Tata Sponge is one of India`s largest sponge iron maker (based out of Odisha) with a capacity of 390,000 tonnes. Tata Steel`s stake in this company was at 39% until a few months back, after which a buyback was initiated at Rs 375/share. Tata Steel looking to increase its stake to 50% after the buyback. Not only does the company get valuable managerial and market inputs from Tata Steel, but also the company`s total iron ore requirement (worth Rs 200 Crs as of last year) has been provided by Tata Steel. The same if procured in the open markets would cost substantially more for the company. This is the main reason for the wonderful PAT and cash flow numbers the company publishes year on year.
WHAT IS SPONGE IRON
The 2 types of raw materials for steel making include: pig iron and sponge iron. While pig iron is produced by the blast furnace route in which iron ore is melted, sponge iron is made by a direct reduction process (no phase change of iron ore [solid to solid reduction]). The different manufacturing processes employed for making pig and sponge iron endow them with inherently different physical and chemical properties. As a raw material for steel making, pig iron is used by primary steel producers who have access to coking coal while secondary producers (who do not have access to coking coal) use sponge iron instead of steel scrap as their raw material (just for a perspective, 55% of Indian steel is produced by secondary steel producers).
INDIAN SPONGE IRON INDUSTRY
The massive increase in steel demand combined with restricted availability of quality scrap led to the growth of the Indian sponge iron industry. At an installed capacity of 33 million tons per annum, India is the world`s largest sponge iron producer and Tata Sponge Iron at 390,000 tons is India`s largest coal based sponge iron maker (Essar has the largest gas based sponge iron plant at 5 million tons per annum).
But, as with all infrastructure sectors in India, the sponge iron industry is currently facing a slew of problems related to raw material availability (coal and iron ore due to environmental issues and government scams), logistical problems and a general economic slowdown.
THE CASH CONUNDRUM
Stuff with Rs 220 Crs of cash and Rs 25 Crs in mutual fund investments, the company`s market cap of Rs 460 Crs can be discounted by this cash component (zero debt company). That comes to an enterprise value of Rs 215 Crs. With the average of the last 3 years PAT coming to Rs 90 Crs, the company`s P/E is 2x (P is enterprise value). The company, unable to find any worthwhile investment opportunities is doling out the cash back to shareholders. At a dividend of Rs 8/share the company has paid out a total of Rs 36 Crs over the last 3 years.
MINING SCAM
The company has been one of the prominent names in the recent coal mining scams. Allotted the Radhikapur(East) coal block in 2006 (120 million ton coal block allotted to 3 companies with Tata Sponge having highest stake of 45%) , the company was reprimanded by the Inter ministerial group(setup to investigate the coal scam) for not developing the block in time and subsequently, the Bank guarantee worth Rs 32 Crs submitted by the company was en-cashed. The company has gone to court and the issue in stalemate.
POWER BACKUP
Coal based sponge iron produces large amount of waste heat which the company uses in its 26 MW waste heat power plant. It is hard estimating y-o-y revenues from these plants considering that waste heat availability is dependent on the sponge iron plant`s availability which swings wildly (2011-12 only saw 80 MU`s [million units] of electricity sold while 2009-10 saw 120 MU`s being sold).

WHY TATA SPONGE
Ultra cheap valuation, Tata group backed company, access to Tata Steel`s iron ore and excellent operational efficiencies are reasons convincing enough to stock up on this script.

It is these kinds of discrepancies between intrinsic value and market cap that offer a jackpot to the patient investor. People are scared about the wild swings in the prices of commodities and the effect of mining scams. Nonetheless, that does not mean that we are going to stop using metals in the near future. The best companies which operate most efficiently will find ways out of these situations. In such a scenario companies like TATA sponge iron will emerge stronger than their more inefficient peers.

DISCLAIMER:I have a vested interest in seeing this script go up.

Snippets from Annual Reports/Other sources
1) The radhikapur(east) coal block if developed would entail a cost of Rs 600 Crs, of which Rs 435 Crs would be debt funded massively increasing the company`s gearing.
2) Company planning for 25 MW AFBC boiler (atmospheric fluidized bed combustion). Project cost of same budgeted at Rs 150 Crs.
Both above snippets from ICRA credit services dated Sep-2010
3) Company envisioning to become an integrated steel producer and hence the move to develop the coal block. But the huge capex involved for the same and social baggage of land acquisition making the company to hesitate.
4) AR 2011-12 balance sheet showing Rs 220 Crs of cash and equivalents but very peculiarly, the cash flow statement shows cash and equivalents at Rs 36 Crs. Probably a Rs 184 Cr error during preparation of the statement.