Irrespective of the drop in realisations in steel prices and its raw material, the fact remains that iron-ore mining remains one the most lucrative business in the steel sector in the country. This fact is borne by the consistent year-on-year performance of Sesa Goa.

In the fiscal 1998-99, although the sales dipped by 8 per cent, the bottomline has up shot by 16.63 per cent from Rs 27 crore in 1997-98 to Rs 32 crore in 1998-99. The sales turnover has dipped primarily due to fall in iron ore prices by 11 per cent.

This was mainly on account of Japanese and Korean steel producers cutting production, thereby resulting in lower offtake from iron-ore producers. Secondly, the price of iron-ore is also determined by the substitutes such as shredded steel scrap. Lower scrap rates pushes down the rates of pig-iron and Direct reduced iron - the basic material formed after reduction of iron ore in the furnace.

The prices of scrap were ruling at $100 per tonne for most part of 1998-99 year,resulting in pig iron and HBI/DRI prices to be in the same range. This also pushed down the prices of iron ore in the range of $14 to $16 per tonne last year, compared to $ 16 to $ 18 per tonne in 1997-98.

Despite the fall in prices, Sesa Goa's operating margins have shot up from 16.4 per cent in 1997-98 to 21 per cent in 1998-99.

In fact performance in the fourth quarter has been much better with operating margins increasing to 23 per cent.

The rise in operating margins are due to lower baltic freight rates which fell from over 1000 to as low as 750 in the month of August 1998. The freight rates recovered in the February, but on an average one can assume that on year-to-year basis the freight rates were lower by at least 20 per cent compared to that of last year.

Since freight is an important element of price, much lower freight rates compared to fall in realisation helped the company post higher margins.Secondly as a proportion of total production, the company buys a lot of iron ore from othermining companies. As a result of the fall in prices, the company outsourced its requirement from other mining companies at lower prices, resulting in higher margins to the company.

Thirdly on a year-to-year basis, the rupee depreciated by 7 per cent resulting in higher margins for the company. Higher depreciation of Rs 11.18 crore in fiscal 1998-99 is due to installation of plant for recovery of pellets feed from the tailings at Codli Mines.

With most of the mines of the company located in Goa and Karnataka, high freight rates by railways have not hurt the company as much as it does to NMDC mine. The cost of mining iron ore at Sesa- Goa at Rs 110 per tonne is the lowest in the world. In contrast the cost of production for iron-ore in Brazil (world's second largest iron-ore exporter) in rupee terms is Rs 210 per tonne. All these factors have resulted in higher bottomline for the company. The share price has also mirrored the performance of the company. After touching a low of Rs 82 in April, the price haverisen to 110 on 4th June and is likely to maintain the trend.

Larsen & Toubro

Once again, rumours are floating in the market that Larsen & Toubro (L&T) will announce a business split in three divisions consisting - EPC, cement and software. The rise in the price of the scrip is attributed to the split.

One fails to understand the logic of the proposed split. L&T Information Technology (a 100 percent subsidiary) commenced operations in April 1997, it was till then a Information Systems Division of L&T. Only the dividend declared by a 100 per cent subsidiary is reflected in parent's books. Dividend income is tax free but will not be a significant contributor to L&T's PBT though the return on investment is better than in any other business of L&T. In all probability, L&T will opt for the listing of the subsidiary through offer for sale route. It will not only generate cash for L&T but the value of the investment will also be reflected in its market price. The subsidiary is growing rapidly withprofit after tax in 1998-99 standing at Rs 36.85 crore against Rs 17.53 crore in 1997-98.

As regards, hiving off cement division into a separate company, it will serve little purpose. First of all, if L&T wants to retain control of the resultant company, demerger is not possible. If spun off, L&T has two options. First, retain it as a subsidiary and earn no returns for at least three years because of accumulated loss of the division which rules out dividend. Any player capable of taking substantial stake in the new company will not be interested in minority stake and in case, even a 51 percent subsidiary will generate cash which L&T does not need desperately. Two, get out of cement business altogether. This will generate great cash and vastly improve RoCE but will not be an easy decision. At least Tadpatri unit enjoys 80 IA benefits and it means tax free status for the unit as this benefit can not be adjusted against profit of a unit which does not get this benefit because the benefit is qua unit. Thedivision has been a drag on the company because it opted for greenfield units which started commercial production during a bad period for the industry.

Another point to consider is that the bulk terminals at Mumbai and Mangalore (0.5 mtpa) have become operational in the second half of 1998-99 and hence the savings on freight in the current year will result in an improved net cement realisation (NCR). Because Gujarat and AP plants are new, the unabsorbed depreciation and carried forward loss because of interest burden must be substantial resulting in company paying only MAT. Since cement division is able to recover costs except depreciation, pick up in volumes (as is reflected in cement despatches) is a major benefit. Though in books also, depreciation not covered by cement division has to be above Rs 65 crore, but net of tax saved (including in future), it will not be alarming. After two years, the cement division will contribute to the bottomline.

The scrip is running because of the quality of order bookposition of EPC division (unlike in 1997-98, `mandatory' DHDS projects account for less than 10 percent), cement division is also performing better than expectations. A marginal boost could be the innovative financing deal for IPCL's captive power plant because for any EPC major, ability to provide finance for the project is a crucial benefit.

(With contributions from Manish Saxena and Urmik Chhaya)