20131211-Maybank_KERPL-Resource_Rich_Major__Initiate_BUY_28页_892kb

Sesa Sterlite Limited: Investment Summary

Core Information

• Company: Sesa Sterlite is a subsidiary of Vedanta Group, a London-based company controlled by Anil Agarwal.
• Industry: One of the largest diversified non-ferrous metal companies in India, operating in aluminum, copper, zinc, iron ore, oil, and power.
• Share Price: INR196
• Target Price (TP): INR240 (new)
• Shares Issued (m): 2,965
• Market Cap (USD m): 9,370
• 3-Month Avg Daily Turnover (USD m): 19.4
• Free Float (%): 45.1
• Major Shareholders:
  • Vedanta Resources (promoters): 54.9%
  • Citibank NA New York NYADR: 6.0%
  • Franklin Templeton Investment Funds: 2.9%

Key Indicators

• ROE – Annualised (%): 8.2
• Net Debt (INRbn): 403.7
• NTA/sh (INR): 247.7
• Interest Cover (x): 4.4

Investment Highlights

A) Why we like the stock?

• Diversified Earnings Profile: SSLT's earnings are spread across multiple commodities and geographies, providing a stable outlook even in volatile markets.
• Stable Zinc and Volume Growth in Oil and Power: These are the key drivers of EBITDA growth, expected to increase by 15% in FY15 and 30% in FY16.
• Potential for Profitability in Aluminum: Once bauxite mining at Niyamgiri is approved, the aluminum business is expected to become profitable and generate significant cash flows.
• Regulatory Concerns Receding: Issues with the iron ore and aluminum businesses are being addressed, and the company is optimistic about resolution.
• Attractive Valuation: SSLT is trading at a low EV/EBITDA of 3.5x FY15F, significantly below domestic and global peers.

B) What factors are holding the shares back?

• Regulatory Delays: Ongoing issues with the iron ore and aluminum businesses, particularly in Goa and Niyamgiri, are affecting profitability.
• Delayed Ramp-Up: The power and oil businesses are still in the process of ramping up, which could impact short-term growth.
• Conservative Assumptions: Current forecasts do not include potential increases in commodity prices, which could affect future performance.

C) Re-rating Catalysts

• Supreme Court Order: Resumption of iron ore mining in Goa.
• Government Approval: Acquisition of residual stakes in Hindustan Zinc and Balco.
• Bauxite Mining Permission: Expected decision on Niyamgiri bauxite mines.
• Recovery in Metal Prices: Expected rise in aluminum and zinc prices in 2014.
• Fuel Supply Agreements: Signing of agreements with Coal India for power plants.

D) Opportunities Not Included in Valuation

• Iron Ore Production from Goa: Expected to resume in 1HFY15, which could significantly boost EBITDA.
• Bauxite Mining at Niyamgiri: If approved, will reduce production costs and improve aluminum profitability.
• Commodity Price Recovery: Potential for higher prices in aluminum and zinc, which are currently at a three-year low.

Earnings Drivers and Key Assumptions

• Key Commodities: Oil and zinc together constitute 77% of EBITDA.
• Revenue Growth Drivers: Power and aluminum businesses are expected to grow their contribution to revenue over the next two years.
• Volume Growth:
  • Oil: Expected to grow at 10% pa, reaching 238k bbl/day in FY15.
  • Power: Expected to grow at 10% pa, reaching 10.9bn units in FY15.
  • Zinc India: Expected to grow at 10% pa, reaching 851k ton in FY15.
  • Zinc Overseas: Expected to stabilize after a decline in FY14 due to lower grade ore.
• Selling Prices:
  • Oil: Expected to rise by 3% YoY.
  • Zinc India: Selling prices are expected to decline slightly.
  • Aluminum: Expected to increase as prices recover and production costs decrease.

Valuation and Target Price

• Sum-of-the-Parts Valuation:
  • Total EV: INR1,115,951m
  • Less Net Debt: INR403,714m
  • Equity Value: INR712,237m
  • TP (INR/sh): INR240, based on an EV/EBITDA multiple of 4.2x FY15F.
• Valuation Multiples:
  • EV/EBITDA (FY15F): 3.5x (vs 4.6x domestic, 5.4x global)
  • PER (FY15F): 7.0x (vs 9.9x domestic, 12.7x global)
  • P/BV (FY15F): 0.7x (vs 1.2x domestic, 1.1x global)

Key Risks

• Sharp Increase in Royalty Rates in India
• Delays in Ramp-Up of Power and Oil Businesses
• Prolonged Regulatory Headwinds affecting iron ore and aluminum businesses

Summary

• SSLT is a diversified resource company with a strong asset base and potential for growth.
• The company is currently undervalued compared to its peers, offering a compelling investment opportunity.
• The target price of INR240 is based on a sum-of-the-parts valuation and is considered attractive.
• The main growth drivers are the oil and zinc segments, with the power and aluminum businesses expected to improve over time.
• The re-rating of the stock is contingent on the resolution of regulatory issues and recovery in global metal prices.