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Metal czar’s steep discounting to end as
concerns recede
Sterlite Industries India Ltd (SIIL) which provides diversified
exposure to major base metals, silver and power and boasts of a
promising future on the back of organic growth across assets has
been trading at a big discount to its fair value during the last one
year, thereby underperforming the benchmark Nifty by over 25%.
The main reasons for this underperformance in our view has been
i) VAL’s expansion and backward integration plans going for a
toss due to government intervention and subsequent huge losses
by VAL wiping out SIIL’s invested equity ii) delay in expansion
project of BALCO and SEL and shortage of coal for running captive
and merchant power plants and iii) pumping of excessive cash by
SIIL into Vedanta owned VAL which has resulted into poor returns
for SIIL shareholders and raised investor concerns.
Though we agree these concerns are valid, we also infer that the
discounting done by the market for valuing SIIL stock has been
more than pessimistic and does not capture the full value of zinc
businesses nor does it account for the future volume growth
across assets and future positive triggers. We have seen a smart
upmove in the stock recently and believe that SIIL stock ‘s
discount to its fair value has come to an end on account of i)
better clarity from management on cash use through increased
dividends ii) volume growth across assets and improving
profitability ahead and iii) positive triggers from possible
minority stake buyouts and starting of BALCO captive coal block.
With SIIL’s expansion pipeline across assets coming on-stream by
FY13E, we expect sales volume CAGR of 7.4%, 45.3% and 9.7%
across zinc & lead, silver and aluminium operations during FY11-
14E. We expect net sales and EBITDA CAGR of ~12% and ~16%
during FY11-14E. We initiate coverage on SIIL with a Buy rating
and a SOTP target price of Rs 149.
Zinc: domestic – best in class, international – shows potential:
Domestic zinc operations under HZL remain best in class with low
cost, increase in volumes of lead and silver and robust balance
sheet. We expect HZL to register EBITDA CAGR of ~11% during
FY11-14E. International assets have stable operations and show
potential for future with increasing exploration at Scorpion &
Lisheen and from the proposed 400 ktpa new project at Gamsberg.
Aluminium: mixed bag with high costs and VAL: SIIL’s aluminium
operations remain a mixed bag with high COP at BALCO and losses
at VAL. With expansions in aluminium and power at BALCO in
FY13E, we expect EBITDA CAGR of ~13% during FY11-14E. We see
VAL retaining PAT losses on account of non-integration, high raw
material costs and very high interest.
Power: lacks steam sans coal, but growth seen ahead: Power
portfolio lacks steam without captive coal but volume growth is
seen ahead despite challenges with expansions coming on-stream
by FY13E and coal feed from linkage and e-auctions. We expect
~15.3bn units of power sales from BALCO and SEL in FY14E. Starting
of captive coal block of BALCO would be the key trigger.
Positive triggers in store: We see the possibility of positive triggers
for the stock from successful minority stake buyouts in BALCO and
HZL and starting of captive coal block of BALCO going ahead.
Valuations – trading at discount, BUY: We see SIIL trading at a
sharp discount to fair value. We see earnings growth ahead driven
by volumes and value the stock on a SOTP basis giving no value to
its investments in VAL. We initiate coverage on SIIL with a Buy rating
and target price of Rs 149.
Key Risks: Lower sales volumes on project delays, drop in LME
prices, higher losses in VAL and ineffective use of the cash pile.
Investment Rationale
Steep discounting to end as concerns recede and earnings grow
Sterlite Industries India Ltd (SIIL) which provides diversified exposure to
major base metals, silver and power and boasts of a promising future on the
back of organic growth across assets has been trading at a big discount to its
fair value during the last one year, thereby underperforming the benchmark
Nifty by over 25%. The main reasons for this underperformance in our view
has been i) VAL’s expansion and backward integration plans going for a toss
due to government intervention and subsequent huge losses by VAL wiping
out SIIL’s invested equity and requiring further equity investment by SIIL
into VAL for covering the accumulated losses as well as for maintaining its
stake ii) delay in expansion project of BALCO and SEL and acute shortage of
coal for running captive and merchant power plants and iii) pumping of
excessive cash by SIIL into Vedanta owned VAL which has resulted into poor
returns for SIIL shareholders. SIIL has recently indicated that it would convert
a part of its loans given to VAL into equity to maintain its 29.5% stake in VAL
and this has not gone down well with the SIIL shareholders and investors at
large as pumping more equity into a loss making group company implies
lower returns for the SIIL shareholders.
Though we believe that above concerns of the market are justified but also infer that the
discounting done by the market for valuing SIIL stock has been more than pessimistic and doesn’t
capture the full value of zinc businesses nor does it account for the future volume growth across
assets and expected positive triggers going ahead. We see SIIL stock ‘s discount to its fair value
coming to an end on account of i) better clarity from management on cash use through increased
dividends ii) volume growth across assets and improving profitability ahead and iii) positive
triggers from minority stake buyouts and starting of BALCO captive coal block. SIIL has made clear
that they would just maintain their 29.5% stake in VAL through conversion of loans into equity and
would not be looking to increase the same as some investors feared might be the case.
With SIIL’s expansion pipeline across assets coming on-stream by FY13E, we expect sales volume
CAGR of 7.4%, 45.3% and 9.7% across zinc & lead, silver and aluminium operations during FY11-
14E. Power operations of SEL are expected to contribute ~7% of EBITDA in FY14E with increase in
merchant power volumes and we see base metal prices improving with cost curve support at
current levels. We expect net sales and EBITDA CAGR of ~12% and ~16% during FY11-14E. We
initiate coverage on SIIL with a Buy rating and a target price of Rs 149.
We see smart upside in Sterlite from current levels and ascribe a fair value target of Rs149 to the
stock. We have remained conservative in our earnings estimates and have used EV/EBITDA
valuation on FY14E earnings for our SOTP valuation. We have valued domestic zinc business at 5x
EV/EBITDA and BALCO’s aluminium business at 4.5x EV/EBITDA whereas for short life international
zinc assets, we have ascribed 3x EV/EBITDA multiple. For copper operations we ascribe EV/EBITDA
multiple of 5x. We have ascribed a relatively conservative 4x EV/EBITDA multiple to SEL as clarity
on full operations of its 2400 MW power plant and availability of coal for running the same remains
low amidst a tight domestic coal market. We have not given any value to company’s investments
in VAL and also not considered interest bearing loans and advances as cash for our SOTP valuation.
We have given a holding company discount of 20% to SIIL’s attributable EV in HZL and BALCO. We
advise Buy with a target price of Rs149.
Key risk and concerns
Downward movement of metal prices
Sharp fall in LME prices of base metals from current levels could directly impact the earnings of SIIL.
With global economic uncertainty still prevailing in the developed world and developing
economies faced with the threat of inflation, base metal prices are subject to downward risk but
this is expected to be low now with prices already below global marginal COP levels. However,
sharp downward movements in prices could pose a risk to earnings and valuation for the company
Hike in royalty rates
Mining business in India is subject to royalty and the government has been actively considering
levying a charge equal to 100% of royalty for allocating to people displaced by the mining
activities in a particular region. This has been proposed in the new mining bill and could come into
force from FY13/14 onwards after the bill is passed in the parliament. At present the royalty rates in
zinc, lead and silver have been 8.4%, 12.7% and 7.2% respectively and doubling of these rates
would have a negative impact of ~10% on EPS as well as the valuation of HZL.
Negative exchange rate fluctuations
All three metals, zinc, lead and silver are denominated in USD on LME and realizations for HZL
depend on LME prices. They are subject to the risk associated with the USD/ INR exchange rate
with strong appreciation in rupee reducing price realizations overall. Rupee appreciation of Rs 1
per USD results in an EPS drop of ~2.5% for HZL.
Lower production volumes and increase in costs
Any delay and inadvertent production losses on the smelter front can lead to lower production
volumes and hence lower earnings. Also, increase in mining costs and rise in commodity prices
causing increase in smelting costs could lead to lower profitability with reduced margins.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Metal czar’s steep discounting to end as
concerns recede
Sterlite Industries India Ltd (SIIL) which provides diversified
exposure to major base metals, silver and power and boasts of a
promising future on the back of organic growth across assets has
been trading at a big discount to its fair value during the last one
year, thereby underperforming the benchmark Nifty by over 25%.
The main reasons for this underperformance in our view has been
i) VAL’s expansion and backward integration plans going for a
toss due to government intervention and subsequent huge losses
by VAL wiping out SIIL’s invested equity ii) delay in expansion
project of BALCO and SEL and shortage of coal for running captive
and merchant power plants and iii) pumping of excessive cash by
SIIL into Vedanta owned VAL which has resulted into poor returns
for SIIL shareholders and raised investor concerns.
Though we agree these concerns are valid, we also infer that the
discounting done by the market for valuing SIIL stock has been
more than pessimistic and does not capture the full value of zinc
businesses nor does it account for the future volume growth
across assets and future positive triggers. We have seen a smart
upmove in the stock recently and believe that SIIL stock ‘s
discount to its fair value has come to an end on account of i)
better clarity from management on cash use through increased
dividends ii) volume growth across assets and improving
profitability ahead and iii) positive triggers from possible
minority stake buyouts and starting of BALCO captive coal block.
With SIIL’s expansion pipeline across assets coming on-stream by
FY13E, we expect sales volume CAGR of 7.4%, 45.3% and 9.7%
across zinc & lead, silver and aluminium operations during FY11-
14E. We expect net sales and EBITDA CAGR of ~12% and ~16%
during FY11-14E. We initiate coverage on SIIL with a Buy rating
and a SOTP target price of Rs 149.
Zinc: domestic – best in class, international – shows potential:
Domestic zinc operations under HZL remain best in class with low
cost, increase in volumes of lead and silver and robust balance
sheet. We expect HZL to register EBITDA CAGR of ~11% during
FY11-14E. International assets have stable operations and show
potential for future with increasing exploration at Scorpion &
Lisheen and from the proposed 400 ktpa new project at Gamsberg.
Aluminium: mixed bag with high costs and VAL: SIIL’s aluminium
operations remain a mixed bag with high COP at BALCO and losses
at VAL. With expansions in aluminium and power at BALCO in
FY13E, we expect EBITDA CAGR of ~13% during FY11-14E. We see
VAL retaining PAT losses on account of non-integration, high raw
material costs and very high interest.
Power: lacks steam sans coal, but growth seen ahead: Power
portfolio lacks steam without captive coal but volume growth is
seen ahead despite challenges with expansions coming on-stream
by FY13E and coal feed from linkage and e-auctions. We expect
~15.3bn units of power sales from BALCO and SEL in FY14E. Starting
of captive coal block of BALCO would be the key trigger.
Positive triggers in store: We see the possibility of positive triggers
for the stock from successful minority stake buyouts in BALCO and
HZL and starting of captive coal block of BALCO going ahead.
Valuations – trading at discount, BUY: We see SIIL trading at a
sharp discount to fair value. We see earnings growth ahead driven
by volumes and value the stock on a SOTP basis giving no value to
its investments in VAL. We initiate coverage on SIIL with a Buy rating
and target price of Rs 149.
Key Risks: Lower sales volumes on project delays, drop in LME
prices, higher losses in VAL and ineffective use of the cash pile.
Investment Rationale
Steep discounting to end as concerns recede and earnings grow
Sterlite Industries India Ltd (SIIL) which provides diversified exposure to
major base metals, silver and power and boasts of a promising future on the
back of organic growth across assets has been trading at a big discount to its
fair value during the last one year, thereby underperforming the benchmark
Nifty by over 25%. The main reasons for this underperformance in our view
has been i) VAL’s expansion and backward integration plans going for a toss
due to government intervention and subsequent huge losses by VAL wiping
out SIIL’s invested equity and requiring further equity investment by SIIL
into VAL for covering the accumulated losses as well as for maintaining its
stake ii) delay in expansion project of BALCO and SEL and acute shortage of
coal for running captive and merchant power plants and iii) pumping of
excessive cash by SIIL into Vedanta owned VAL which has resulted into poor
returns for SIIL shareholders. SIIL has recently indicated that it would convert
a part of its loans given to VAL into equity to maintain its 29.5% stake in VAL
and this has not gone down well with the SIIL shareholders and investors at
large as pumping more equity into a loss making group company implies
lower returns for the SIIL shareholders.
Though we believe that above concerns of the market are justified but also infer that the
discounting done by the market for valuing SIIL stock has been more than pessimistic and doesn’t
capture the full value of zinc businesses nor does it account for the future volume growth across
assets and expected positive triggers going ahead. We see SIIL stock ‘s discount to its fair value
coming to an end on account of i) better clarity from management on cash use through increased
dividends ii) volume growth across assets and improving profitability ahead and iii) positive
triggers from minority stake buyouts and starting of BALCO captive coal block. SIIL has made clear
that they would just maintain their 29.5% stake in VAL through conversion of loans into equity and
would not be looking to increase the same as some investors feared might be the case.
With SIIL’s expansion pipeline across assets coming on-stream by FY13E, we expect sales volume
CAGR of 7.4%, 45.3% and 9.7% across zinc & lead, silver and aluminium operations during FY11-
14E. Power operations of SEL are expected to contribute ~7% of EBITDA in FY14E with increase in
merchant power volumes and we see base metal prices improving with cost curve support at
current levels. We expect net sales and EBITDA CAGR of ~12% and ~16% during FY11-14E. We
initiate coverage on SIIL with a Buy rating and a target price of Rs 149.
We see smart upside in Sterlite from current levels and ascribe a fair value target of Rs149 to the
stock. We have remained conservative in our earnings estimates and have used EV/EBITDA
valuation on FY14E earnings for our SOTP valuation. We have valued domestic zinc business at 5x
EV/EBITDA and BALCO’s aluminium business at 4.5x EV/EBITDA whereas for short life international
zinc assets, we have ascribed 3x EV/EBITDA multiple. For copper operations we ascribe EV/EBITDA
multiple of 5x. We have ascribed a relatively conservative 4x EV/EBITDA multiple to SEL as clarity
on full operations of its 2400 MW power plant and availability of coal for running the same remains
low amidst a tight domestic coal market. We have not given any value to company’s investments
in VAL and also not considered interest bearing loans and advances as cash for our SOTP valuation.
We have given a holding company discount of 20% to SIIL’s attributable EV in HZL and BALCO. We
advise Buy with a target price of Rs149.
Key risk and concerns
Downward movement of metal prices
Sharp fall in LME prices of base metals from current levels could directly impact the earnings of SIIL.
With global economic uncertainty still prevailing in the developed world and developing
economies faced with the threat of inflation, base metal prices are subject to downward risk but
this is expected to be low now with prices already below global marginal COP levels. However,
sharp downward movements in prices could pose a risk to earnings and valuation for the company
Hike in royalty rates
Mining business in India is subject to royalty and the government has been actively considering
levying a charge equal to 100% of royalty for allocating to people displaced by the mining
activities in a particular region. This has been proposed in the new mining bill and could come into
force from FY13/14 onwards after the bill is passed in the parliament. At present the royalty rates in
zinc, lead and silver have been 8.4%, 12.7% and 7.2% respectively and doubling of these rates
would have a negative impact of ~10% on EPS as well as the valuation of HZL.
Negative exchange rate fluctuations
All three metals, zinc, lead and silver are denominated in USD on LME and realizations for HZL
depend on LME prices. They are subject to the risk associated with the USD/ INR exchange rate
with strong appreciation in rupee reducing price realizations overall. Rupee appreciation of Rs 1
per USD results in an EPS drop of ~2.5% for HZL.
Lower production volumes and increase in costs
Any delay and inadvertent production losses on the smelter front can lead to lower production
volumes and hence lower earnings. Also, increase in mining costs and rise in commodity prices
causing increase in smelting costs could lead to lower profitability with reduced margins.
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