Sesa Sterlite: Hardening of zinc prices to benefit

Fair value of Sesa Sterlite might increase by Rs 9/share for each $100/tonne increase in zinc prices

The year 2014 proved a brutal one for the entire metals complex, as commodity prices collapsed across the board. However, the outlook for select metals such as zinc continues to be healthy. Investors have largely stayed away from metals as prices weakened and demand slowed across the board, but the change in certain industry dynamics and company-specific factors is resulting in some upgrades.

After the sharp fall in Sesa Sterlite, analysts are seeing a buying opportunity, as several positives  are not being priced in. Sesa Sterlite has been one of the biggest losers in the sector, with the stock falling by 29 per cent in three months, owing to headwinds faced by many of its projects, which are not in a steady state.

The first factor leading the change in view is the closure of large capacities globally and depletion of zinc reserves over the next couple of years. According to Kotak Institutional Equities, hardening zinc prices will benefit Sesa Sterlite’s 0.9-1 million tonne per annum (tpa) volumes,  though two of its own mines risk closure. The brokerage expects the existing global supply deficit to widen from 125,000 tpa in 2014 to 305,000 tpa in 2016.

“Our base-case zinc price assumption of $2,200/tonne, $2,250/tonne and $2,300/tonne for FY15, FY16 and FY17 has upside risks,” says the brokerage. Kotak says the fair value of Sesa Sterlite increases by Rs 9 a share for each $100-a-tonne increase in zinc prices.

The Street also expects the company to start sweating its aluminium asset. The $8.5-billion complex in Jharsuguda, Odisha, has been stuck largely due to a lack of captive alumina. While analysts say sourcing of captive alumina might not happen just yet, the 1.2-million tpa smelter might get commissioned through purchased alumina, if the economics works.

According to JPMorgan, Sesa Sterlite offers large a embedded option value, thanks to the potential for further corporate restructuring (via minority buyouts in key cash generating subsidiaries), which would drive re-rating. The potential volume growth across power and aluminium is another trigger, where utilisations remain less than 40 per cent.