>METAL SECTOR (GOLDMAN SACHS)

Exploring the power option: Upgrade Sterlite to Buy, on Conv list

Base metals' fundamentals appear bleak, look for other catalysts LME fundamentals remain under pressure from rising inventory since 3Q2008 and restarts from Chinese smelters in 2009 on the back of recent price rises. We remain uncertain over the outlook for the base metals complex, and look for catalysts independent of LME price movements. We adopt GSJBWere Commodities Research team’s recently adjusted LME price assumptions, revise FY10E-FY12E EPS for stocks under our coverage by -17% to 155%, and raise our 12-month TPs by 21%-96%.

Upgrade Sterlite to Buy, on CL: Free option value on power sub
We upgrade Sterlite Industries (STRL.BO) to Buy and add it to our Conviction List, from Neutral, as we believe:

• Current valuation reflects underlying fundamentals of the base business only, implying a free option value for its power subsidiary, Sterlite Energy, which we estimate at Rs137/share.

• Commissioning of the first unit of its 600 MW commercial power plant in December 2009 would be a significant catalyst. We expect this to be followed by three more units of 600 MW each every subsequent quarter.

• The power subsidiary would contribute 35% to earnings by FY12E.

• Recent equity fund raising, although dilutive in the short term, is a positive development as it could potentially enable the revival of the captive power projects at associate group company Vedanta Alumina as well as the 1,980 MW Talwandi Saboo commercial energy project.

Although Sterlite’s power subsidiary fundamentals are not as strong as JSPL’s, we believe it has the potential to enhance the growth and return profile of the company over the long term. We raise Sterlite’s 12-month SOTP-based target price to Rs763 (from Rs389), as we roll forward to FY11E valuation and incorporate the DCF value of its power subsidiary.

Maintain Sell on NALCO, Neutral on Hindalco and Hind Zinc We maintain Sell on NALCO (NALU.BO) due to expensive valuation, weak aluminium fundamentals and frequent coal supply disruptions. We maintain Neutral on Hindalco (HALC.BO) and Hindustan Zinc (HZNC.BO).

Risks
Volatility in equity and commodity markets, delays in project execution.

To see full report: METAL SECTOR