Vedanta’s demerger fails to excite brokerages; Stock adds up 3%

Most brokerages have maintained their sell rating on Vedanta post the demerger announcement, barring CLSA, which has revised its rating upwards mainly due to the stock correction but reduced the target price due to capital structure uncertainty. The lack of clarity on debt profiles, reversal of past consolidation efforts, Vedanta’s funding gap, and lack of focus on core operations are some of the concerns of these brokerages.

An interesting take has been offered by Investec Securities, which sees the demerger as a strategic move that will eventually make it easier for the promoter to consider monetisation or delisting.

Also read: Vedanta’s merger-demerger merry-go-round

Here’s what the brokerages have to say:

CLSA:

CLSA has raised its rating for Vedanta from underperform to Outperform due to a significant stock correction observed over the past three months. However, the brokerage has also reduced its target price from Rs 255 to Rs 230. This decision was made based on a lower target multiple, which was influenced by the uncertainty surrounding the company's capital structure and allocation. According to the brokerage’s analysis, a crucial factor for a potential re-rating would be a shift in focus towards core operations.

According to CLSA, Vedanta has been adjusting its capital structure for approximately a decade, with the goal of simplification and value enhancement. It believes that this effort was also aimed at reducing leverage at the parent company, Vedanta Resources (VRL). From the brokerage’s perspective, this shift has diverted attention away from the core business and diminished investor interest. CLSA now believes that a cleaner holding structure and renewed focus on the core business will help VRL reduce its debt, as it would facilitate the sale of stakes in operational entities and streamline brand fee payments to VRL.

Also read: Vedanta gains 2%, brokerages have mixed views as demerger may ease debt load

Citi:

Citi has maintained its sell rating but changed the target price to Rs 225 from Rs 222. The brokerage reckons that Vedanta’s objective in pursuing these actions is to reduce the conglomerate discount and potentially facilitate a stake sale by the promoter. However, Citi has expressed uncertainty about whether these measures would lead to improved multiples, particularly in light of concerns about leverage at both Vedanta Resources and Vedanta. The management's lack of clarification on the debt breakdown has provided limited visibility into independent leverage ratios.

Kotak Institutional Equities:

Kotak Institutional Equities has maintained its ‘Sell’ rating for Vedanta with an unchanged Fair Value (FV) of Rs 200, primarily due to what it perceives to be an unfavourable risk-reward scenario, and the belief that the demerger alone might not bring about a significant unlocking of value.

The brokerage highlights that this demerger represents a reversal of Vedanta’s previous efforts, between 2012 and 2017, to consolidate stakes in different businesses, and contradicts the rationale behind those earlier corporate actions.

Additionally, Kotak Institutional Equities points out that VRL, the parent company, has been facing significant challenges due to its high leverage and a funding gap of $3 billion projected for FY2025. The report mentions “divestment of non-core businesses was deemed necessary to address these issues”. However, the brokerage, in its analysis, also noted that the demerger on its own might not necessarily unlock any value.

Kotak Institutional Equities emphasised that the reduced fungibility of cash flows and increased cash flow volatility associated with the demerger could pose challenges in obtaining lender approval, especially considering Vedanta's elevated debt levels.

Investec Securities:

Investec has retained its sell rating on Vedanta and maintained its target price of Rs 240 per share. The brokerage sees this as a strategic move because it eliminates the need for a majority of minority approval, facilitates debt allocation, and eventually makes it easier for the promoter to consider monetisation or delisting.

While there is a theoretical argument for expansion on multiple fronts through peer benchmarking, Investec points to potential risks in the new ventures, including inter-group restructuring, carbon-heavy assets, and potential cash-flow challenges. The brokerage has emphasised that it is critical to have clarity on the debt profiles and other financial aspects of the new entities before making a comprehensive assessment.