Vedanta’s (VEDL) Q1FY17 EBITDA of R34.4 billion (-1% quarter-on-quarter (q-o-q) -24% year-on-year (y-oy)) was below our estimate of R39.9billion. Cost of production of aluminum was temporarily higher than expected, though volumes are ramping up as expected. Iron ore volumes were up 14% quarter-on-quarter, yet fell short of expectations. Earnings before interest taxes depreciation and amortization EBITDA (ex- HZ and CAIR) declined 9% q-o-q (but grew 18% y-o-y) to R15.1billion, below our estimate of R19.4 billion. Net debt (ex-HZ and CAIR, including ICD from CAIR) declined R49 billion (lower than expected) to R801billion, despite R64 billion dividend from HZ.
Increase in working capital and R15 billion capex affected free cash flows. Interest expense was down 9% q-o-q to R13.9 billion, courtesy Ind-AS. R1.3 billion interest on yet-to-be-commissioned smelter pots is now capitalised.
We expect Vedanta’s attributable EBITDA to increase from R110 billion in FY16 to R147 billion/R166 billion in FY17E/18E on volume ramp-up and cost advantage in aluminum, positive outlook on zinc, turnaround of iron ore business, and sweating of power assets.
We have reduced our target price to R146/share (earlier R164/share) on higher than expected debt and aluminum CoP. The merger with CAIR (more likely under revised terms) will significantly improve net debt/EBITDA ratio among the businesses with cash fungibility though it will dilute SOTP.
The stock has doubled in six months, factoring turnaround in aluminum and iron ore businesses, bullish zinc price outlook, and expected merger with CAIR.
Over the next six months, zinc supply is likely to ease (HZ production to double in H 2), while zinc demand remains sluggish.
The aluminum business is exposed to alumina prices. We see little stock upside; downgrade to ‘neutral’.