Sesa Sterlite: Price is right; upgrade to BUY from REDUCE:: Kotak Sec, report link

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Price is right; upgrade to BUY from REDUCE. We upgrade Sesa Sterlite to BUY from
REDUCE after 25% fall in the stock price over the past three months. (1) Improving zinc
fundamentals from constrained global mine supplies, (2) start of asset sweating of idled
aluminum investments, besides (3) strong cash-flow generation drive our positive view.
We also believe SSLT has the most to gain in the upcoming coal mine auctions with its
large demand and locational advantage. We cut our TP to `250 from `275 earlier due
to lower long-term crude oil price assumption and moderation in aluminum prices. The
stock trades at 5.6X EBITDA (attributable) and 0.7X P/B on FY2016E financials and
offers favorable risk-reward.

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Trigger #1: Strong zinc pricing outlook from mine closures, SSLT’s 0.9 mtpa volumes will benefit
We expect improving fundamentals of zinc to support prices, especially from 2HCY15. The
unavoidable closures of large zinc mines from depleting reserves over the next 1-2 years drive
our view; large mine closures include Century, Lisheen, Skorpion, among others. The hardening
zinc prices will benefit SSLT’s 0.9-1 mtpa zinc volumes even though two of its own mines risk
closure. We expect the existing global supply deficit to widen from 125 ktpa in CY2014 to 305
ktpa in CY2016. Our base-case zinc price assumption of US$2,200/ton, US$2,250/ton and
US$2,300/ton for FY2015E, FY2016E and FY2017E has upside risks. Our fair value of SSLT
increases by `9/share for each US$100/ton increase in zinc prices.
Trigger #2: Aluminum investments idled for long; expect some asset sweating now
Investment of US$8.5 bn in Jharsuguda aluminum complex has been a drag for SSLT. While
captive bauxite mining unquestionably creates large value from this asset (but can still be some
time away), the improved business economics from purchased alumina led by higher aluminum
prices will lead to progressive commissioning of 1.25 mtpa smelter and gradually create value
for an implied sunk investment until now. SSTL has started commissioning first 50 pots from
surplus power of 1,215 MW captive power plant. The start of remaining smelter pots awaits
approval from the Odisha government to divert power from 2,400 MW for captive use.
Trigger #3: SSLT has most to gain from coal mine auctions; we factor lower crude prices
We believe Sesa Sterlite has the most to gain from coal mine auctions with large demand of 46
mtpa without adequate fuel-supply arrangements and the locational advantages of extant
facilities. SSLT can benefit from mine auctions given (1) current low utilization for its extant
capacities and (2) commissioning of 3,200 MW of new capacity. SSLT’s cash generation will get a
boost besides HZ and Cairn from improving profitability of the aluminum business and iron ore
mining. Besides, (1) restart of Goa mines and probably a less onerous taxation regime, given 30%
export duty does not let India export any iron ore, and (2) progress towards captive bauxite will
aid. We upgrade SSLT to BUY but cut our TP to `250 from `275 earlier due to lower crude price
assumption and moderation in aluminum prices. Our fair value assumes long-term crude oil prices
of US$90/bbl and changes by `14/share for each US$15/bbl change in crude prices.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily29122014ap.pdf