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Higher iron ore export duties negative for Sesa Goa, Vedanta: Moody’s

Moody’s Investors Service, a credit rating agency, has said that an increase India’s iron ore export duties from 20 per cent to 30 per cent is credit negative for India’s largest iron ore exporter Sesa Goa, which is a 55 per cent owned subsidiary of London-listed Vedanta Resources.

“Sesa Goa exported almost 90 per cent of its iron ore production in FY11, but because of the export duty hike, it will now lose significant volume,” said the agency in a statement.

The hike in export duties was announced on December 30, 2011 after the country increased duties on iron ore fines to 20 per cent from 5 per cent in February 2011.

As far as Vedanta is concerned, the company needs all the cash it can generate in order to service its debt burden of over $16 billion. It has already paid $4.5 billion to complete its acquisition of 58.5 per cent of oil producer Cairn India a month ago.

Vedanta received an EBITDA contribution from iron ore of $1.17 billion in fiscal 2011. As per the agency estimates, the contribution will fall to an annual run rate of $700-$750 million. However, tension in the Middle East and the accompanying rise in crude oil prices could lead to improved returns from Cairn India’s gross production of 170,000 barrels of oil per day.

The agency said that the reason for the duty increase is unclear and its benefits are far from certain. India exports 80 per cent of its iron ore and is the world’s third-largest exporter of iron ore after Australia and Brazil. As much of India’s iron ore exports go to China, India’s politicians have suggested that India keep its resources for its own steel industry.

However, the iron ore fines that form the bulk of India’s exports are low grade and few of India’s steelmakers have made the necessary investment in sintering plants needed to use fines. Decreased export of iron ore fines will not necessarily boost Indian steel production.

The country’s fiscal deficit should benefit from an increase in revenue as long as volumes hold up. However, volumes have been sliding, with the country exporting 97 million tonnes in the year to March 2011, down from 110 million tonnes a year earlier.

The main beneficiaries of the higher duties will be domestic steel companies without captive mines such as JSW Steel (unrated) as the agency expects them to see improved iron ore availability in the domestic market. This is important as Karnataka, one of the three key states where iron ore is mined, last August banned all mining in an attempt to stamp out illegal mining. Vedanta operates mines in Karnataka and Goa.

Iron ore is an important commodity for Vedanta. It sold 18.1 million tonnes in the fiscal year ended in March 2011, which represented 17 per cent of group revenue and 33 per cent of EBITDA, and helped the company achieve an EBITDA margin of 59.3 per cent. However, in the six months to September 2011, Vedanta’s iron ore sales were 5.8 million tonnes, while iron ore’s group revenue contribution was 10per cent, the EBITDA contribution was 18 per cent, and its EBITDA margin was 48.9 per cent. Worse still, iron ore production in the three months to September 2011 was a mere 1.1 million tonnes owing to the Karnataka mining ban, seasonal effects, and the expiry of its Orissa mining licence.

Recognising the mounting challenges at home, Vedanta in August 2011 paid $102 million for a 51 per cent stake in Western Cluster, a collection of iron ore deposits in Liberia with estimated resources and reserves of 1 billion tonnes. However, there is no timetable for production in Africa and it could be three to five years before commercial quantities are mined. Vedanta also has attempted to mitigate the gradual clampdown on iron ore exports by expanding its pig iron production in Goa.

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