Wednesday, February 8, 2012

Sterlite Industries - Buy on dips

Sterlite Industries reported strong Q3FY12 results at the operating level with: (i) a strong copper business, and (ii) a fall in production cost at Balco, Vedanta Aluminium (VAL) and power business. After repeated increase in the cost of production at VAL and Balco, the company reported a decrease in cost of production with: (i) higher utilisation leading to efficiency realisation; (ii) lower alumina cost; and (iii) better coal availability lowering power costs. The company has indicated that VAL’s aluminium cost of production at $2,004/t (from $2,554/t in Q2FY12) and Balco’s cost of production at $1,880/t (from $2,399/t in Q2FY12) is sustainable at current levels. Sterlite Energy has also lowered the cost to R2.6/KWH down from R3/KWH in Q2FY12 on higher generation and better coal availability.

Sterlite’s investments in VAL remain high at R101.7 bn (R5.6 bn equity and R96.1 bn of loans) for its 29.5% stake in the company. As per our calculations, at D/E (debt/equity ratio) of 0.6, Sterlite has R66.9bn of surplus investment in VAL. The company has stated that VAL would be restructuring its capital structure in Q4FY12 and with that there would be more clarity on the surplus investments. We believe any clarity on this would be a key trigger for the stock.

Sterlite Energy has reported improvement in the number of units generated (1.5 bn units from 1.1 bn units in Q2FY12), with better coal supply and the commissioning of the third unit of 600MW during the quarter. Higher generation has also helped in realising operating efficiencies, which has lowered the cost of generation. While PLF (plant load factor) still remains sub-50% for the three units commissioned, there has been a gradual improvement. The company has said that the fourth unit of 600MW would be commissioned in Q4FY12—which should further improve operations. However, coal supply still remains a challenge and key impediment to its profitability.

The management indicated that 325ktpa aluminium smelter at Balco would be commissioned by Q2FY13 (a delay of six months from last guidance) and the first 300MW power plant would come on line by Q4FY12. However, the key to these projects would be coal availability and bauxite mine allocations. The company has obtained environmental clearance for its coal mine and now it would apply for forest clearance. This would take at the least one year.

Sterlite Industries reported R23.2bn of Ebitda ahead of our estimate of R22.3 bn. This is primarily on account of better-than-expected copper results and lower cost of production at aluminium operations. Despite better-than-expected operating profits, net profits at R9.14bn came in below our estimate of R10.54 bn, on account of forex losses of R4.2 bn. Please note that other income at R8.8 bn was also higher than our estimates and hence the disappointment was lower. Adjusted for the above one-offs, net profits were largely in line with our estimates.

Sterlite’s management has indicated that it is in discussions with the government of India for purchasing its remaining stakes in Balco (49%) and Hindustan Zinc (25%). Any clarity on this would be a positive, in our view, given it will release excess cash in HZ for better deployment.

We maintain our Buy on the stock on weak valuations and most of the problems being discounted in the stock price. While there are early signs of recovery, any progress on lower costs and clearances to coal mine/aluminium expansion would be a key trigger for the stock, in our view.

After hitting a 52 week low of Rs.86 Sterlite has recovered quite sharply and is now trading around Rs.125 levels. Utilize any major correction to buy around Rs.100 levels to add to your portfolio and hold for a target price of Rs.180 holding period of 6 months.

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Ingenious Investor
Equity Research Division

Ravina Consulting
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