>Sterlite Industries India Ltd. (MERRILL LYNCH)

STRONG RALLY; BEST IS BEHIND

Downgrade from Neutral to U/perform; PO & EPS unchanged
Sterlite is up 50% over the last one month. It is one of the best performers not just in India but also among the global metal stocks. It now ranks among the most expensive metal stocks globally trading at FY10E P/E of 22.5x and EV/EBITDA of 8.9x. Earnings outlook remains dismal. We forecast 4Q profit fall of >20% q-o-q and FY10 fall of 68%. Hence we recommend selling the strong recent rally.

Running ahead of zinc leverage; ally still barely break-even
Zinc (~60% of Group EBITDA post minorities) tends to be the most significant driver of stock performance. Over the four year period of 2004-2007, correlation with zinc was very high at 0.97. This correlation has broken down to just 0.2 over the last five months given that the stock has run up far ahead of zinc price recovery. We believe the beta trade has been played excessively and it is now time to book profit, more so when aluminum division is still barely break even.

Price outlook and demand fundamentals unchanged
The recent rally in the metal sector reflects positive impact of continued commodities buying by China and an increase in confidence in global financial markets. Confidence aside, we have not identified any significant improvement in demand. Hence we believe the recent rally in metal prices will not sustain. From their recent bottoms, ally / zinc / copper are up 8 / 26 / 44%.

Asarco & aluminum capex to drain down surplus cash
On cons. basis, Group has surplus cash of $3.6bn. But this should be drawn down fully to fund Asarco acqn. ($1bn & balance staggered) & Ally capex ($2.5bn). We believe Asarco will be EPS dilutive & negative free cash flows and key negatives.

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