>STERLITE INDUSTRIES: Earnings growth to bring back focus

Event
■ Downgrades to base metals: Our global commodities team has downgraded their aluminium, zinc and lead price forecasts. However, we believe that Sterlite’s expansions are now coming through, which should bring the focus back to this stock post its underperformance last year. We have retained our Outperform rating but marginally cut target price to Rs850 from Rs930 earlier.

Impact
■ Downgrading aluminium, zinc and lead price forecasts: We have downgraded FY11 zinc and lead price forecasts by 10% and 12% to US$1,877/t and $1,926/t, respectively. Our global commodities team has slightly changed aluminium price forecasts for FY11 by -3% to US$1,935/t from $1,995/t, respectively.

■ Expansions to drive doubling of profits in two years: Sterlite’s expansions of its zinc, power and aluminium businesses are now nearing completion. Highly profitable zinc business continues to contribute 50% to earnings. A large part of the growth is coming from the power business and expansion at Balco.

■ Lack of approvals can hurt production: Approval for its bauxite mines for aluminium projects is awaiting final clearance. In addition to the high costs that we are building in, we are concerned that due to infrastructure bottlenecks it may not be physically possible to get enough bauxite for full production at its JV ‘Vedanta Alumina’.

■ Coal block auctioning can come as blessing: One of the most awaited mining sector reforms involves auctioning of coal blocks by the government. While the timeline is not definitive, it is expected by end of the year. Sterlite can use its strong balance sheet to acquire resources that have eluded it for some time.

■ Sensitivity to commodity prices is low: An increase of 10% in aluminium price should increase consolidated earnings by 2%. Also, a 10% increase in zinc prices would increase consolidated earnings by 5%.

Earnings and target price revision
■ We have revised our EPS estimates for FY11 and FY12 by -6% and -4%, respectively.

Price catalyst
■ 12-month price target: Rs850.00 based on a Sum of Parts methodology.
■ Catalyst: Coal sector reform, clarity of bauxite linkage for VAL.

Action and recommendation
■ Maintain Outperform: We believe Sterlite continues to offer value, with its strong diverse growth pipeline, strong balance sheet and numerous upcoming catalysts. We think that the strong earnings growth should become the focal point driving the stock price. There also is a possibility of sharp re-rating if Sterlite can resolve its long-standing issues involving the government.

To read the full report: STERLITE INDUSTRIES