The merger process of Sesa-Sterlite crossed another hurdle after the companies announced on Monday that shareholders had approved formation of the combined entity. Some nervousness existed, as the first restructuring exercise attempted by Vedanta in 2008 had failed, with objections raised by minority shareholders. The concern at that point of time was associated with valuations of the Konkola Copper Mines (KCM), not a part of the merged entity this time. Sesa Goa’s stock ended in the green at Rs 187.35, up 0.8 per cent. However, Sterlite’s stock, which rose initially, came under pressure during closing hours in line with the broader markets.
Meanwhile, though outlook for the iron ore business remains weak for Sesa Goa, analysts see the stock gaining due to valuations of the combined entity and gains from being present across diverse businesses —ferrous, non-ferrous, oil and gas. For Sterlite, while its current stock price shows the swap ratio is favourable, more important is that higher volumes on account of commissioning of new capacities will support its performance in FY13.
With the iron ore mining ban continuing in Karnataka and no respite yet, Sesa Goa continues to suffer as it has around six million tonnes per annum (MTPA) mining capacity in the state. Further, in Goa, where the company has a little more than 15 mtpa capacity, the logistic issues continue and Goa mining is also under a scanner. With prices also under pressure, the outlook for the iron ore business remains weak.
|SESA STERLITE VALUE
(incl Western Cluster)
|CAIRN India **
|Additional debt for Cairn
|Fair value for Sesa Sterlite
|Fair value for Sterlite
|*20% Holding company discount
** Being conservatively valued at CMP
Source: Emkay Research
Even the Sesa management, in the annual report, has shown only cautious optimism on the iron ore business, says Giriraj Daga at Nirmal Bang Institutional Equities. He, however, assigns a ‘buy’ rating to the stock, taking into consideration the combined entity’s valuation (a major portion of the valuation is driven by Cairn India and Hindustan Zinc), with a target price of Rs 230, slightly lower than his earlier target price of Rs 241. From Bloomberg data, of 41 analysts polled, 20 had ‘buy’ ratings, 14 had ‘hold’ and just seven had ‘sell’ ratings on the stock (consensus target price is Rs 213).
The swap ratio of 5:3 — for every five shares of Sterlite, shareholders will get three shares of Sesa Sterlite — makes the Sterlite stock, now at Rs 99, attractive (value of three shares of Sesa Goa at Rs 187.35 each are worth Rs 562). Sterlite Industries has reasonably good business prospects. The outlook for the copper business remains strong, as profitability depends on treatment and refining charges (TcRc). Copper contributed 46 per cent to revenue during the March quarter.
Zinc and lead segments, that contributed 37.7 per cent to revenues during the quarter, are the major profitable segment and contributed 59 per cent to the March quarter’s earnings before interest and tax.Though global prices have fallen, the outlook remains strong as zinc and lead mining capacity has been expanded by 10 per cent to 1.064 mtpa, which should help expand volumes of these metals. The 350-tonne per annum silver refinery, commissioned in the December 2011 quarter, will result in a three-fold rise in total capacity to 530 tonnes per annum and drive silver volumes in FY13.
The smaller aluminium segment that contributed eight per cent to gross revenues remains a cause of concern, looking at weak prices. Also, though Balco’s 1,200 Mw power plant is shortly to be commissioned, analysts remain concerned on coal supplies.
Overall, most analysts remain positive on the stock. Ravindra Deshpandey at Elara Capital says that at current levels, the stock is trading at attracting valuations. Analysts at Motilal Oswal Securities had arrived at a sum of the parts (SOTP) price target of Rs 143 in their report after the March quarter results. Bloomberg data also shows a consensus price target of Rs 129 for the stock.
The Vedanta group expects to complete the formation of the combined entity, Sesa Sterlite — comprising Sesa Goa, Sterlite Industries, Madras Aluminium, Sterlite Energy and Vedanta Aluminium, as well as its 38.8 per cent stake in Cairn India — by the end of calendar year 2012. The merger of VAL in the combined entity was being looked at with scepticism in February, at the time of announcement of the merger, since it brought a debt of $5.9 billion. However, its 38.8 per cent stake in Cairn India is also coming to Sesa Sterlite. Sesa Goa already had a 20.1 per cent stake in Cairn, which would give Sesa Sterlite a controlling stake of 58.9 per cent in Cairn and, hence, presence in a lucrative segment (crude oil).
Though Sesa Sterlite would end with total debt of $14 billion, Giriraj adds that all these concerns already remained factored in. The combined cash flows should also be sufficient to service this debt and bring it down in the longer run.
In terms of valuations, analysts at Motilal Oswal Securities had observed that the merged entity, Sesa-Sterlite, is trading at 4.6 times FY13 estimated EPS and at an enterprise value of 4.4 times FY13 estimated Ebitda (earnings before interest, taxes, depreciation and amortisation). While their SOTP value for Sesa-Sterlite stood at Rs 192, emkay analyst peg the value at Rs 207.