Sesa Sterlite (SSLT IN) Zinc subsidiary conference call highlights: JPMorgan

Sesa Sterlite (SSLT IN) Zinc subsidiary conference call highlights		Overweight Price: Rs193.65 22 Apr 2014 Price Target: Rs240.00 PT End Date: 31 Dec 2014

· Production to remain weak into Q1, but pick up thereafter: SSLT’s 65%-owned zinc subsidiary HZ highlighted that FY15 production will likely improve marginally Y/Y (900-920kt vs 880kt in FY14). However, the production trend is likely to be back-end weighted with 1H mined metal volume declining Y/Y. It also indicated that production is set to remain weak in Q1, as the mining sequence is changing, which would result in concentrate imports in the qtr (but no import after 1Q). The company indicated that mined metal production would be 1MT by FY16E, with higher from Rampura Agucha after this.

· Rampura Agucha – change in UG mining sequence: RA underground mines have started stepping up operations and are expected to produce 1mt of ore in FY16. The ramp-up of the UG mining project has been slowed with the company re-optimizing the open pit mine (increasing depth) to increase the mine life of the open cast mine.

· Silver production to improve: Silver production in the quarter was impacted by lower grade from SK mines (96ppm vs 156ppm last year) leading to a 32% decline in silver production Y/Y. Management highlighted that it expects silver grade to improve every year. On integrated silver production, management indicated <350t 300t="" 350-400t="" and="" fy14="" fy15e="" fy16e.="" in="" span="" vs="">

· CoP increase in the quarter primarily due to higher concentrate import: HZL reported CoP (without royalty) of $899/mt vs $840/mt in 3QFY14, which was higher due to the use of imported concentrate (given weak mined metal production) and lower volume in the quarter. Higher mine development cost also contributed to some increase.

· Other details: Capex for next year is expected at $250Mn. The tax rate will gradually move up.

Investment Thesis

While the stock has moved 60%+ from its Aug'13 lows (vs SENSEX +14% over the 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) a diversified resource base providing earnings stability; and d) the 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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