Troika of issues to have a bearing on Vedanta's near-term earnings

Soft base metal prices, cost pressures and lower volumes in some segments present key challenges

Shares of Vedanta, which have underperformed leading indices over the past one year due to pressure on base metal prices, were among the top Sensex gainers on Monday. Analysts attribute the gains to the bounce in the metals pack as a whole, led by expectations that a trade agreement between the US and China could improve demand and, in turn, realisations for metals.

While sentiments may have improved, the outlook for non-ferrous players such as Vedanta, Hindalco still remains challenging, looking at the suppressed base metal prices on the London Metal Exchange (LME). Per-tonne aluminium prices, at slightly over $1,700, are much lower than $2,500-2,600 levels seen in April 2018 and over $2,100 levels in October 2018. At such low levels, most domestic aluminium players are not able to sustain their operating performance. For instance, led by higher power costs, Vedanta’s aluminium segment (its largest, contributing 30 per cent to consolidated revenues) saw operating loss widen during the September quarter (Q2) to Rs 575 crore from a loss of Rs 27 a year ago. Hindalco had also seen the profitability of its aluminium segment decline by 38 per cent year-on-year, even though it is an integrated player.

The next important contributor for Vedanta remains its Zinc India operations (including lead and silver production) represented by Hindustan Zinc, which contributes about a fifth to overall revenues. Zinc prices on the LME too remain subdued, down from $3,000 a tonne in May 2019 to around $2,300 a tonne now. The impact was visible in the September quarter with the segment’s profits down 18 per cent year-on-year. Analysts say that while the global zinc production deficit is likely to continue, inventories currently remain high and are putting pressure on prices. Also, the recovery in zinc will depend on the uptick in steel demand as the metal is predominantly used in making steel. Analysts at Prabhudas Lilladher say they don’t see zinc prices sustaining above $2,550 a tonne due to weaker demand and pick-up in supplies. Even as Hindustan Zinc remains committed to raising zinc output, there are temporary hiccups due to a fall in ore grades and geo-technical issues at its SK mine. Hence, Hindustan Zinc’s management had lowered guidance for mined metal/silver production by 5 per cent and 13-19 per cent for FY20, respectively.

For Vedanta, the copper segment already remains under pressure with continuing production disruption at its Tuticorin plant.

Among the few bright spots is Vedanta’s oil and gas division (earlier Cairn India), which contributes as much as copper (14-15 per cent of revenues) and continues to do well. However, crude oil prices remain range-bound and the segment’s volumes are not expected to see significant upside in FY20, which is likely to keep investors’ sentiment soft for now.

Overall, analysts say that despite its robust balance sheet with FY20 estimated debt-equity ratio at 0.9, they see challenges for Vedanta on the operating front as volume guidance for its key business segments has been lowered while costs remain high. Those at Motilal Oswal Securities had already cut their FY20 and FY21 EBITDA estimate by 10 per cent and 9 per cent, respectively, on the back of higher costs for the aluminium business. While the company expects the cost of production in aluminium business to reduce through higher captive bauxite and coal linkages, coal availability issues may weigh on costs over the near term, say analysts.