Sterlite Industries (India)

Updated: Apr 21 2002, 05:30am hrs
Rationale
These ratings were placed on Rating Watch with developing implications on December 28, 2001, following the companys decision to purchase up to 50 per cent of its equity shares from its shareholders at a total cost of around Rs 4.2 billion.

The rating reaffirmation takes into account the companys decision to purchase its equity shares from shareholders and the subsequent reduction in its equity capital as well as its investment of Rs 2.75 billion in a special purpose vehicle (SPV) floated for acquiring stake in Hindustan Zinc Ltd (HZL; Crisil rated "FAAA/P1+").

Crisil estimates that the above will entail a fresh debt issuance of around Rs 5 billion by Sterlite in FY2002-03 (including the Rs 1.4 billion worth of debentures issued to shareholders as part payment towards the purchase of Sterlite shares).

While this additional debt will affect the companys stand-alone financial risk profile, the rating is based on the consolidated financials of Sterlite and its key subsidiaries, Bharat Aluminium Company Ltd (Balco), Thalanga Copper Mines and Copper Mines of Tasmania (the last two being Sterlites wholly-owned copper mines).

The ratings reflect Sterlites favourable business risk profile underpinned by a comfortable market position in the domestic copper industry and high operating efficiencies. Its copper mines acquisition in FY2001 not only increased the degree of operational integration, but also gives it the potential to improve cost efficiencies in future.

However, the ratings could be revised downwards in case Sterlite makes any incremental investments in the SPV (from the currently envisaged level of Rs 2.75 billion) or if the SPV borrows debt with recourse to Sterlite.

Further, the ratings do not factor in any major capital expenditure in Balco or any further acquisitions by Sterlite in future as these plans are yet to be finalised. The impact of these developments will be factored into the ratings as and when they arise taking into account the quantum of the investment and the funding pattern for the same.

Sterlite is a semi-integrated copper producer with business interests in aluminium and zinc held through subsidiary and affiliate companies. Its copper manufacturing facilities include a 150,000-tonne per annum (tpa) copper smelter in Tuticorin (Tamil Nadu), a copper refinery and 196,000-tpa rod drawing facilities in Silvassa besides two wholly-owned copper mines in Australia, which meet 30 per cent of its copper concentrate requirement.

Sterlites presence in other non-ferrous metals is through Balco (a subsidiary with 100,000 tpa aluminium smelting capacity at Korba), Madras Aluminium Company Ltd (Malco, Crisil rated "P1+"), a group company in Mettur with 29,500 tpa aluminium smelting capacity and HZL, an affiliate with 169,000 tpa zinc and 43,000 tpa lead production capacities.

For the six-month period ending December 31, 2001, Sterlite reported a net profit of Rs 0.60 billion (Rs 0.73 billion for the corresponding period in the previous year) on net sales of Rs 15.6 billion (Rs 15 billion).

Crisil expects the results for the nine-month period ending March 31, 2002 (the company is changing its financial year-end to March from this year) to be in line with the six months results. For the fiscal ended June 30, 2001, the company reported a net profit of Rs 1.28 billion on net sales of Rs 28.90 billion.

Sterlite has recently acquired a 26 per cent stake in HZL as part of the governments disinvestment programme. In accordance with the Securities and Exchange Board of Indias (Sebi) guidelines, the company will make an open offer to acquire up to 20 per cent of the public share holding in HZL.

The total acquisition is expected to cost about Rs 7.9 billion and will be routed through an SPV floated for this purpose along with another group company. Sterlites investment in the SPV will be limited to Rs 2.75 billion and the borrowings in the SPV would be without any recourse to Sterlite.

Apart from this, Sterlite is also in the process of purchasing up to 50 per cent of its equity shares from its existing shareholders at a price of Rs 150 per share, out of which Rs 100 will be paid in cash while the balance will be in the form of a five-year debenture.

The total outlay on account of this is expected to be around Rs 4.2 billion including the debentures to be issued to shareholders. The shares so purchased will be extinguished and the company will be delisted from Indian stock exchanges. Subsequently, Sterlite plans to go in for an overseas listing to tap the international equity markets.

Sterlites investments in the SPV for the HZL acquisition and its purchase of equity shares will have a negative impact on its stand-alone financial risk profile because of a weakening of its capital structure and interest and debt coverage ratios. This will not be consistent with the companys outstanding rating category. Sterlites financial risk profile is also constrained by its low current ratio and return on capital employed (ROCE). The current ratio was low at 0.79 time as on June 30, 2001, largely due to high reliance on short-term debt.

Sterlite has assured Crisil that, going forward, it will work at improving its current ratio by substituting short-term debt with long-term borrowing. The companys large investments in subsidiary companies (around Rs 7.5 billion in Balco and the mines) without commensurate returns result in low ROCE, which is expected to decline further following its investment in the SPV.

The outstanding ratings are based on the consolidated financials of Sterlite and its subsidiaries, Balco and the copper mines. Balco and the copper mines are largely debt-free companies with reasonable cash accruals. Hence, the consolidated financials have a more favourable financial risk profile characterised by comfortable gearing and debt protection ratios. The ratings assume that there would not be any major capital expenditure in Balco and also factor in significant improvement in its profitability over the next two years.

Any significant deviation from this assumption could have an impact on the consolidated entitys financial risk profile and consequently, on Sterlites outstanding ratings.

Sterlites favourable business risk profile is characterised by the semi-integrated nature of its operations and favourable operating efficiencies. The company is one of the two large copper producers in the country.

Its cost of production has been improving over the last few years and is expected to improve further subsequent to the enhancement of its smelting capacity from 120,000 tpa to 150,000 tpa and the commissioning of a 25-MW captive power plant thereby meeting its entire power requirement in-house in FY 2002.

The companys smelter and refinery are located far away from each other (Tuticorin and Silvassa respectively), which is a logistical disadvantage.

The transportation of anodes from Tuticorin to Silvassa is a significant component of Sterlites production cost.

Moreover, given Sterlite dependence on outsourced copper concentrate to the extent of 70 per cent, its profitability is also dependent on treatment and refining charges (TC/RC), which are cyclical and negotiated between the copper mines and smelters.

While Sterlites business diversity has increased after the Balco and HZL acquisitions, the companys risk profile continues to be constrained by its high dependence on non-ferrous metals since there is a strong correlation between the prices of various non-ferrous metals like aluminum, copper and zinc.

The ratings are also tempered by the commodity nature of the non-ferrous metals business and the strong linkages between Sterlites and its affiliates profitability with customs duty protection, international price movements and the rupee-dollar exchange rate.

Prospects
The fortunes of a company in the non-ferrous metals business are dependant on economic growth and the metal prices on the LME. Given the global slowdown, demand has declined, pushing down LME prices of copper (average of $1,526 per tonne in FY2002 as against $1,806 per tonne in FY2001).

With the global economy now showing signs of recovery, the outlook on demand and prices is favourable from current levels. In line with the industry, Sterlite will benefit from this upturn.

The increase in production capacity and commissioning of a captive power plant are also likely to result in improved margins for Sterlite. But the reduction in customs duty by 10 per cent on copper in the Union Budget 2002-03 could have a negative impact on its margins, although the expected rupee depreciation would provide some cushion against an anticipated fall in prices.

Key Issues
In future, Sterlites rating will be critically dependent on its ability to improve its stand-alone financial risk profile by reducing its debt levels, reducing dependence on short-term debt and limiting its exposure to group/subsidiary companies.

Moreover, the companys ability to maintain its stand-alone profitability despite the expected cut in customs duty in future will also be crucial for improving its stand-alone financial risk profile.

Further, its ability to improve Balcos profitability and maintain the favourable capital structure of Balco and its mines will be key rating sensitivities. Any further debt funded acquisition or capital expenditure would result in a rating downgrade.