Performance likely to turn around Q3 onwards with volumes offsetting LME headwinds; FY20e Ebitda up 2%; ‘Buy’ retained.
Vedanta’s (VEDL’s) Q2FY19 operating numbers were slightly lower compared to our estimates for key divisions—Zinc-India (Zn-India), aluminium (Al) and oil & gas (O&G). However, going ahead, we expect an improved performance due to: (i) volume uptick & cost reduction in Zn-India; (ii) enhanced gas production in O&G division; (iii) lower cost in Al division on increased domestic bauxite sourcing; (iv) Gamsberg ramp up at Zn-international; and (v) ramp-up at Electrosteel Steels. Taking cognisance of revised USD:INR for FY19/ FY20e at 70/72 (earlier 68/69) and LME Zn at $2,700/2,500 (earlier $2,782/2,600), we revise up FY20e Ebitda 2% but keep TP unchanged at `293. Maintain Buy at an exit multiple of 4.7x FY20e Ebitda.
Slight miss on operating numbers compared to our estimates
VEDL’s Q2FY19 operating numbers were up to 3% below our estimates across key divisions. Compared to our estimates:
(i) O&G production was off 3% owing to natural decline at Mangla field, though gas volumes were better; (ii) Al division’s production was lower primarily due to Jharsuguda-I; and (iii ) in power, PLF was lower owing to coal availability constraints. On the positive side, iron ore and copper production was slightly ahead, while Zn-international’s was in line.
Production likely to ramp up across all divisions
Going ahead, we expect VEDL’s operating performance to inch up due to: (i) O&G: Higher gas production & more wells coming in line in Rajasthan oilfields;
(ii) Al: Expect lower operating cost with full ramp-up of three lines at Jharsuguda-II & enhanced sourcing of domestic bauxite;
(iii) iron ore & steel: Higher ceiling in Karnataka & ramp-up of Electrosteel Steels; and (iv) Zn-international: Gamsberg start.
Outlook and valuations: Higher volumes to benefit; maintain ‘BUY’
We expect VEDL to turn around Q3FY19 onwards as volume uptick is likely to compensate the lower LME prices. Taking cognisance of revised USD:INR and LME Zn estimates, we are revising FY20e Ebitda 2%. Maintain ‘BUY/SO’ with TP of `293 (exit multiple of 4.7x FY20e Ebitda).
VEDL’s portfolio of resources business provides advantages of scale, diversification and strong balance sheet. The company benefits from ownership of low cost, cash rich oil & gas (Cairn) and zinc-lead-silver (HZL) businesses. It has globally competitive unit production costs in zinc, led by its quality captive mines. This aspect will help the company better withstand margin pressures during price downturns. In FY19, we expect ramp-up of Zinc-India’s production and Jharsuguda-2 smelter. Key potential triggers for the stock are success of enhanced oil recovery measures at Cairn, acquisition of GoI’s residual stakes in BALCO and HZL and grant of bauxite and/or dolomite mining licences (not considered in our estimates and valuation).
• Fall in zinc prices or premiums.
• Decline in LME aluminium price or premiums
• Cairn: Exploration failure, reinvestment of cash generated into low return assets
• HZL: Lack of volume growth or increase in cash cost
• Lower than expected average tariffs.
Company Description: VEDL is a subsidiary of Vedanta Resources, the London-listed metals and mining group. VEDL is a globally leading diversified resources company with presence in oil & gas, zinc-lead-silver (through 64.9% stake in HZL and 100% stake in erstwhile zinc-lead business of Anglo American), copper, iron ore, aluminium and commercial power (largely in standalone business but in subsidiaries as well). The company was formed through the merger of Sterlite Industries into Sesa Goa along with acquisition of additional 38.8% stake in Cairn which was consummated in August, 2013 and announced in February, 2012.