes in FY10 (including sales volumes of ~4 mn tonnes from Dempo), as against 15.1 mn tonnes in FY09. 4) Appetite for inorganic growth: Post-acquisition of Dempo, Sesa has a cash of Rs. 20.5 bn on its balance sheet. The company continues to scout for iron ore assets domestically as well as abroad. There are a number of smaller mines in states such as Karnataka and Jharkhand which Sesa may consider. These alternatives, particularly mines in Karnataka, are an attractive option as their proximity to ports and existing operations, as well as their low-grade fine ore profile, match its requirements. Sesa could use its large cash reserves to acquire larger iron ore miners. However, most Indian players are government-controlled, making them tricky acquisition targets. Therefore, the company might look towards Australia, Brazil and South Africa for potential targets. The company has completed geological survey at its allotted Jharkhand mine and Sesa expects to file the applications within next two months. Total iron ore reserves are expected at 50 mn tonnes, with an average cut-offgrade of 50%+. Also Sesa's management expects Dempo's iron ore reserves to increase to 100-110 mn tonnes from current levels of 70 mn tonnes. Going forward, we believe that the company's explorations at its ongoing mines could result in further iron ore findings

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Valuation
Key Financials: (Rupees in Crores)

Source: Company, ICICI Direct Research

The estimated EPS for the year is Rs 25

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Calculation of the market price of the stock by Discounted Cash Flow method
Calculation of WACC Calculation of Cost of Debt Cost of Debt (PLR) Corporate Tax Rate Education & Secondary education cess Post-tax cost of debt (Kd) 8.29% 12% 30% 3%

Cost of equity via CAPM Ke= Rf + Beta (Rm-Rf) Rf (Source:10 yr 2020 govt bond from rbi) beta (source:reuters) Rm-Rf (Source: Dealing with risk - Investment Analysis By Damodaran) Ke 18.33% 7.60% 1.43 7.50%

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Calculation Sesa Goa Ltd of WACC Equity Share Capital Reserves & Surplus Long Term Debt Total WACC

Amount 78.72 4439.06 1.91 4519.69 18.36%

Cost 0.1833 0.1833 0.0829

Weights

WeightedCost

0.017417 0.003192559 0.98216 0.180029979

0.000423 0.00035067 0.183573208

Calculation of Cash Flow & Market Price (Rupees in Crores) FY 09 PAT Depreciation Cash Flow WACC DCF Total DCF (In Crores) Total outstanding shares (In Crores) Market Price 485.5 1994.9 51.7 2046.6 18.36% 1729.13 1540.36 1585.53 4855.02 10 FY 10E 2052.9 105 2157.9 FY 11E 2504.1 124.9 2629

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Conclusion
The market price as on 15th March 2010 is Rs 436.6 whereas Market price as per discounted cash Flow method is Rs 485.5. Hence I would recommend a buy decision for the stock of sesa goa ltd.

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