JPMorgan: Sesa Sterlite - Zinc sub reports marginally lower EBITDA but PAT higher than estimates

Sesa Sterlite (SSLT IN) Zinc sub reports marginally lower EBITDA but PAT higher than estimates		Overweight Price: Rs192.70 17 Apr 2014 Price Target: Rs240.00 PT End Date: 31 Dec 2014

SSLT’s 65% owned zinc subsidiary, HZ, reported Q4 earnings with EBITDA below estimates at Rs17.3bn essentially driven by a slight miss in volumes. PAT at Rs18.9bn was ahead driven by sharply higher Other Income and lower tax rate. HZ declared total dividends of Rs3.5/share (slightly higher than JPM of Rs3.4/share), which implied total payout ratio (including dividend tax) of 25%. HZ reported total gross addition of 26.1MT to reserves and resources, prior to depletion of 9.1MT. Total reserves and resources stood at 365.1MT, implying mine life of +25 years. The guidance for FY15 is muted with mined metal and integrated metal production expected to be marginally higher from FY14 while cost of production is expected to remain stable.

· Result highlights- lower production leads to lower EBITDA: Against the company’s earlier guidance of a pick up in production in H2FY14, production was lower than expected, which the company blamed on slower than expected ramp up of underground mining and change in mining sequence, with preference given to mine development. Total mined metal production in Q4 stood at 200KT, down 23% y/y and 9% q/q (FY14 at 880kt, +1% y/y). Refined zinc production at 182KT was flat y/y in Q4, and down 7% q/q (FY14 at 749KT, +11% y/y), while lead stood at 36KT, +10% y/y (FY14 123KT, +4% y/y). Silver production was down 25% y/y on an integrated basis. Cost of production at $899/T was up 8% y/y and 7% q/q. This is surprising given that input prices have been broadly stable during the quarterand were likely driven by a relatively higher share of non integrated metal production in lead and silver. EBITDA stood at Rs17.5bn, -4% q/q and -17% y/y. Other Income increased sharply 43% y/y to Rs5.9bn with tax rate falling to 11.2%. PAT at Rs18.8bn, -13% y/y.

· Expansion projects update: As per the company, the Kayad and Rampura Agucha underground mine projects started commercial production during the year and are now ramping up. Total mine development increased by 75% as per HZ and marked the beginning of the transition to underground mining from open cast. HZ has guided to capex of ~$250mn in FY15.

· FY14 year ending cash balance stood at Rs255bn up 6% q/q.

Table 1: HZ 4QFY14 results summary

	4QFY13	3QFY14	4QFY14	% y/y	% q/q
Net Sales	39,087	34,501	36,427	-7%	6%
EBITDA	21,160	18,238	17,552	-17%	-4%
PBT	23,951	20,280	21,195	-12%	5%
PAT	21,658	17,227	18,812	-13%	9%
EBITDA Margin	54.1%	52.9%	48.2%
Tax rate	8.8%	15.1%	11.2%
Production
Mined Metal	260,000	220,126	200,000	-23%	-9%
Refined Zinc	182,000	196,000	182,000	0%	-7%
Integrated zinc	181,000	196,000	179,000	-1%	-9%
Refined Lead	35,000	24,984	36,000	3%	44%
Integrated lead	32,000	25,000	29,000	-9%	16%
Integrated silver	100,000	72,000	68,000	-32%	-6%
Other details
CoP (Rs/MT)	44,901	52,014	55,467	24%	7%
CoP ($/MT)	829	840	899	8%	7%
Cash balance	214,790	240,950	255,350	19%	6%

Source: Company reports

Investment Thesis

While the stock has moved 60%+ from Aug'13 lows (vs. SENSEX +14% over same period), we think the re-rating is likely to continue over the next year as: a) SSLT delivers consolidated EBITDA of ~$1.2-1.4bn on a quarterly run rate with volume growth in key oil and zinc subs; b) Net debt continues to fall with strong cash generation at subs and limited capex; c) Diversified resource base providing earnings stability; and d) Regulatory environment continues to improve. We expect SSLT to emerge as a key holding across MM/Industrials, given size, cash flow strength and embedded option values from power and ally investments.

Valuation

Our Dec-14 PT of Rs240 is based on a sum-of-the-parts (SOTP) valuation where we assign EV/EBITDA multiples to underlying FY15E EBITDA. We do not use a DCF approach, given most of businesses are currently not in steady state, and for the key ones such as aluminum and power, it remains difficult to predict when they will achieve steady state.

Table 4: SOTP Summary

	FY15E EBITDA	Multiple	FY15E	Explanation
Zinc-India	56,784	5.5	312,311	Valued at the lower end of its historical trading range
Zinc Int	12,827	4.0	51,308	Valued at a 30% discount to India zinc assets given limited mine life
BALCO	4,791	7.0	33,534	Given that LME aluminum is currently below marginal cost, and the investments made by the company are yet to be fully operational, valued at the higher end of historical global aluminum company valuations
VAL	20,961	7.0	146,730	Given that LME aluminum is currently below marginal cost, and the investments made by the company are yet to be fully operational, valued at the higher end of historical global aluminum company valuations
Copper	15,793	6.0	94,757	The copper smelter earnings are relatively steady state and less volatile, hence valued at the higher end of commodity company valuations
Power	14,986	5.5	82,425	Valued at higher end of earnings range as most of the assets yet to be fully operational
Iron ore	12,805	5.5	70,428	Valued at the lower end of its historical trading range, as volume growth outlook remains hazy
Oil	89,479	3.0	268,436	Valued at the mid range of commodity companies given volume growth prospects
		Total EV	1,059,930
		Net debt	352,937
		Equity	706,993
		Per Share	240

Source: J.P. Morgan estimates.

Risks to Rating and Price Target

Key risks include: 1) no start to Goa mining; 2) copper smelter remains shut; and
3) power segment ramp up gets delayed

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