CLSA: Buy Sterlite Industries: Better prices but coal worries

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Better prices but coal worries
CLSA’s resources team has upgraded CY11-12 aluminium, zinc and lead price
forecasts by 9-36%. We factor this in our numbers but also build in a slower
ramp-up in Sterlite Energy’s (SEL) plant and higher coal costs in SEL and
Balco due to Coal India’s production woes. The result – FY11 EPS falls 9%,
FY12 EPS rises 5% while FY13 EPS falls 9%. Completion of Anglo-zinc
acquisition could add 11-18% to our FY12-13 EPS. Sterlite’s valuations are
reasonable and we expect stock performance to improve once SEL’s profits
start flowing through quarterly results starting 4QFY11. O-PF stays.

Base metal prices have improved
Prices of aluminium and zinc on the LME have improved in recent months.
Aluminium in particular has been strong due to cost push and production cutbacks
in China. CLSA’s resources team has upgraded CY11-12 aluminium price forecasts
by 9-12%, zinc forecasts by 12-31% and lead by 18-36%. Factoring in this, our
Hindustan Zinc (HZL) profits rise by  22-53% over FY12-13. Higher aluminium
price forecasts also improve Vedanta Aluminium’s (VAL) ability to service interest
payments, though principal repayments remain a concern.
Coal supply to SEL and Balco is a worry
Given Coal India’s (CIL) acute production problems due to MoEF’s ‘critically
polluted areas’ criteria, we are sceptical of its ability to fully honour coal linkage
commitments over FY12-13. We now assume that SEL gets only 25% of its coal
requirements from CIL with the balance coming from imported coal (65%) and eauction (10%). Similarly, we also assume that Balco, too, will have to import part
of its coal requirements for its 1200 MW CPP over FY12-13.
Triggers ahead – SEL and Anglo Zinc
SEL’s profits will start flowing through Sterlite’s quarterly results by 4QFY11. This
combined with timely commissioning of balance three units by mid-FY12 should
help improve Sterlite’s stock performance. Successful completion of the Anglo-zinc
acquisition by end-FY11 will add 11-18% to our FY12-13 EPS and will be another
positive trigger for the stock. Return of the outstanding Rs35bn loan by Vedanta
Aluminium (VAL) to Sterlite would further assuage market concerns.
Maintain O-PF
Sterlite’s stock underperformed substantially in 2010 weighed down by the delays
in SEL’s plant, denial of bauxite mining approval to VAL and rising costs in HZL. All
this has now been adequately factored in our estimates. We see Sterlite’s profit
growth rising sharply in coming quarters boosted by SEL. This combined with
absence of further negative government related news flow should improve stock
performance. Maintain O-PF with a FY13-based SOTP target price of Rs200.