No bright spots

Updated: Feb 27 2012, 06:19am hrs
We are downgrading Sesa Goa (Sesa) to Sell. As we have highlighted earlier, if the CEC (central empowered committee) recommendations are accepted, it will take Sesas Narrain mines at least 5-6 months to restart and production is not likely to exceed around 3.5 million tonne (overall production from Chitradurga-Tumkur being capped at 5 million tonne). The recent news flow regarding a possible restructuring of the Vedanta group is an added overhang. Reduced scope of any near-term volume growth, increasing cost profile, and no clarity on possible restructuring from the management, trigger our downgrade to Sell from Reduce with a target price of R192.

Street overly optimistic on Karnataka: The companys Narrain mines have been placed in Category B, as per the CEC recommendations. Our ground research suggests that it will take at least 5-6 months to restart production, as the company will have to adhere to a new mining plan coupled with a lower production limit for Chitradurga-Tumkur at 5 million tonne.

What possible impact on production is expected in Goa There will be volume impact on account of two reasons (i) Indian Bureau of Mines (IBM) has reduced the cut-off grade for reserves to <45% Fe and Goan miners (probably including Sesa, though we have not confirmed the same with the management) have sold ore exceeding their environmental clearance. This volume needs to be streamlined. A similar process is underway in Karnataka, and (ii) the issue of contract mining is being looked through in detail, as contract mining is not yet legally defined in the Mines Regulation Act of 1960 and has not been addressed even in new MMDR (Minerals Development & Regulation) draft.

Realisations to trend down in Q4FY12. Sesa and NMDC, both reported higher than expected realisations in Q3FY12, contrary to the trend observed in iron ore prices globally. We believe that realisations would go down sequentially, as NMDC has already announced price cuts for Q4FY12 and the effect of global prices come with a lag of one quarter.

Downgrade to Sell: The compelling case of base business valuation no longer holds at current levels. Neither is there any growth case which can be built on the base business (based on issues which we are witnessing in Karnataka and the possible implications that Goa can face), nor is there any assurance that minority shareholders will continue to enjoy the cash dividend from Cairn, given the recent media speculation around the group restructuring. Downgrade to Sell with a target price of R192.

ICICI Securities