It?s a classic case of the tail wagging the dog. Rising ore prices have pushed up margins so high for the mining industry that its profits are in multiples of companies offering finished products like steel and copper, and often within the same corporate group. Vedanta?s Sterlite and Sesa Goa, and Aditya Birla Group?s Hindalco and Essel Mining are some markers to this trend.

Vedanta?s Sesa Goa (Revenue: R4,660 crore; net profit: R2,118.09 crore) registered a staggering net profit margin (NPM) of 45.45% in 2009-10 as compared to a piddly 6.34% NPM for Sterlite, Vedanta?s diversified and integrated metals and mining group primarily in the production of copper of copper cathodes and cast copper rods. Though Sterlite?s revenue, at R13,124 crore, is almost three times Sesa Goa?s sales, its net profit (at R831 crore) is just a third of the group?s mining firm. The story is similar for Sterlite?s peer group, with NPMs hovering in the range of 5-12%. Hindustan Copper recorded an NPM of 11.86%, Nissan Copper at 4.83% and Arcotech at 8.24%.

Likewise, in 2009-10, Aditya Birla Group?s mining firm Essel Mining & Industries registered an NPM of 30% with a total income of R2,560.3 crore and net profit of R767.8 crore, whereas Hindalco, Aditya Birla Group?s aluminium rolling and copper smelting firm, managed an NPM of 9.81%. Hindalco?s sales, at R19,536.28 crore are almost eight times Essel?s, but its net profit is not even thrice that of Essel. Within Hindalco?s peer group, Nalco with 15.74%, Parekh Aluminex with 7.26%, and Ess Dee Aluminium with 19.76% NPM, too, have not had the best profitability margins as compared to mining firms.

Even PSUs are caught in this divide. The country?s top iron ore miner NMDC clocked a whopping net profit margin of 55.25%, compared to India’s largest integrated iron and steel producer SAIL with a 16.35% net profit margin.

This gap, however, might just get narrow after the finance minister announced in his Budget speech a proposal to impose uniform 20% duty on shipments of iron ore. ?Iron ore attracts an export duty of 15% in the case of lumps and 5% in the case of fines. This is a natural resource that needs to be conserved,? he had said. This move, point out industry experts, is expected to have an overall negative impact on mining firms? profits, even as a hot debate over possible ways, including legislation, to share irrational profits being raked in by mining firms is on. There are also talks that miners might be asked to pay higher royalty tax, which is calculated as a percentage of price.

Bhavesh Chauhan, senior analyst (metals and mining), Angel Broking, confirms that right now, mining companies are earning very high EBITDA margins (50-80%) compared to steel companies (15-30%) owing to a fast increase in resource prices. Chauhan explains that mining companies’ return on equity (ROE) is much higher, as cost of production remains more or less constant, while rise in prices of resources directly adds to their margins. Globally, iron ore prices have risen from $60 in March 2009 to $150 in 2010. Clearly, mining is where the margins are.

Anjani K Agrawal, national leader, mining and metals sector, Ernst & Young, elucidates this when he says, ?As against iron ore production cost of $20-30 per tonne, for instance, the net realisation of around $70-80 reflects very attractive margins for ore producers.?

The story is no different for the country’s largest integrated iron and steel producer SAIL. With a revenue of Rs 41,307 crore and net profit of just Rs 6,754 crore, its NPM percentage was about 16.35% in 2009-10. Within its peer group, Tata Steel at 20.17%, JSW Steel at 11.04 % and Jindal Steel at 20.08% spell similar findings.

Experts point out that for the steel business, margins are lower as a percentage of revenues. Dilip Kumar Jena, knowledge manager, mining practice, PwC, explains that iron ore accounts for about 30% of the raw material cost for a steel producer without captive mines. Global market prices for key raw materials, including iron ore and coking coal, have been very volatile in recent times, impacting profitability levels. Jena adds that coking coal accounts for the single largest cost element, with about 50% of raw material cost for a non-captive plant. And with India having limited coking coal reserves? barely 17% of indigenous proven coal reserves are coking coal ? the steel sector is heavily dependent on import of metallurgical coal. For the record, India imported over 21 million tonnes during 2008-09, while international coking coal prices have gone up by 300% in recent times. Add to it the high cost of purchased power, and you have the reasons for squeezing margins.

Chauhan of Angel Broking adds that in case of steel companies, only players with captive mines are able to enjoy higher margins (like Tata Steel’s Indian operations), where value is captured at the mining stage. ?As far as copper firms are concerned, only integrated companies (such as Hindustan Copper) would enjoy higher margins as they would benefit from rise in copper prices. Companies such as Sterlite and Hindalco only charge for treating and refining copper, which is not very lucrative business and they do not stand to benefit with rise in prices of copper,? he says.

Agrawal of E&Y says metal producers are responding to this situation by securing raw material sources, with most scouting for captive mines in India and overseas, a trend that will just grow. ?Pure play metal producers will be challenged to generate enough internal free cash flows for funding growth. Strategy for large metal groups would centre around backward integration into captive mineral sources, as margins have shifted in favour of mining,? he says.

The latest example is Sterlite’s acquisition of the Lisheen Zinc Mine in Ireland from Taurus International SA for $546 million. In 2010, Sajjan Jindal?s JSW Steel acquired 42% of Ispat Industries, giving it access to iron ore mining permits that Ispat holds in Maharashtra. Following suit is the announced Bellary Steel acquisition by JSW Steel. Also in 2010, Naveen Jindal-owned Jindal Steel and Power acquired Oman-based Shadeed Iron and Steel Co for $464 million. One is led to believe what Ratan Tata said almost six years ago, ?I really believe that owners of iron ore are going to rule the industry. They will be the Opec of the steel industry.?