Sesa Sterlite Merger - Buy Sterlite

Vedanta Resources PLC on 25 February 2012 announced the merger of all its key investments in India into a single company called 'Sesa Sterlite'. The new holding company will own controlling stakes in all of Vedanta's companies in India and would be a metals, mining and natural resources giant. The merged entity would be India’s natural resources company and is expected to be seventh largest global diversified natural resources major on EBITDA basis. By this exercise, the group structure has also been simplified and cross holdings have been eliminated, which is expected to benefit the group through superior capital structure, increased flexibility to allocate capital, broader access to capital markets and enhanced visibility of earnings and cash-flow. In addition to this, increased diversification is expected to reduce volatility of earnings through commodity cycles, lowering the cost of capital and enhancing value. As per the management, the transaction is expected to be completed in CY12 and the synergies are expected to generate cost savings of Rs10bn per annum.

Restructuring done to lighten up Vedanta Plc balance sheet
Indiainfoline believes that restructuring has been done largely to lighten the parent company’s balance sheet, bring in synergies between VAL and Sterlite Energy (SEL), use the accumulated losses at VAL and reduce the financing costs for the company. Vendanta Resources Plc, the parent company had taken loan to the tune of US$2.8bn to acquire stake in Cairn India, which was to be repaid over the next two years. In addition to this, the parent company had to infuse equity in its loss making subsidiary VAL to fund its capex. Sterlite, 29.5% stake holder, had invested more capital in VAL than its equity contribution over the last two years.

Sterlite to witness buying
The merger ratio would boost Sterlite’s stock in the near term as it is done at a premium to Friday’s closing of Rs119. On the other hand, we expect it to be negative for Sesa Goa as the debt of VAL would be shared on its books. Indiainfoline believes the deal is largely done in a fair way except the valuation of VAL. The merged company would be a must own entity as it would provide a large diversified portfolio under one roof. Indiainfoline values the merged entity ‘Sesa Sterlite’ on sum-of-the-parts method. They have used EV/EBIDTA method to value the metal assets, price/book for the power and a holding company discount to Cairn India. They derive a target price of Rs217 per share for Sesa Sterlite (and Sesa Goa) which on an implied basis (swap ratio of 0.6x as per deal) indicates a target price of Rs130 for Sterlite. Indiainfoline maintains their ‘Market Performer’ rating on Sesa Goa and our ‘BUY’ rating on Sterlite.

Restructuring exercise
The restructuring exercise includes merger of four companies viz Sterlite Industries, Sesa Goa, Vedanta Alumina and MALCO and transfer of Vedanta’s stake in Cairn India to the merged entity with an associated debt. The steps for the proposed transaction are:

1) Sterlite will merge into Sesa Goa to create Sesa Sterlite, through the issue of Sesa Goa shares to shareholders of Sterlite. Sterlite shareholders as of the record date are expected to receive 3 Sesa Goa shares for every 5 existing Sterlite shares. Sesa Goa also intends to establish an ADS facility comparable to Sterlite’s current ADS. This would allow holders of Sterlite’s ADS as of the record date to receive Sesa Goa ADS with appropriate adjustments to reflect the foregoing exchange ratio. Each Sterlite ADS currently represents four equity shares of Sterlite.

2) Consolidation of VAL, via the merger of Ekaterina Limited (a Mauritius holding company for Vedanta’s 70.5% shareholding in VAL) into Sesa Sterlite and the issue of 72.3mn Sesa Goa shares to Vedanta after obtaining all necessary approvals. Based on Sesa Goa’s closing price on 24 Feb 2012 of Rs227/share, the equity value of VAL equates to Rs23.32bn (US$473mn).

3) MALCO to merge into Sesa Sterlite, through the issue of 78.7mn Sesa Goa shares to shareholders of MALCO as of the record date. Based on Sesa Goa’s closing price on 24 Feb 2012 of Rs227/share the value of MALCO equates to Rs17.9bn (US$363mn) including the value of MALCO’s existing 3.6% shareholding in Sterlite. As part of the merger MALCO’s existing shareholding in Sterlite will be cancelled by Sesa Sterlite.

4) Post the merger of Sesa Goa and Sterlite, Sterlite Energy Limited and VAL’s Aluminium business will be merged into the consolidated Sesa Sterlite. As wholly-owned subsidiaries no shares will be issued in consideration of the mergers. 

5) Vedanta will transfer its 38.8% direct shareholding in Cairn India to a wholly-owned subsidiary of Sesa Goa at a nominal consideration of US$1, together with the associated acquisition debt of $5.9bn (coupon of 5.2%). The debt will continue to be guaranteed by Vedanta. This transfer is not inter-conditional on the merger of Sesa, Sterlite, MALCO and VAL.

Positives of the deal:
- Consolidated balance sheet to be stronger and would reduce the cost of funds for the companies.
- Increased diversification is expected to reduce volatility of earnings through commodity cycles, lowering the cost of capital and would enhance value.
- Accumulated loss of Rs15bn at VAL would reduce the tax out flow for the group.
- Overhang of merger of VAL with Sterlite is over.
- With the merger of SEL and VAL aluminium, the capex for VAL’s power plants would reduce.
- Shareholders of Cairn India and HZL would receive higher dividend over the next two years as the merged entity has high debt repayment.
- Positive for Sterlite shareholders in the near term as the deal is done at a premium to Friday’s closing price of Rs124.


Our Recommendation :


If you are presently holding Sesa Goa shares look to sell around 225 levels.  Long term investors should buy Sterlite Industries on all dips and hold for 2-3 years for a 100% return



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Metal Stocks - Best buys !!

The metals sector has been facing a tough time, partly due to the correction in global commodities prices and also because of certain domestic developments like the ongoing CBI probe into the mining industry in Karnataka.

Many frontline metal stocks like JSW Steel, Tata Steel, Sesa Goa, Hindalco and Sterlite, to name just a few, have seen a severe contraction in prices. What has further compounded the problem is the ongoing crisis in the Euro Zone and the fear that China's metal demand may slow.

It is tough to say which metals segment — copper, steel or aluminium — would take a greater hit than the others or whether the producers catering to domestic demand would be spared from demand recession compared to companies like Tata Steel which has a significant presence in European markets.

But for long term investors, it would be tempting to know whether the current meltdown in metal stocks make them hot investments, even in the likelihood of further price correction in these shares. All the five metal stocks mentioned earlier have suffered serious erosion in value and three of them have seen their Price to Earnings (PE) ratio come down to single digits.

The extent of carnage the sector has suffered could be judged by taking a look at today's NSE closing prices compared to their year's high (given in brackets):

Sesa Goa - Rs 204.25 (Rs 383.65); Jindal Steel and Power – Rs 480 ( Rs 755.50); Tata Steel - Rs 420.70 ( Rs 737); Hindalco - Rs 126.10 (Rs 252.85) and Sterlite - Rs 113.35 (Rs 195.95).

But what is intriguing is that while the stocks of metal companies has seen a correction, it is not as if all metal prices have corrected. For instance, the steel prices have not gone down so much compared to the share price of steel stocks. Given the problem in mining in India, it is possible that domestic steel prices may remain firm, benefiting steel producers.

In an interview to Business Line, Mr Bhavesh Chauhan (Senior Research Analyst  — Metals & Mining), Angel Broking, Mumbai, shares his views on the metal sector's performance and what it holds for them in future. Excerpts:           

Metal stocks have taken a hammering. Do you consider them worthy of investment at current prices or is some more pain due?

The last 6-8 months have been bad for metal companies due to escalating debt crisis in Europe and stocks have been battered. As long as the situation in Europe remains grim, metal demand would remain weak and sentiment will keep metal prices lower. Monetary tightening in China has also played its part, although there hasn't been any huge decline in China's appetite for resources so far.

Different metal stocks (Sterlite (copper), Hindalco (aluminium), JSW Steel, Tata Steel and Sesa Goa) have suffered. Do you see any particular company recovering in the short term? Are all metal stocks in the same league?

Metal being a global commodity, all the stocks would be in the same league, although broadly we classify the companies as ferrous and non-ferrous and then we could have the classification in terms of steel makers and miners as well. Again, recovery of any stock would depend on how Europe shapes out. Also, there are concerns on US going into double dip too. So that factor has to be seen closely.

The reasons for the downslide in shares — controversy in the Karnataka mining sector and slowdown in Europe — are different. Do you think it would take some time for these negative factors to disappear?

 For Karnataka mining, it is more of a regional thing and it affects companies operating in Karnataka. I believe the Karnataka issue could be sorted out in 6-9 months. European slowdown is a big concern actually and how long it will take for these factors to disappear is a challenging question.

The economic slowdown has led to demand contraction resulting in fall in metal prices. But any economic recovery would see demand for metals picking up. So, do you feel the fall in prices is temporary or will it continue for a while?

Any recovery in Europe should see base metal prices recovering, although the way the scenario is today, it is difficult to give a time frame. At least in the near-term I do not expect any recovery in base metal prices.

Which are the sectors that would benefit due to metal prices falling — autos, housing, electrical goods, capital goods. Do they have any upside potential because of this?

Companies in capital goods and infrastructure will benefit if prices fall. However, steel prices have not fallen so far. Steel is the commodity which is used mainly as a raw material in machinery and construction. We do not expect any significant fall in steel prices anyway as prices of raw material remain high and are expected to remain firm due to supply concerns.

Though metal prices have fallen, the woes in Europe and US may not lead to pick-up in demand for products. How will Indian companies benefit?

Base metal prices have fallen. So, a little benefit will flow to some companies. However, steel remains the most widely used commodity.

How will the rise in dollar value and fall in rupee value affect the Indian metal cos? Hasn't the fall in rupee value neutralised any benefit of fall in commodity prices?

With the rupee depreciating, it helps companies selling metals as imports become expensive and hence domestic producers can raise prices. As far as importers of commodities are concerned, so far the falling rupee has offset falling commodity prices as you rightly say.

Have the frontline metal stocks become investment worthy after price correction? What are your picks and why?

We do feel that front-line metal stocks are now worth investing as we believe markets are discounting on the near term global macro issues (primarily Euro zone crisis). The current price levels do not discount the expansion plans by companies over the next 2-3 years. We like companies with captive resources and big expansion plans. With captive resources, these companies would generate higher return on capital employed at even current metal prices. Though we like Hindustan Zinc, SAIL, Sterlite amongst others, Tata Steel and Hindalco are our top picks –Tata Steel with a target price Rs 614 and Hindalco with a target price of Rs 196.

We like Tata Steel for its buoyant business outlook, driven by higher sales volume on completion of its 2.9 mt brown field expansion in Jamshedpur. The company's raw material projects are expected to be commissioned by 4Q FY2012 with lower off take initially; the full benefit is expected to accrue in FY2013E. Additionally, restructuring initiatives at Tata Steel Europe are likely to benefit the company going forward. We believe Hindalco is well placed to benefit from its aluminium expansion plans (capacity increasing by nearly two-three folds in the next two-four years). Most of its new capacities will be backed by captive mines leading to robust margins. Further, we expect steady EBITDA of $1 billion annually from Novelis.   

Steel prices have not fallen much but steel stocks have suffered. Because of the mining issue, steel prices may remain firm. Does that make steel stocks attractive for investment?

Steel prices have not fallen because prices of iron ore and coking coal across the globe are still firm. The mining problem is only India-specific and does not have any impact on the steel prices, which are globally determined. We believe steel stocks are attractive given that their margins have shrunk drastically over the last 9 months or so. We like steel stocks as coking coal prices are expected to fall, interest rates in India should fall sooner than later, capex cycle should pick up in the next six months. The stock prices have discounted all the negatives, leaving some of the stocks highly undervalued. 

Ingenious Investor
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Buy Sterlite Industries

UK-based Vedanta's Indian arm has outperformed its peers in terms of sales and earnings growth and is still available at a lower P/E multiple. Profits rose 63% on higher aluminium prices and better copper treatment and refining margins. While softening of base metal prices due to sluggish demand is a concern, earnings growth from its silver business remains strong. The scrip has under performed during the last 3 years and is likely stay muted going forward. Time Span Price Change %Change Today 122.00 -3.05 -2.43 Week 125.35 -0.30 -0.23 Month 167.95 -42.90 -25.54 Three Months 167.50 -42.45 -25.34 Six Months 159.70 -34.65 -21.69 One Year 152.10 -27.05 -17.78 Two Years 170.15 -45.10 -45.10 Three Years 153.74 -28.69 -18.66 Long term investors should utilize deep cuts to accumulate the stock from current levels and hold for a period of 2 years for a near 100% return. Bought to you by Ingenious Investor Equity Research Division Ravina Consulting Pattamal Plaza 3rd Cross Kamanahalli BANGALORE 560084 For Free Stock Advise + Ideas sowmya@ravinaconsulting.com Talk / SMS 08105737966 Read - www.ingeniousinvestor.blogspot.com Follow us - www.twitter.com/smartinvestor