Weak commodity prices made FY16 a tough year for leveraged names—Vedanta walked a tight rope in managing cash flows at its standalone entity and used a combination of working capital release and debt (buyer’s credit, NCD, CPs). The recovery in prices, especially of zinc and oil coupled with volume ramp-up in aluminium and power makes FY17-18E more promising and we expect liquidity concerns to ease gradually. Maintain BUY with a revised TP of R140 (R130).
Standalone cash flows—a tight run in FY16
The tight liquidity at the standalone entity and maturing bonds at parent Vedanta Resources Plc led to Vedanta repaying R80 billion in FY16 through a combination of working capital release of R36 billion, and increase in debt by R43 billion. Vedanta raised standalone debt mainly through buyer’s credit in copper operations (+ R32 billion), issue of non-convertible debenture in aluminium business (R20 billion) and commercial papers. Of the total
$2.6 billion due to Vedanta Resources Plc in March 2015, Vedanta now owes a more manageable $1 billion after payments made until April 2016 (through HZ’s special dividend).
The improvement in standalone earnings in FY17-18e led by volume ramp-up in aluminium, power, and iron-ore will meaningfully improve the company’s debt servicing ability, despite assuming low commodity prices. Moreover, strong zinc and improving oil prices will also enable HZ, Cairn India to maintain healthy dividend payouts, given lower capex requirements.
Hindustan Zinc—ramp-up of SK, Kayad mine compensates for RA mine decline
Mined metal volumes from Rampura Agucha mine declined 19% to 565,000 tons in FY16 due to lower open cast volumes but were made up by higher volumes from SK mines (140,000 tons, +44%) and Kayad mine (86,000 tons). The decline in RA mine volumes will cap mined metal volumes over next
1-2 years, but on the flip side, higher SK mine volumes will be a boost for silver volumes.
Maintain our BUY rating with revised TP of R140
Refined zinc markets were in deficit of 55,000 tons in 1QCY16 due to mine closures. We expect this deficit to increase to 350 kt in CY2016 and drive our strong outlook on zinc prices. Besides volume ramp-up in the standalone business, higher oil prices will aid earnings. We maintain BUY rating with revised TP of R140 (R130 earlier). We raise our EPS estimate by 5-9% for FY2017-19e due to change in interest cost, depreciation assumption.
Standalone cash flows—higher debt, working capital used to repay Cairn acquisition loan
The tight liquidity at the standalone entity and maturing debt (bonds) at Vedanta Resources Plc led to Vedanta repaying about R80 billion from the standalone entity to its subsidiary TSMHL (Twin Star Mauritius Holdings) for part repayment ($1 billion) of total $4.3 billion of loans at TSMHL.
The funds at the standalone level were raised through a combination of working capital release and higher debt. We highlight that special dividend from Hindustan Zinc was received in April 2016 and Vedanta further repaid inter-company loan of $0.9 billion.
Repayment of R80 billion—routed through investments
Vedanta’s repayment of R80 billion in FY2016 was routed through investment in subsidiaries. Of R80 billion, the company invested (i) R20 billion directly in Cairn India shares—this was through purchase of 4.98% in Cairn India for $315 million in June 2015 from TSMHL, and (ii) R60 billion in Malco Energy through 2% compulsorily convertible debentures. Malco Energy in turn invested this sum in equity shares of Fujairah Gold—this company is now a subsidiary (with 98% stake) of Malco by virtue of the investment. While we do not have annual report of Fujairah Gold yet, we believe the money was then routed to TSMHL from Fujairah Gold which could be through share purchase of Cairn India if not through advances.
Working capital release—50% to reverse in FY2017E
Vedanta has stated that 50% of working capital initiatives in FY16 are expected to unwind in FY17E. We also highlight that implementation of Ind AS may lead to re-classification of some of the working capital components to debt (such as debtors discounted).
Standalone debt flat, but includes working capital release
The standalone debt (including wholly owned subsidiaries) has remained flat in FY16 at R785 billion though after certain working capital release. The company borrowed at standalone level (net debt increased to R411 billion from R368 billion) and repaid debt at Cairn acquisition SPV i.e. TSMHL—net debt in this entity declined to R223 billion from R268 billion in March 2015, excluding borrowings from Cairn India of $1.25 billion.
Borrowing costs decline to 7.9%: The cost of borrowing declined to 7.9% in FY16 from 8.2% in FY15. The decline in interest rate was led by (i) lower term loan costs, (ii) lower CP rates, and (iii) replacement of high cost FCCBs with CP and short term loans. Finance cost increased by 1% in FY16 to R57 billion due to capitalisation of capacities and Balco and Talwandi Sabo (R3.5 billion impact).
Debt situation at Vedanta Resources Plc, Vedanta’s parent: Vedanta Resources Plc had net debt of $7.3 billion as on March 2016. Against this amount, the company is to receive $1.9 billion from TSMHL (Vedanta Ltd) and adjusted for this inter-company loan had net debt of $5.4 billion. Vedanta being a holding company has no income of its own. The company mostly relies on dividend from Vedanta India for its annual interest payments (net of interest on advances) of $350 million.