>STERLITE INDUSTRIES INDIA LIMITED: Metal czar’s steep discounting to end as concerns recede; Main reasons for underperformance are -

Sterlite Industries India Ltd (SIIL) which provides diversified exposure to major base metals, silver and power and boasts of a promising future on the back of organic growth across assets has been trading at a big discount to its fair value during the last one year, thereby underperforming the benchmark Nifty by over 25%. The main reasons for this underperformance in our view has been i) VAL’s expansion and backward integration plans going for a toss due to government intervention and subsequent huge losses by VAL wiping out SIIL’s invested equity ii) delay in expansion project of BALCO and SEL and shortage of coal for running captive and merchant power plants and iii) pumping of excessive cash by SIIL into Vedanta owned VAL which has resulted into poor returns for SIIL shareholders and raised investor concerns.


Though we agree these concerns are valid, we also infer that the discounting done by the market for valuing SIIL stock has been more than pessimistic and does not capture the full value of zinc businesses nor does it account for the future volume growth across assets and future positive triggers. We have seen a smart upmove in the stock recently and believe that SIIL stock ‘s discount to its fair value has come to an end on account of i) better clarity from management on cash use through increased dividends ii) volume growth across assets and improving profitability ahead and iii) positive triggers from possible minority stake buyouts and starting of BALCO captive coal block.


With SIIL’s expansion pipeline across assets coming on-stream by FY13E, we expect sales volume CAGR of 7.4%, 45.3% and 9.7% across zinc & lead, silver and aluminium operations during FY11-14E. We expect net sales and EBITDA CAGR of ~12% and ~16% during FY11-14E. We initiate coverage on SIIL with a Buy rating and a SOTP target price of Rs 149.


■ Zinc: domestic – best in class, international – shows potential: Domestic zinc operations under HZL remain best in class with low cost, increase in volumes of lead and silver and robust balance sheet. We expect HZL to register EBITDA CAGR of ~11% during FY11-14E. International assets have stable operations and show potential for future with increasing exploration at Scorpion & Lisheen and from the proposed 400 ktpa new project at Gamsberg.


■ Aluminium: mixed bag with high costs and VAL: SIIL’s aluminium operations remain a mixed bag with high COP at BALCO and losses at VAL. With expansions in aluminium and power at BALCO in FY13E, we expect EBITDA CAGR of ~13% during FY11-14E. We see VAL retaining PAT losses on account of non-integration, high raw material costs and very high interest.


■ Power: lacks steam sans coal, but growth seen ahead: Power portfolio lacks steam without captive coal but volume growth is seen ahead despite challenges with expansions coming on-stream by FY13E and coal feed from linkage and e-auctions. We expect ~15.3bn units of power sales from BALCO and SEL in FY14E. Starting of captive coal block of BALCO would be the key trigger.


■ Positive triggers in store: We see the possibility of positive triggers for the stock from successful minority stake buyouts in BALCO and HZL and starting of captive coal block of BALCO going ahead.


■ Valuations – trading at discount, BUY: We see SIIL trading at a sharp discount to fair value. We see earnings growth ahead driven by volumes and value the stock on a SOTP basis giving no value to its investments in VAL. We initiate coverage on SIIL with a Buy rating and target price of Rs 149.


■ Key Risks: Lower sales volumes on project delays, drop in LME prices, higher losses in VAL and ineffective use of the cash pile.


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