Sterlite Industries (India) : Talks of Progress on Minority
Consolidation; Can Be a Catalyst if Progress Happens
Quick Comment – Impact on our views: We remain
OW but remain cognizant of some downside risks in
next 3-6 months before Sterlite starts inching up towards
our price target.
The newspaper Livemint has quoted Sterlite group
chairman as saying that he hopes to acquire the
government’s remaining stake in Balco by March, 2011.
The newspaper further quoted Sterlite’s chairman as
saying that “Balco arbitration is about whether the call
option is valid or not. If it is established (that the call
option is valid), then it would be valid for Hindustan Zinc
Ltd (HZL) as well”.
What if indeed the Balco and HZL stake purchase
were to happen by March 2011: 1) This issue has
been a major roadblock for the stock in the last three
years and, if resolved by March 2011, could give the
stock a leg up. 2) It could push up our F12e EPS by
more than 30%, as we currently assume the stake
purchase will happen by end-F12. 3) It could allow the
Sterlite group to utilize more freely the more than
US$2.5 bn of cash on the HZL B/S. (4) It would also
indicate that there is nothing wrong with Sterlite group’s
relationship with the government, something that has
been a debating point for investors in recent months.
Why we are not changing our forecasts: Even though
the arbitration proceedings over the legality of the Balco
acquisition are over, we believe the following may act as
hindrances to the process of stake acquisition: A) The
arbitration panel has yet to give its recommendation –
we are still not aware of the outcome. B) The arbitration
panel’s recommendation is not binding – any of the two
parties could still take the matter to the court.
C) Valuation issues (even for Balco where the purchase
price is already fixed) may not be resolved easily.
Key Risks
Downside risks come from the likelihood that
1) The government revokes the license of the existing
Lanjigarh alumina refinery (although this has a low
probability, in our view), or the approval to restart
Lanjigarh refinery may come after a long time – say,
one year.
2) Sterlite does not get environmental permit to expand its
VAL refinery and smelter even in F13.
3) The government refuses to sell the minority stakes in HZL
and Balco.
4) Sterlite is not able to source captive coal for its 2,400MW
merchant power project.
5) Lead smelter takes longer than expected to ramp up to a
higher capacity utilization
6) We also note that loans to VAL have increased tenfold in
F10 over F09. Considering the multitude of hurdles that
VAL faces, we believe servicing these loans could prove
another downside risk.
7) The adverse ruling on the Tuticorin Smelter is an
additional downside risk that could reduce our base case
value for Sterlite by a further Rs15.
Upside risks
1. If aluminum and zinc prices run ahead of our expectations
2. If there is some concrete progress on resolution of
regulatory issues then our target price may have
upside risks.
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