Hindalco + Sterlite + Sesa Goa – Revival Not Yet Visible

The aluminum and zinc prices may not be far off from their bottoms, but a pick up may be some time away. Medium-term earnings trajectories for stocks like Hindalco (UW), Nalco (EW), Sesa (EW), and Sterlite (EW) do not look that encouraging even though valuations look interesting, and balance sheets at Sterlite, Sesa, and Nalco are strong. Sterlite remains top pick in the space due to its multi dimensional growth story and strong balance sheet even though concerns about its restructuring plan and near-term earnings slump may cap the stock near term. On Hindalco, our concerns hover around Novelis profitability and its balance sheet.

Sterlite Industries:
Depressed metal prices and lack of near-term revival in demand should keep stock sentiment low, in our view. However, zinc division (contributed about 70% to Sterlite’s EBITDA in F2008) may be coming close to an earnings bottom as zinc prices seem unlikely to decline much from here. EPS expectations for FY09 is Rs 47 and for FY10 it is very likely to dip to Rs 37.

Compared to the previous down-cycle of F2000-03, we do not consider the valuations of the Indian nonferrous metals companies attractive. Hindalco may look attractive on P/BV valuation, but in the context of its sharply reduced ROE, the current P/BV looks on the higher side to us.

Due to expensive acquisition of Novelis, EPS will be subdued over the next 2 years. For FY09 it will be -Rs 2.4 and for FY10 it is expected to be -Rs 0.45. [Negative]

Aluminum and alumina prices remain subdued in the medium term. We expect a moderate recovery only in F2H10, spurred by some improvement in demand-supply balance.

Strong production growth of 16% in F2010e for alumina and 12% for aluminum, global cost leadership are the supporting factors for the stock. EPS for FY09 is expected to be Rs 19.7 and Rs 13.1 for FY10.

Sesa Goa:
Iron ore supply-demand dynamics are worsening as global steel production outages grow. We expect declines of 40% and 10% in contract ore prices for F2010 and F2011, respectively, capping the stock’s movement, especially for a pure commodity stock like Sesa. Also, spot ore prices may fall a further 20-25% after the contract settlement given the faster fall in ore demand than in supply in China.

Earnings for FY09 will be Rs 24 / share and for FY10 it is likely to be Rs 16 / share.

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