Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Power ramp-up a key catalyst
News flow should improve –
valuations at deep discount,
reaffirm Buy
Action: Overly pessimistic valuation; attractive opportunity
Sterlite Industries has corrected by 40% over the past 12 months (Sensex:
-26%), reflecting continuous negative news flow and concerns over a
deteriorating macro environment. We believe the current stock price is
building in a USD1,600/t zinc price (current: USD1,860/t), assigning no
value to the power and aluminium business, and ignoring loans to group
companies. Although its 64.9% stake in Hindustan Zinc (HZ) contributes
50-55% of earnings, Sterlite has underperformed HZ by 28% over the past
12 months.
Catalysts: Improving power business and news flow
Improving utilization of power plants should be a key catalyst along with
resilient earnings, we believe. Any news flow on a stake sale by the
government in HZ and Balco should also be positive.
Valuation: Target price cut to INR169; reiterate Buy
We value Sterlite Industries on a sum-of-the-parts basis at INR169/share.
We have cut our target price to incorporate expected lower zinc prices and
higher coal costs. The stock is trading at 5.6x FY13F EPS of INR18.7 and
3.4x FY13F EV/EBITDA. The stock is trading at a FY12F P/B of 0.8x,
despite an ROE close to 14% even on our conservative estimates. We
believe these are attractive valuations and reaffirm our Buy rating.
Sterlite Energy (SEL) has shown PLF improving to 60% over the past two
months from near 30% in March 2011. Although coal costs have risen, we
believe SEL has performed much better than expected. With a third unit of
600MW under commissioning, we expect SEL to see better performance.
Investment thesis
Sterlite’s stock price has remained weak following a series of negative developments, i.e
shortages of coal, denial of a bauxite mine, environmental issues at VAL, etc. While we
acknowledge the issues that Sterlite Industries is facing, we believe some positive
developments should start to emerge with the power business ramping up operations.
Power operations will likely be a key catalyst to a turnaround in the share price, in our
view, as Sterlite Energy (SEL) is on the verge of commissioning its third unit, and the
already-commissioned other two units are running at 50-55% plant load factor (PLF), as
per Central Electrical Authority (CEA) data.
Our positive stance on Sterlite Industries gets support from our belief that most, if not all,
of the negative news flow has already hit and the stock has overreacted, in our view.
With an end to the negative news, improving operations and better earnings visibility, we
believe the stock should give strong returns. We maintain our Buy rating on the stock,
and revise our target price to INR169.
Negative news flow key to Sterlite’s underperformance vs HZ
Sterlite Industries stock has underperformed HZ’s by close to 40% over the past two
years, undermined by a series of negative news reports, i.e. denial of a bauxite mine,
environmental issues at the aluminium operations of Vedanta Aluminium (VAL) (Sterlite
Industries holds a 29.5% stake in VAL) and coal shortages at SEL. In comparison, HZ
remained largely free of any controversy and has performed well. While we agree with
HZ’s valuation and believe it is fair, Sterlite Industries stock has been over-penalized, in
our view.
HZ contributes ~58% of Sterlite Industries’ total value, on our estimates. Nonetheless,
HZ stock has outperformed Sterlite Industries by 50% over the past two years. A look at
the charts overleaf suggests that the stake in HZ contributes ~86.5% of Sterlite
Industries’ total value based on current market capitalization (on our calculations it
should be 58% of total value). This is despite the fact that only 50-55% of Sterlite’s
earnings are from its stake in HZ. Note that the value contribution from the stake in HZ
has increased from 47% in Feb 2010 to 86.5% now, despite our estimates that earnings
contribution will fall from 70% in FY10 to close to 51% in FY12F.
In our view, this shows that Sterlite Industries is undervalued compared to HZ at current
levels. Even for Sterlite’s zinc business, with which the charts overleaf suggest the
market is comfortable, it is being valued at a discount vs HZ’s valuation based on current
market capitalization.
Sterlite Industries stock valuing only the zinc business at
present; other operations ignored
The chart above suggests that while the market is comfortable with its zinc business,
other businesses appear to be getting penalized for uncertainties. At its current
valuation, we believe Sterlite Industries is being valued just for its zinc business — i.e.,
its 64.9% stake in HZ and overseas zinc assets acquired earlier this year.
In our view, the current share price of Sterlite Industries is not giving any value to the
following operations:
1) The aluminium business, comprising a 51% stake in Balco and a 29.5% stake in
VAL. At the same time, we see no value assigned to Sterlite’s INR80.2bn loan to
VAL. This implies to us that the aluminium business is ascribed a negative equity
value of INR81bn.
2) The 100% owned power business, Sterlite Energy (SEL, unlisted), is also being
valued at zero, and even loans and advances from Sterlite to SEL are not being
given any value. Thus, in effect, we see SEL as being valued at negative equity of
INR41bn.
3) The copper smelting business is also not being valued which on our valuation
should contribute INR 8.4/share.
On our calculations, even under a stressed case scenario (described below) and at the
current market cap of HZ, Sterlite stock should be valued at INR108/share. Some key
estimates for the stress case scenario are as following:
1) HZ and overseas zinc businesses valued at zinc and lead prices of USD1,600/t
(current zinc and lead prices are at USD1,860/t and US$ 1,900/t respectively)
2) Zero value to Sterlite Energy (SEL) and its stakes in Balco and Vedanta Aluminium
3) Loan of INR80bn to VAL written off
Even in the above scenario, Sterlite Industries can be valued at INR108/share, according
to our estimates. Given the current price of INR104, the market is already valuing the
stock at the stressed level, therefore, we believe that at the current level, the risk-reward
is favourable for Sterlite Industries.
We believe the above discounting is not justified…
VAL – we recognise problems but shouldn’t default on its debt
While we agree with the zero equity value ascribed to VAL because of the delay in
expansion plans and high cost of production at its existing operations, we do not agree
with the view that Sterlite’s loans to VAL should not be valued either. Vedanta Resources
holds 70.5% equity in VAL, and even if expansion plans are delayed, we do not see a
scenario of VAL defaulting on its debt as Vedanta, the holding company, is unlikely to
allow VAL to default, in our view.
At the same time, we believe most of the issues facing VAL are short term in nature.
According to the company, the plants are ready for commissioning, and we expect to see
some progress on the bauxite mine allocation and environmental issues as the state
government of Orissa is favourable to these projects. Orissa has large untapped bauxite
reserves and the state government has been favourable to the projects of VAL. Earlier
VAL was allotted a mine at Niyamgiri but was denied environmental clearance. Post that,
VAL is still awaiting allocation of a new mine. To be conservative, we have not built in
any positive upside from the above to our estimates.
Sterlite Energy – does not deserve negative value
At Sterlite’s current valuations, the market appears to be ascribing SEL a negative value
as the shares of Sterlite are neither valuing the power business, nor the INR41bn loan
from Sterlite to SEL. Thus, SEL effectively is getting assigned negative equity value of
INR41bn, on our estimates.
We believe Sterlite doesn’t deserve a negative value for this business, as SEL is
operating at 50-55% PLF and, has been profitable in 1HFY12 despite high coal costs.
Even on our conservative estimates, we think SEL should get assigned a positive value,
given that it has two units of 600MW up and running, while a third unit is in the process
of commissioning. During 1HFY12, SEL reported PLF of 50-55%, which is in line with our
estimates. We have built in PLF assumptions of 55% in FY12F and FY13F. Even our
coal cost assumptions are high, as we have built in fuel costs to remain in excess of
INR1.5/unit.
Note that we are assuming just 35% of total coal (at 55% PLF, 15-20% of total
requirement at rated PLF) to come through linkage, 10-15% through imports and the rest
through E-Auction. Even at what we believe are conservative estimates, we value the
power business using DCF at an equity value of INR11.5bn (close to its book value).
Strong earnings growth expected in FY12F driven by
overseas zinc operations and SEL
According to management, most of the Sterlite Industries’ expansion plans are complete,
and we expect to see earnings growth led primarily by power business and zinc business
acquired overseas.
1) HZ already has commissioned a 210KT zinc and the 100KT lead expansion, while
silver expansion is underway.
2) Sterlite Energy has commissioned the first two units of 600MW each which are
operating at 50-55% PLF and the remaining units should be completed in the next
two quarters.
3) VAL (29.5% owned by Sterlite) should see full production from its 500KT aluminium
smelter and 1mn tonne alumina refinery from FY12F. However further expansion
plans remain deferred due to environmental issues. We don’t expect any near-term
solution to these issues.
4) Balco’s (51% owned by Sterlite) capacity expansion of 325KT is still on hold, but a
1,200MW (4*300MW) power plant is under construction and should come on line in
the next 6-9 months, according to management.
5) Another potential growth avenue we see is expansion at the recently acquired (Feb-
2011) Gamsberg mine, where Sterlite Industries expects to produce 400KTPA of
zinc in 2-3 years’ time with an investment of USD2bn.
Given the above-mentioned capacity expansion plans/phases, we expect Sterlite
Industries’ consolidated EPS to increase at a CAGR of ~12% during FY11-13F, with
FY12F earnings growth of close to 32% y-y.
Our forecast earnings growth for FY12 is driven by: 1) zinc earnings from assets
acquired from Anglo American in February 2011; and 2) growing contributions from the
power business as capacities come online. In FY13F, however, we see earnings
suffering somewhat from higher royalty payments to be made at HZ.
Dependence on HZ to decline, but zinc remains the key driver
HZ’s earnings contribution will likely come down with improving power operations and a
growing contribution from overseas zinc business. We estimate that HZ will account for
51.9% of total earnings in FY13F, down from 63.1% in FY11. However, we look for the
zinc business as a whole (i.e., comprising overseas business) to account for 72% of
earnings by FY13F, up from 70.3% in FY11, despite higher power earnings.
Once again, we note that despite Sterlite Industries deriving close to 52% of its earnings
from stakes in HZ and 72% from zinc business, Sterlite Industries shares have
significantly underperformed HZ shares over the past two years.
Our estimates are conservative, we believe
Our revised estimates capture the following key considerations:
1) For SEL, 55% PLF in FY12F and FY13F and an average coal cost of INR2,584/t
(4000 Kcal coal). Of note, SEL is already operating at 55% PLF and we do not build
in any improvement in utilization over the next two years (therefore, we are not
overly optimistic). Even on the coal cost side, our assumptions build in a 65-70%
coal purchase from E-Auction and imports. Our average coal cost is higher than the
current E-Auction price of INR2,400-2,500/t.
2) For Balco and VAL, we build in a continued high cost of production at USD1,900-
2,000/t. We are not ascribing any value creation from the USD5bn of capex already
incurred but mired in environmental issues. The resolution of environmental issues
would be a key catalyst to the stock, in our view.
3) We have not built in any production/reserve upside from overseas zinc assets.
We value Sterlite at INR169/share, maintain Buy
We value Sterlite Industries at INR169/share (from INR196 earlier) on a sum-of-the-parts
basis. While our methodology is unchanged, our revised target price is driven by lower
valuations of Sterlite Energy and HZ. Our INR169 target price breaks down as follows:
The Hindustan Zinc stake contributes INR97.7/share (HZ valued at 10x FY13F EPS of
INR12); overseas zinc assets contribute INR19.8/share based on DCF; the aluminium
business (ie, stakes in Balco and VAL) contributes INR4.6/share at 5x FY13F
EV/EBITDA; the power business (SEL) contributes INR3.4/share using DCF; the
standalone copper business contributes INR8.4/share; and INR35/share comes from
cash and investments.
Stake sale by the government in HZ and Balco could unlock
cash potential at HZ
The Government of India holds a 24.5% stake in HZ and a 49% stake in Balco. Sterlite
Industries has a call option to purchase the government’s stakes in the two companies.
However the transaction has been on hold as there has been disagreement on valuation
(between the government and Sterlite Industries) and on the legality of these call
options. Any decision by the government to sell its stakes in HZ and Balco would be
positive for Sterlite Industries, as HZ’s cash of INR 190bn (by end FY12E) could be
utilized in a much better way. Due to delays in the government’s approval, HZ couldn’t
acquire the overseas zinc assets (which could have utilized the cash reserves at HZ)
which Sterlite Industries had to undertake on its own books. Please note that we have
not built in any upside from the above stake sales in our estimates.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Power ramp-up a key catalyst
News flow should improve –
valuations at deep discount,
reaffirm Buy
Action: Overly pessimistic valuation; attractive opportunity
Sterlite Industries has corrected by 40% over the past 12 months (Sensex:
-26%), reflecting continuous negative news flow and concerns over a
deteriorating macro environment. We believe the current stock price is
building in a USD1,600/t zinc price (current: USD1,860/t), assigning no
value to the power and aluminium business, and ignoring loans to group
companies. Although its 64.9% stake in Hindustan Zinc (HZ) contributes
50-55% of earnings, Sterlite has underperformed HZ by 28% over the past
12 months.
Catalysts: Improving power business and news flow
Improving utilization of power plants should be a key catalyst along with
resilient earnings, we believe. Any news flow on a stake sale by the
government in HZ and Balco should also be positive.
Valuation: Target price cut to INR169; reiterate Buy
We value Sterlite Industries on a sum-of-the-parts basis at INR169/share.
We have cut our target price to incorporate expected lower zinc prices and
higher coal costs. The stock is trading at 5.6x FY13F EPS of INR18.7 and
3.4x FY13F EV/EBITDA. The stock is trading at a FY12F P/B of 0.8x,
despite an ROE close to 14% even on our conservative estimates. We
believe these are attractive valuations and reaffirm our Buy rating.
Sterlite Energy (SEL) has shown PLF improving to 60% over the past two
months from near 30% in March 2011. Although coal costs have risen, we
believe SEL has performed much better than expected. With a third unit of
600MW under commissioning, we expect SEL to see better performance.
Investment thesis
Sterlite’s stock price has remained weak following a series of negative developments, i.e
shortages of coal, denial of a bauxite mine, environmental issues at VAL, etc. While we
acknowledge the issues that Sterlite Industries is facing, we believe some positive
developments should start to emerge with the power business ramping up operations.
Power operations will likely be a key catalyst to a turnaround in the share price, in our
view, as Sterlite Energy (SEL) is on the verge of commissioning its third unit, and the
already-commissioned other two units are running at 50-55% plant load factor (PLF), as
per Central Electrical Authority (CEA) data.
Our positive stance on Sterlite Industries gets support from our belief that most, if not all,
of the negative news flow has already hit and the stock has overreacted, in our view.
With an end to the negative news, improving operations and better earnings visibility, we
believe the stock should give strong returns. We maintain our Buy rating on the stock,
and revise our target price to INR169.
Negative news flow key to Sterlite’s underperformance vs HZ
Sterlite Industries stock has underperformed HZ’s by close to 40% over the past two
years, undermined by a series of negative news reports, i.e. denial of a bauxite mine,
environmental issues at the aluminium operations of Vedanta Aluminium (VAL) (Sterlite
Industries holds a 29.5% stake in VAL) and coal shortages at SEL. In comparison, HZ
remained largely free of any controversy and has performed well. While we agree with
HZ’s valuation and believe it is fair, Sterlite Industries stock has been over-penalized, in
our view.
HZ contributes ~58% of Sterlite Industries’ total value, on our estimates. Nonetheless,
HZ stock has outperformed Sterlite Industries by 50% over the past two years. A look at
the charts overleaf suggests that the stake in HZ contributes ~86.5% of Sterlite
Industries’ total value based on current market capitalization (on our calculations it
should be 58% of total value). This is despite the fact that only 50-55% of Sterlite’s
earnings are from its stake in HZ. Note that the value contribution from the stake in HZ
has increased from 47% in Feb 2010 to 86.5% now, despite our estimates that earnings
contribution will fall from 70% in FY10 to close to 51% in FY12F.
In our view, this shows that Sterlite Industries is undervalued compared to HZ at current
levels. Even for Sterlite’s zinc business, with which the charts overleaf suggest the
market is comfortable, it is being valued at a discount vs HZ’s valuation based on current
market capitalization.
Sterlite Industries stock valuing only the zinc business at
present; other operations ignored
The chart above suggests that while the market is comfortable with its zinc business,
other businesses appear to be getting penalized for uncertainties. At its current
valuation, we believe Sterlite Industries is being valued just for its zinc business — i.e.,
its 64.9% stake in HZ and overseas zinc assets acquired earlier this year.
In our view, the current share price of Sterlite Industries is not giving any value to the
following operations:
1) The aluminium business, comprising a 51% stake in Balco and a 29.5% stake in
VAL. At the same time, we see no value assigned to Sterlite’s INR80.2bn loan to
VAL. This implies to us that the aluminium business is ascribed a negative equity
value of INR81bn.
2) The 100% owned power business, Sterlite Energy (SEL, unlisted), is also being
valued at zero, and even loans and advances from Sterlite to SEL are not being
given any value. Thus, in effect, we see SEL as being valued at negative equity of
INR41bn.
3) The copper smelting business is also not being valued which on our valuation
should contribute INR 8.4/share.
On our calculations, even under a stressed case scenario (described below) and at the
current market cap of HZ, Sterlite stock should be valued at INR108/share. Some key
estimates for the stress case scenario are as following:
1) HZ and overseas zinc businesses valued at zinc and lead prices of USD1,600/t
(current zinc and lead prices are at USD1,860/t and US$ 1,900/t respectively)
2) Zero value to Sterlite Energy (SEL) and its stakes in Balco and Vedanta Aluminium
3) Loan of INR80bn to VAL written off
Even in the above scenario, Sterlite Industries can be valued at INR108/share, according
to our estimates. Given the current price of INR104, the market is already valuing the
stock at the stressed level, therefore, we believe that at the current level, the risk-reward
is favourable for Sterlite Industries.
We believe the above discounting is not justified…
VAL – we recognise problems but shouldn’t default on its debt
While we agree with the zero equity value ascribed to VAL because of the delay in
expansion plans and high cost of production at its existing operations, we do not agree
with the view that Sterlite’s loans to VAL should not be valued either. Vedanta Resources
holds 70.5% equity in VAL, and even if expansion plans are delayed, we do not see a
scenario of VAL defaulting on its debt as Vedanta, the holding company, is unlikely to
allow VAL to default, in our view.
At the same time, we believe most of the issues facing VAL are short term in nature.
According to the company, the plants are ready for commissioning, and we expect to see
some progress on the bauxite mine allocation and environmental issues as the state
government of Orissa is favourable to these projects. Orissa has large untapped bauxite
reserves and the state government has been favourable to the projects of VAL. Earlier
VAL was allotted a mine at Niyamgiri but was denied environmental clearance. Post that,
VAL is still awaiting allocation of a new mine. To be conservative, we have not built in
any positive upside from the above to our estimates.
Sterlite Energy – does not deserve negative value
At Sterlite’s current valuations, the market appears to be ascribing SEL a negative value
as the shares of Sterlite are neither valuing the power business, nor the INR41bn loan
from Sterlite to SEL. Thus, SEL effectively is getting assigned negative equity value of
INR41bn, on our estimates.
We believe Sterlite doesn’t deserve a negative value for this business, as SEL is
operating at 50-55% PLF and, has been profitable in 1HFY12 despite high coal costs.
Even on our conservative estimates, we think SEL should get assigned a positive value,
given that it has two units of 600MW up and running, while a third unit is in the process
of commissioning. During 1HFY12, SEL reported PLF of 50-55%, which is in line with our
estimates. We have built in PLF assumptions of 55% in FY12F and FY13F. Even our
coal cost assumptions are high, as we have built in fuel costs to remain in excess of
INR1.5/unit.
Note that we are assuming just 35% of total coal (at 55% PLF, 15-20% of total
requirement at rated PLF) to come through linkage, 10-15% through imports and the rest
through E-Auction. Even at what we believe are conservative estimates, we value the
power business using DCF at an equity value of INR11.5bn (close to its book value).
Strong earnings growth expected in FY12F driven by
overseas zinc operations and SEL
According to management, most of the Sterlite Industries’ expansion plans are complete,
and we expect to see earnings growth led primarily by power business and zinc business
acquired overseas.
1) HZ already has commissioned a 210KT zinc and the 100KT lead expansion, while
silver expansion is underway.
2) Sterlite Energy has commissioned the first two units of 600MW each which are
operating at 50-55% PLF and the remaining units should be completed in the next
two quarters.
3) VAL (29.5% owned by Sterlite) should see full production from its 500KT aluminium
smelter and 1mn tonne alumina refinery from FY12F. However further expansion
plans remain deferred due to environmental issues. We don’t expect any near-term
solution to these issues.
4) Balco’s (51% owned by Sterlite) capacity expansion of 325KT is still on hold, but a
1,200MW (4*300MW) power plant is under construction and should come on line in
the next 6-9 months, according to management.
5) Another potential growth avenue we see is expansion at the recently acquired (Feb-
2011) Gamsberg mine, where Sterlite Industries expects to produce 400KTPA of
zinc in 2-3 years’ time with an investment of USD2bn.
Given the above-mentioned capacity expansion plans/phases, we expect Sterlite
Industries’ consolidated EPS to increase at a CAGR of ~12% during FY11-13F, with
FY12F earnings growth of close to 32% y-y.
Our forecast earnings growth for FY12 is driven by: 1) zinc earnings from assets
acquired from Anglo American in February 2011; and 2) growing contributions from the
power business as capacities come online. In FY13F, however, we see earnings
suffering somewhat from higher royalty payments to be made at HZ.
Dependence on HZ to decline, but zinc remains the key driver
HZ’s earnings contribution will likely come down with improving power operations and a
growing contribution from overseas zinc business. We estimate that HZ will account for
51.9% of total earnings in FY13F, down from 63.1% in FY11. However, we look for the
zinc business as a whole (i.e., comprising overseas business) to account for 72% of
earnings by FY13F, up from 70.3% in FY11, despite higher power earnings.
Once again, we note that despite Sterlite Industries deriving close to 52% of its earnings
from stakes in HZ and 72% from zinc business, Sterlite Industries shares have
significantly underperformed HZ shares over the past two years.
Our estimates are conservative, we believe
Our revised estimates capture the following key considerations:
1) For SEL, 55% PLF in FY12F and FY13F and an average coal cost of INR2,584/t
(4000 Kcal coal). Of note, SEL is already operating at 55% PLF and we do not build
in any improvement in utilization over the next two years (therefore, we are not
overly optimistic). Even on the coal cost side, our assumptions build in a 65-70%
coal purchase from E-Auction and imports. Our average coal cost is higher than the
current E-Auction price of INR2,400-2,500/t.
2) For Balco and VAL, we build in a continued high cost of production at USD1,900-
2,000/t. We are not ascribing any value creation from the USD5bn of capex already
incurred but mired in environmental issues. The resolution of environmental issues
would be a key catalyst to the stock, in our view.
3) We have not built in any production/reserve upside from overseas zinc assets.
We value Sterlite at INR169/share, maintain Buy
We value Sterlite Industries at INR169/share (from INR196 earlier) on a sum-of-the-parts
basis. While our methodology is unchanged, our revised target price is driven by lower
valuations of Sterlite Energy and HZ. Our INR169 target price breaks down as follows:
The Hindustan Zinc stake contributes INR97.7/share (HZ valued at 10x FY13F EPS of
INR12); overseas zinc assets contribute INR19.8/share based on DCF; the aluminium
business (ie, stakes in Balco and VAL) contributes INR4.6/share at 5x FY13F
EV/EBITDA; the power business (SEL) contributes INR3.4/share using DCF; the
standalone copper business contributes INR8.4/share; and INR35/share comes from
cash and investments.
Stake sale by the government in HZ and Balco could unlock
cash potential at HZ
The Government of India holds a 24.5% stake in HZ and a 49% stake in Balco. Sterlite
Industries has a call option to purchase the government’s stakes in the two companies.
However the transaction has been on hold as there has been disagreement on valuation
(between the government and Sterlite Industries) and on the legality of these call
options. Any decision by the government to sell its stakes in HZ and Balco would be
positive for Sterlite Industries, as HZ’s cash of INR 190bn (by end FY12E) could be
utilized in a much better way. Due to delays in the government’s approval, HZ couldn’t
acquire the overseas zinc assets (which could have utilized the cash reserves at HZ)
which Sterlite Industries had to undertake on its own books. Please note that we have
not built in any upside from the above stake sales in our estimates.
No comments:
Post a Comment