Sesa goa & Sterlite Industries Business performance steady, merger overhang on stocks to remain : Centrum

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Sesa goa & Sterlite Industries

Business performance steady, merger overhang on stocks to remain

m  Sterlite industries (SIIL) reported decent Q4FY12 results after better-than-expected results were announced by Hindustan zinc (HZL) and Sesa goa (Sesa) during the last few days. Vedanta group had announced the formation of Sesa Sterlite (involving the merger of Sesa goa, Sterlite, VAL, MALCO and the transfer of 38.8% stake of Vedanta in Cairn) during the quarter resulting in a simplification of the group structure. We had already noted this event (Refer our report on Sesa Sterlite merger dated 27 February 2012) as being more beneficial to Vedanta group with limited benefits to the consolidated entity and its shareholders on account of huge debt and skewed EBITDA profile of the proposed entity.  The proposed merger is pending for approvals and expected to get completed before the end of CY12 and since the market should keep valuing Sesa shares on the proposed Sesa Sterlite group value and SIIL shares at 0.6x of Sesa Sterlite value, we also continue to value the stocks based on this new formula (as is the case with proposed merged structure) which we had adopted in our event update note after the event was announced in Feb-12.  We remain positive on the prospects of zinc, lead and silver business and expected increase in power volumes going ahead but remain concerned on lower iron ore volumes and profitability of VAL (which would become the 100% subsidiary of the merged entity).  Huge debt servicing also remains a key balance sheet concern.

m  We have used FY14E EV/EBITDA valuation (see table below) to arrive at a SOTP fair value of Rs208 for Sesa Sterlite and corresponding fair value of Rs125 for Sterlite (based on 0.6x Sesa Sterlite value).  Stocks have seen substantial correction post the merger announcement and we believe that merger overhang would remain on the stocks going ahead. We recommend hold on Sesa goa with a target price of Rs 208 and Buy on Sterlite industries with a target price of Rs 125.

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