Kotak Institutional Equities has reiterated its sell rating on diversified metals & mining company Vedanta Ltd, citing significant leverage concerns for the parent Vedanta Resources Ltd (VRL).
In a note on Tuesday, Kotak trimmed the fair value estimate for Vedanta to Rs 200 per share from Rs 215 earlier. The stock is trading at around Rs 247 at present.
The broker highlighted VRL’s high debt load and large impending bond maturities as overhangs for the stock.
Vedanta Resources Ltd is the London-listed holding company of Vedanta Ltd, India’s largest diversified natural resources company. It owns 50.1% of Vedanta Ltd and has stakes in businesses like Hindustan Zinc Ltd, Bharat Aluminium Company Ltd, Talwandi Sabo Power Ltd and Electrosteel Steels Ltd.
Vedanta Resources has total debt of around $11.5 billion as of FY22, up from $7.7 billion in FY20 after large increase in loans from Vedanta Ltd. It has been utilizing dividends and brand fee paid by the Indian listed subsidiary to service its debt obligations so far.
High leverage, large upcoming maturities and negative free cash flow at the parent level have emerged as key investor worries recently.
“Hefty dividends..shifted Vedanta Resources’ debt to Vedanta Ltd,” the broker added, pointing out the all the surplus cash of Hindustan Zinc has been given out as dividends.
As such, Vedanta Ltd itself has seen debt/EBITDA rise to 4.7x in FY24 from 2x in FY22.
According to Kotak, VRL has total debt repayments of $3.6 billion due in FY25, including $2.2 billion of bonds. This poses a funding gap of $3.1 billion, equivalent to 29% of Vedanta Ltd’s current market capitalization.
The parent holding company has addressed its FY24 repayment obligations through one-time measures like front-loaded dividends, brand fee payments and stake sales, it noted. However, refinancing the FY25 bonds could be challenging amid a weak global macro environment, it added.
This may eventually force VRL to divest more stake in Vedanta Ltd or sell some core assets like oil & gas or zinc India businesses. Kotak believes such options are probable as high leverage restricts Vedanta Ltd’s ability to pay large dividends going ahead.
Bleak Commodity Cycle
The report pointed out that zinc and aluminum contribute close to 60% of Vedanta’s earnings. But both face supply surpluses currently, exerting pressure on prices and margins.
Kotak forecasts 3% and 4% cuts to Vedanta’s consolidated EBITDA estimates for FY24 and FY25 respectively, factoring in lower London Metal Exchange aluminum prices. The brokerage’s FY24-26 EBITDA estimates are 13-14% below consensus forecasts.
Moreover, the company’s major expansion projects in aluminum and steel face delays, as only a small portion of budgeted capex has been incurred so far in FY23. This may push back volume growth assumptions.
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Despite the leverage overhang and muted earnings outlook, Vedanta stock has recovered around 15% from June lows and trades at 11.6x FY25E EPS.
Kotak believes this factors in an overly optimistic view on leverage and commodity prices. Given likely earnings downgrades ahead, it finds valuations expensive for a cyclical business with strained balance sheet.
The report maintains Vedanta should trade at 6-7x EV/EBITDA on normalized earnings, implying limited upside. Kotak has a sell recommendation with price target of Rs 200, around 17% downside versus current market price.
The metals & mining sector is facing headwinds currently from sliding commodity prices, weak demand outlook and sticky cost inflation. Within this environment, highly leveraged companies like Vedanta are more vulnerable to potential shocks or earnings downcycles.
