Sesa Goa Limited - Analysis

Sesa Goa Limited is engaged in the business of prospecting, mining, processing and exporting iron ore. It is also involved in support activities like shipping and shipbuilding. The Company exports iron ore, fines and lumps to customers in Japan, China and Europe from ports on both the east and west coasts of India. Besides its mining activities in Goa, the Company has mining operations in Karnataka and Orissa.

Looking at the financial statements the future of the company looks promising. But is the current price at which it is trading lucrative enough for a sound investment?

Even after analysis, we may end up being wrong. To keep the probability of such a situation low, I would primarily stick to bargain issues with sufficient "Margin of Safety". Here I will be looking at two types of investment bargains. The first where stocks of companies are selling at discount to the cash and cash equivalents held by the company (generally known as Cash bargains) and the second, where debt free companies under depression conditions are selling for less than the amount of bonds (debt bearing capacity) that can safely be issued against its property and earning power (known as Debt Capacity bargains). The second type of bargains are deduced from the inverse of the "Rule of maximum valuation for senior securities" given by Ben Graham. Sesa-Goa being a debt free company, can be analyzed for both types of bargains.

Considering it is a debt free company, it has been trading on is trading in the lower range of its 52-week spectrum (see price chart), I thought it might prove to be a debt capacity bargain. Calculating the debt a company can carry needs some assumptions where we can go wrong, but I think we should remember the Margin of Safety priciple (given by Graham) and understand that if we keep a good margin of safety in our investments then minor errors in our assumptions might not be of great significance.

Source: Google Finance

Looking at the Cash Flow statement, we can see that the Net cash flow for the year 2007-08 is negative, but a more detailed look will tell you that most of the cash generated from operations (Rs.1100 Crores) has been used up for buying up investments. Assuming this cash to be a part of Free Cash Flow, and taking conservative assumptions for Cost of Capital and a Interest Coverage Ratio, the debt bearing capacity of this company comes somewhat in the range of Rs.2000 Crores. Adding 75% of the debt capacity (Value of Equity as suggested by Graham) and the surplus cash to the debt capacity, we get the value of the company in the range of Rs.5500 Crores. The value of this Sesa Goa's stock through this valuation comes out to be around Rs.139/share.

At the current price of Rs.130, and also discounting some errors in my assumptions the stock seems to be correctly priced by the market. In my opinion, it is time to sell this stock (if already holding) and wait for it to dip and present a sufficient margin of safety on the value derived through the debt capacity.

A mere glance on the balance sheet will tell us that the company is not cheap when looked as a cash bargain.

Explanation for the interested: You can see that at the end of 2008, the company held around Rs.2000 Crores in investments (Cash equivalents). Adding inventory and Cash would add another Rs.275 Crores to the figure. After the stock split (10:1 issue) in 2008, the outstanding shares have reached 39.36 Crores. If we try to find out the cash available per share, the figure comes out to be around Rs.58. Thus, it is not a good idea to get into this company at the current price of Rs.130.

This was my first analytical post on a company. I may not be right with certain things, so please feel free to correct me/express your opinions and help me learn (it is for this reason that I have started this blog.)