Vedanta: Hopes of commodity upcycle seem priced in

Mining and natural resources major Vedanta Limited (VEDL) has seen a surge in share price after a recent upgrade by CLSA. Indeed, the stock is up more than 30 per cent in the last month. The company has been hard to evaluate for a while because it is due for a complicated corporate restructuring into six separate companies and also the commodity cycle for industrial metals has been in a bearish trend.

Indeed, the consolidated business is estimated to see an 8-9 per cent year-on-year (Y-O-Y) decrease in the January-march quarter (Q4) Ebitda (about 0.7 per cent down quarter-on-quarter or Q-O-Q) due to low prices across most metals and also lower volumes in oil and gas business.

But, the CLSA upgrade is based on an assumption that the group can benefit as the commodity cycle bottoms out and moves into an upcycle. The company is also trying to move past its debt overhang, and increase capacity and profitability across segments through ongoing capex. It has guided that group Ebitda will rise from $5 billion to around $6 billion in FY25 and $7.5 billion by FY27, through capacity expansion, backward integration and value addition. Debt at parent Vedanta Resources (VRL) has also declined meaningfully, although leverage at VEDL has increased.

The group derives 38 per cent of its Ebitda from aluminium, 41 per cent from zinc and 14 per cent from oil. This makes it a diversified play on base metals. The capex could lead to margin expansion as well as revenue growth. VEDL is undertaking $6 billion of capex across all verticals, aiming to double capacities. It expects to have a payback of three years with yearly incremental revenue potential of $6 billion and Ebitda potential of $2.5-3 billion. The group will continue to deleverage and has a deleveraging target of $3 billion at VRL over the next three years.

The existing company will be split into Vedanta Aluminium, Vedanta Oil and Gas, Vedanta Power, Vedanta Steel and Ferrous Materials, Vedanta Base Metals and VEDL. The demerger into six independent companies will create independent capital structures and make it easier for investors to focus on specific segments and may also attract strategic investors.

Key Ebitda drivers include aluminium, which could deliver Ebitda of $3 billion by FY27 from $1.2 billion in FY24. This will be due to capacity expansion to 3 million tonnes (mt) from current 2.3 MT, and access to captive bauxite, alumina, and coal. The power Ebitda should rise to $0.5 billion by FY27 as capacity rises to 4.8GW through the commissioning of Meenakshi Athena, and the other base metals plays (Zinc International, plus Konkola plus India Copper) may see Ebitda rise 10 times by FY27 to $1 billion.

Over the past two fiscal years, parent VRL’S debt has reduced by $3.5 billion, but VEDL debt has increased by around $4.7 billion to $7.5 billion. It has guided for group debt (VEDL and VRL) to be at less than $10 billion within three years, implying debt reduction at VEDL as well. The VEDL Ebitda profile (or the aggregated Ebitda of the six demerged entities) will improve sharply as shown above. The demerger into six different entities is to be done by December 2024, and the transfer of the Konkola mine to VEDL will be another key corporate action. An upcycle in commodity prices is a crucial macro assumption. The management, in late February 2024, said that domestic demand continues to remain robust, driven by demand from manufacturing, automobile, construction, infrastructure, and energy. As the largest, most diversified natural resources company in India, VEDL will benefit most. While the stock is in a bull-grip, it may have also discounted much of the potential value-add with its sharp rise in the past month.