Vedanta Resources’ arm Sterlite Industries (India) Ltd may have bought miner Asarco Llc. from a US bankruptcy court, but that doesn’t mean it has bought a dud firm.
Asarco, formerly known as American Smelting and Refining Co., had earnings before interest, taxes, depreciation and amortization (Ebitda) of as much as $640 million (Rs2,701 crore today) on sales of $1.9 billion in the year till December, Sterlite told analysts in a conference call on Monday. The Ebitda margin of about 34% is not much lower than Sterlite’s consolidated margin of 38% for the year till March.
What’s more, Sterlite expects the payback period for its investment of $2.6 billion to be as low as four years.
This is based on the assumption that copper prices would be around $5,500 per tonne (the current spot price for copper is $8,100 a tonne on the London Metal Exchange), Asarco would be able to charge a premium of $300 per tonne for finished products, and its sales would be between 225,000 tonnes and 250,000 tonnes a year.
All this adds up to an Ebitda expectation of about $2,500 per tonne, slightly lower than the profit of $2,723 per tonne Asarco managed in 2007. But then, copper prices are assumed at much lower levels than where they were in 2007.
The US miner has been in trouble in the past primarily because of large claims related to environmental clean-up costs. Sterlite says it’s completely ring-fenced from these claims, but analysts have concerns clean-up costs related to ongoing operations may become an issue.
Based on Asarco’s strong cash flows, up to 50% of the acquisition price could be funded through non-recourse debt, in which the borrower is not personally liable. The rest is expected to come from the cash on Sterlite’s books, although the firm’s management also mentioned that the Vedanta group as a whole has $6 billion in cash. But, since Asarco will be owned entirely by Sterlite, it’s unlikely that other group entities will get involved in the funding.
Sterlite had raised $2 billion through an American depository receipt issue about a year ago. Much of this remains unutilized since its plan to acquire the residual stake of the government in Hindustan Zinc Ltd (HZL) and Bharat Aluminium Co. Ltd (Balco) hasn’t yet fructified.
An analyst with a foreign brokerage conjectures that the fact the acquisition has been routed through Sterlite is possibly an indication that the stake purchase in HZL and Balco may not happen anytime soon. The funds would instead be used to part-fund the Asarco buyout, he adds. If that’s the case, investors may be disappointed since the markets have priced in the upside from Sterlite’s options to buy out the government.
But, on the whole, the deal looks good for Sterlite, especially since Asarco is already quite profitable.
IIP or ABN Amro’s PMI? Readings at odds
At first glance, the ABN Amro Purchasing Managers’ Index (PMI), which is supposed to “provide an overall view of activity in the manufacturing sector”, shows manufacturing growth was strong last month. PMI for May was 57.4, only slightly below 57.5 notched up both in March and April.
A PMI reading of below 50 indicates manufacturing ec-onomy is generally declining; above 50 means manufacturing is expanding. A reading of 50 signals no change. The greater the divergence from 50, the greater the rate of change the index signals.
Manufacturing activity appears to be stabilizing at a high level, albeit not so high as the 61.9 reading reached in December. Nevertheless, the PMI number is well above the level it was a year ago. It was 53.4 in May 2007.
Does it mean manufacturing is now growing faster than a year ago? That’s very unlikely, if we take the manufacturing index from the Index of Industrial Production (IIP) as our guide. As the chart shows, this index has been going downhill last year, a conclusion reinforced by the 5.8% growth in the manufacturing component of GDP during the March quarter. However, the PMI index, which is seasonally adjusted, seems to say manufacturing activity built up steadily last year and peaked in December before coming down. It’s true that IIP is affected by the base effect and seasonal factors, but this broad divergence is difficult to reconcile.
Nevertheless, the May PMI shows a few trends that are clearly supported by other evidence. For instance, the “input prices” index jumped from 54.9 in April to 57.6 in May, and the “output prices” index moved up from 52.7 to 54.2, showing inflationary pressures are being passed on, which, in turn, means consumer demand is still strong.
It’s corroborated not only by the rising “output index”, but also by the rising “backlogs of work” index and the lower stock of finished goods. The seasonally adjusted “new orders index” registered 63.1, a level indicative of a significant increase in new orders that tallies with the rising order books at engineering firms, but tepid sales growth, showing difficulties in execution.
Incidentally, the CLSA China Purchasing Managers’ Index was at a four-year high in April, which is at odds with anecdotal reports of a slump in the Chinese economy. Note that the Indian index was higher than the Chinese one. It remains to be seen, however, whether the IIP data will show a similarly comforting trend.
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