Sesa Sterlite - Zinc to drive earnings; Hold - Anand Rathi

Hindustan Zinc's good performance. In 3QFY14 Hindustan Zinc's mined-metal production has risen 11.6% yoy to 260,000 tons. Revenue is expected to have risen ~25% yoy, led by higher volumes with corresponding EBITDA growth of 24% due to the higher proportion of mined metal production and steady costs.

Aluminium and power to drag. Sterlite Energy's PLF will be within the ~50% range, with production of 2.1bn units, but the lower cost of production would deliver EBITDA of Rs. 3.7bn. The re-opening of the alumina refinery would have assisted Vedanta Aluminium's margin in the quarter following the lower cost of production similar to 1HFY14 levels.

Good volumes from copper and the international zinc business. Custom copper smelting would have recorded good volumes with higher by-product credits and, after disruptions in the mines during 1QFY14, the international zinc business would have continued to provide stable volumes.

Cash fungibility, a key trigger. Sesa Sterlite (SS) generates 78% of EBITDA from majority subsidiaries, Cairn India and Hindustan Zinc (HZ). On the government-stake divestment, cash fungibility from HZ would be a significant re-rating trigger for growth and deleveraging. The conglomerate structure would require the effective capturing of value generated by Cairn and HZ to reduce the holding-company discount.

Our take. We believe that the business issues regarding logistics, the environment and project commissioning will soon be resolved, providing deep embedded option value from CWIP of ~US$9bn. We retain our Hold recommendation, constrained by cash fungibility, access to resources and regulatory risks. We value SS on a sum-of-parts basis, with multiples in line with its peers and a 20% holdco discount for HZ and Cairn. We value SS at Rs. 193 a share. Risks. Regulatory hurdles, adverse currency movements.

Source : Equity Bulls

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