In an environment of herd mentality, it is refreshing to see completely different viewpoints on Sesa Goa Ltd from two respected brokerages. CLSA is incredibly bearish and IDFC very bullish. Where could the stock be headed?

A very negative environment in iron-ore pricing (after China's removal of export rebate for steel) has been putting pressure on Sesa Goa, India's largest exporter of iron ore in the private sector. However, despite a negative breakout on 29th June, the stock has not broken below the Rs345 level (take a look at the attached chart). Technical analysis shows that if the stock breaches the Rs345 level, it could fall to Rs315. However, if it sustains above this, it could touch Rs400. Interestingly, CLSA India is extremely bearish on this company and has come out with a report today cutting estimates sharply, while IDFC is very bullish. So where could Sesa be headed?

Sesa Goa has some incredible positives - good cash flow, volume growth (mostly from Orissa and Karnataka), reserve addition through acquisitions such as Dempo, and apparently cheap valuations. A recent IDFC research report says its current market price of around Rs350 implies steady state realisation of $47 per tonne for iron ore reserves, which is 70% lower than the spot price and also below the 5-year average contract prices ($65). IDFC pegs Sesa's EV/EBITDA at 1x FY12, lower than peers.

But there are a lot of things that could go wrong for this stock:
(1) The management has a sales volume target of 50 million tonnes per annum (mtpa) for FY12 but they could easily fall short of this (current sales at 21mtpa) since this ramp-up is dependent on too many clearances, mainly environmental.

(2) Most positive reports on the stock assume that the bargaining power will remain with iron ore suppliers over the next few years, especially after the Rio and BHP joint venture. However, recent events have shown that if China continues its strategy of rationalising production of steel, this balance may soon tilt in favour of buyers - and there is no doubt that China has incredible influence as a resource buyer. Sesa sells most of its products in the spot market and would be adversely affected.

(3) Another perceived positive that could easily turn into a major negative is Sesa's acquisition potential. Sesa will probably be sitting on about Rs210 billion in cash and have a net-worth of around Rs240 billion by FY12 (IDFC estimates). However, even in a falling iron ore price environment, any acquisition that it might make in the next two years has the potential to be expensive - this is because iron ore prices are still at unprecedented highs and nowhere near a value zone as far as acquisitions are concerned and secondly, if it is a global acquisition, it will face tough competition from bigger players, which will only drive up prices.

(4) Another risk that is often taken lightly by the market is regulatory risk. The steel ministry has been lobbying for a ban on iron ore exports not on the grounds of shortage, but on the grounds of 'non-renewable resource for the local industry'. Interestingly, this is the reason why China does not promote iron ore exports. Another regulatory risk is environmental clearances or a resource tax on Indian miners. Other risks include even more stringent measures from China to ban low grade iron ore (Sesa's grade is not as good as NMDC's).

CLSA's recent report believes that supply will outstrip demand much sooner than expected (in the second half of 2010 itself) as many projects go on-stream and China's steel demand is likely to slow down very sharply to just 4% in 2011 after the withdrawal of the stimulus.

It is very clear that Sesa is very sensitive to news from China but it is also sensitive to the movements in our broader market. If the Nifty fails to sustain above the 5,400 mark, we could see pressure in the overall market and Sesa would be no exception. However, if the broader market keeps outperforming, Sesa could very well outperform, unless there is some fresh negative news from China.

Sesa Goa operates in Goa, Karnataka and Orissa. In the past couple of years, it has also started manufacturing pig iron and metallurgical coke.