Vedanta: Corporate governance concerns overshadows Q3 earnings

Jitendra Kumar Gupta Moneycontrol Research

Governance issues overshadowed an otherwise modest show from Vedanta. On an average, during the December quarter, international non-ferrous metal prices corrected around 6-21 percent compared to last year. While this could have a huge impact on its performance, the management’s efforts to ramp-up production across businesses and cost of production has started to yield better results.

Key positives

Barring the copper business, which suffered because of its stalled copper plant in Tamil Nadu, Vedanta saw strong traction in most segments such as aluminium, oil & gas, steel and iron ore.

For instance, in the case of aluminium, growth in production of both alumina (up 41 percent on a year-on-year basis) and aluminium (around 15 percent), pushed segment revenue by 18 percent.

Similarly, zinc business, which accounts for close to 25 percent of group sales and 51 percent of earnings before interest, tax, depreciation and amortisation (EBITDA) reported an 38 percent growth in production. Despite a 19 percent correction in international zinc prices during the quarter under review, the segment (zinc India) showed a mere six percent decline in revenue.

Some caution was also seen from the oil & gas segment, which constituted 14 percent of sales. The segment saw marginal improvement in production, but because of average realisations rising 23 percent to $65.1 a barrel in Q3 FY19 from the $53.3 a barrel in Q3 FY18, this business posted a strong 39 percent growth in revenue.

Key negatives Despite strong growth in major segments, group revenue fell 2.8 percent, which was largely on account of a drop in copper revenue as a result of a shutdown of its copper smelter in Tamil Nadu. The India copper business posted a 53 percent drop in revenue and reported negative EBITDA of Rs 75 crore during the quarter-ended December.

In the aluminium business, while the company saw decent volume growth, lower international price had an impact on profitability. Had the aluminium business not achieved the cost benefits of about $97 a tonne during Q3, EBITDA contribution would have been flat or negative.

Aluminium, which is 33 percent of its sales contributed a mere four percent to its EBITDA. But that was not alone, smaller segments such as iron ore and power too added to the company’s woes resulting in an 11 percent drop in consolidated EBITDA to Rs 5,953 crore.

Key observations The management is selectively undertaking capex as well as looking for inorganic opportunities. Its acquisition of Electrosteel Steel is on path to deliver 1.5 million tonne of annual production. During Q3, the steel business posted a 36 percent growth in sales to Rs 1,198 crore. EBITDA rose to Rs 249 crore as against Rs 69 crore in the corresponding quarter of last year.

The question that remains unanswered During Q3, the company invested about Rs 1,431 crore in acquiring an economic interest in Anglo American from Volcan Investments. While the management explained that this is merely a cash management exercise to earn better yield, the market’s fear stems from the fact that the Volcan Investments is a family trust of Vedanta Resources. The company is still sitting on cash and investments of close to Rs 30,000 crore, adjusting for that net debt stood at Rs 39,500 crore.

Outlook and valuation The management is hopeful that the ramp-up in production of most segments, particularly in oil & gas and zinc should continue to help. That apart, efforts to pare down cost, particularly in the aluminium business, should keep financials healthy even if the market dynamics change dramatically.

For a strong recovery or a reasonable growth, investors should closely watch the global non-ferrous metals cycle, particularly in light of talks about the global slowdown and the trade friction among major countries. At the current market price, valuation remains reasonable at 5.5 times its estimated FY20 enterprise value to EBITDA. However, its near term outlook may be clouded due to questionable use of cash and subdued global macro outlook.

Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here