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Vedanta Resources stock rated Outperform by Credit Suisse, says target price Rs 345

Metal News - Published on Wed, 27 Dec 2017

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Financial Express reported that we believe Zinc prices have peaked, and we find Hindustan Zinc Ltd fully valued, despite the planned volume growth in Zn, lead and silver after a lull of many years. We, however, see 60% upside in the ex HZL stub, driven mostly by volume growth in oil and Zn International, and improved profitability in Al.

Al remains a large part of the capital employed for Vedanta and also has the weakest profitability, making it the most important for Vedanta’s incremental profits, and ex-HZL RoCE. The ramp-up of the VAL and Balco smelters is nearly complete (FY18 exit rate 2mtpa). Over the past decade, surging Chinese exports had pushed gross smelting margins (Al price minus alumina and energy costs) below USD 700 per tonne from USD 750 to USD 900 per tonne a decade back. As Chinese exports stagnate (more upside to Al if they decline), ex China capacities could see higher margins. The recent rise in alumina and energy has pushed up the Al cost curve this is also positive for Vedanta due to its partial vertical integration. The expansion in the partly built Lanjigarh refinery could also boost capital productivity.

A heavy debt burden had driven a sharp capex slowdown across the group in the past few years, leaving some projects half-done. However, post the completion of the Cairn merger, and the spike in Zn and oil prices, both cash accretion and fungibility have improved. Stalled expansion projects are re-starting, particularly in higher-margin businesses like Zinc and oil. The ex HZL upside that we see is, therefore, purely execution-dependent; our price forecasts remain conservative. While our volume projections are below company guidance, this remains the most significant risk to our rating, together with a potential unexpected diversification. We also initiate coverage on HZL with NEUTRAL and INR 325 TP on high EV/Ebitda multiple and expected price declines in FY20.

Al: Better outlook in the weakest segment Aluminum remains a large part of the capital employed for Vedanta and also has the weakest profitability. It is thus the most important for Vedanta’s incremental profits, now that the capacity expansion is nearly complete. Global ex China Al demand has stayed steady for several years, and may surprise positively as the long-delayed investment cycle picks up in the US/EU. At the same time, Al supply is being curtailed in China, which has already led to their exports flat-lining, and may even lead to a drop going forward. Chinese net exports of aluminum now meet 12-13% of ex-China demand this has depressed gross smelting margins (Al price minus the cost of alumina and energy) to below USD 700 per tonne vs USD 900 to USD 1,000 per tonne earlier, and thus deterred supply addition elsewhere. Higher smelting margins are thus necessary for supply growth. Warehouse inventory, which used to be an overhang over the London Metal Exchange Aluminum price, has declined meaningfully from its peak, driving stability in the physical premium. Furthermore, Chinese capacity for alumina and coal has been curtailed as well, driving up costs of inputs. This should help Vedanta take the refinery and the power plants to their full utilisation, and help profitability as well as return on capital employed. We build in 2mtpa of output (exit-rate for FY18e: start of 300ktpa pot line could create upside), and slightly better Ebitda/t as CS global forecasts are for Al prices to fall slightly after a few quarters.

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Posted By : Rabi Wangkhem on Wed, 27 Dec 2017
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