ICICI Securities: Sterlite DOWNGRADE: target Rs 194

We downgrade Sterlite Industries (SIL) to HOLD. We also revise down our target
price to Rs194 from Rs201, an upside of 12% from the current levels, primarily led
by reduction in VAL’s contribution. We believe that SIL is now a call option on
zinc prices, as zinc contributes ~60% and holds 0.63x sensitivity to our target
price respectively. Though we maintain a favourable view on zinc prices as key
western mines reach end of their lives and on increasing galvanized steel
penetration in China, we downgrade SIL on limited upside potential given our
FY12E zinc price assumption of US$2200/te.
􀁦 Zinc continues to be the crown jewel. As regard to mining capacity growth over
CY10-11, except the 0.2-mtpa Peñasquito mines in Mexico, most capacities are
small and the combined additions will be largely offset by exhaustion of the 0.25-
mtpa Brunswick and contraction at Antamina mines. With favourable movement of
cancelled warrants both on the SHFE and the LME and lack of any major mining
project taking off, we continue to prefer zinc to aluminium. SIL with 60% valuation
exposure to zinc remains a partly undervalued call option on zinc prices.
􀁦 Niyamgiri a dead issue, Orissa government not in a hurry to allocate new
mines. After the MoEF rejected stage 2 forest clearance to Niyamgiri mining project
and the National Environment Appellate Authority suspending the environmental
clearance, VAL will have to look out for new mines. We have assumed a long-term
aluminium production cost of US$1600/te, as the company has, off late, been
sourcing bauxite via sea route from Gujarat. Also, we have reduced our estimates of
the scale of the project to 1.4mnte alumina refinery and 0.5mtpa aluminium smelter.
􀁦 Reduced estimates for Sterlite Energy. Although Sterlite Energy commissioned its
first unit of the 2,400MW independent power project on August ’10, the facility has
been beset with problems right from the start. Further, our power analyst suggests
synchronization issues for these units. This has led us to reduce production
estimates both for FY11E and FY12E. This is however partly offset by increase in
value on account of increased merchant sales with power freeing up from VAL,
resulting in minor loss in value for SIL from SEL.
􀁦 Valuations and concerns. Our SOTP for SIL yields a fair value of Rs194/share. If
we are to go by the last concall, SIL’s total contribution to VAL including equity
should be below Rs50bn. We have reduced the scope of VAL’s expansion, and
hence the equity component of the project has increased making it further punitive
for equity holders like SIL. Hence money (returning 9% currently) should be freed as
soon as possible specially when the mantle of Anglo’s acquisition can befall on SIL
in the absence of Hindustan Zinc’s board approval.