Sterlite Industries: Risk-reward turning favourable

After SC decision, analysts believe concern regarding its copper plant is now behind and valuations look attractive

Sterlite Industries received respite from a Supreme Court judgment on Tuesday, which saw its stock rise 3.8 per cent to Rs 93.1. Although the court fined the company Rs 100 crore for flouting environment laws, it has also over-ruled the earlier Madras High Court judgment directing closure of its Tuticorin-based copper smelter plant, which was acting as a major overhang for the stock. This plant produces about 300,000 tonnes of copper, which is equivalent to half of the country’s consumption; the copper business contributes about Rs 4,500 crore to top line and Rs 110 crore to profits of Sterlite.

“We believe the present order will remove the long standing plant closure overhang on Sterlite Industries, thereby ensuring long term stable operations at its copper smelter at Tuticorin, Tamil Nadu,” says Dewang Sanghavi, who is tracking the company at ICICI Securities, in a note. The order last weekend by the Tamil Nadu Pollution Control Board (TNPCB) to close the plant due to a gas leak has left analysts unperturbed, as they believe it is temporary in nature.

Going ahead, analysts believe the risk-reward equation is turning favourable even as the near-term outlook for the metals space is weak. That’s because the company’s business strength across segments it operates in remains largely intact while stock valuations are looking attractive. The merger with group firms namely, Sterlite Energy, Madras Aluminium, VAL and Sesa Goa will only lead to a stronger balance sheet.

Worries over poor outlook for non-ferrous metals and lower London Metal Exchange (LME) metal prices had increased fears of earnings downgrades recently, leading to a correction in the share price of Sterlite as well as stocks of other metal producers. Sterlite Industries, which operates in aluminium, copper and zinc segments, has seen its stock fall from Rs 99 levels in mid-March as LME non-ferrous metal prices fell six-eight per cent. However, despite this, the company, on a consolidated basis, is expected to report revenue growth of about seven per cent and net profit growth of 10 per cent in FY14. Importantly, over the next two years the volume growth will be the key growth driver. Analysts are expecting volumes in the zinc, lead, refined aluminium and power businesses to rise with the completion of Sterlite’s on-going expansions.

Additionally, if the buy-out of minority stake in Hindustan Zinc and Balco happens, it will be a positive trigger considering that the same will enhance the balance sheet strength. Hindustan Zinc is a zero debt company with cash and bank balance of about Rs 19,300 crore.

From the valuation perspective too, at current levels of Rs 90.50, it is at multi-year low levels. The PE multiple stands at 5.43 times, based on its historical earnings while the dividend yield is at 2.15 per cent. Even on the basis of EV/Ebitda (enterprise value to operating profits), the stock is trading at just 2.8 times based on FY14 estimated numbers, which again is a historical low and makes it one of the cheapest stocks in the metals space.  

Additionally, the value of Sterlite’s 64.9 per cent stake in Hindustan Zinc alone is worth Rs 60-65 a share. Analysts believe the stock is trading at a significant discount to its fair value and does not capture the full value of Sterlite’s power, aluminium, zinc and copper businesses.